Select Page

Bank of America Merrill Lynch proposed (Table 1) that the investment world is emerging from the post-2008 era with a lean six-pack, after its Banting diet (monetary stimulus ≈ high fat?), and that the bull is now poised to scale dizzying new heights.

This view was also endorsed by Jeffrey Currie, Head of Commodities Research at Goldman Sachs:mmm

“We are seeing a cyclical uptick in global economic activity, and that is driving demand… for all commodities. That is the core reason why we upgraded our outlook on commodities to ‘overweight’. It is not what is happening on the supply side, but rather what’s happening on the demand side… I want to emphasise our positive outlook on commodities is not driven by the supply cuts coming out of OPEC. In fact, we would argue that OPEC is simply taking advantage of where we are in the business cycle, and that is the first-order driver of higher commodity prices.”

After an eight-year bear market, in which the Bloomberg Commodity Index fell by 70% (Chart 1), it now appears poised to bullishly break upwards, similarly to the S&P 500, which consolidated during the whole of 2015 and most of 2016, before bullishly breaking upwards late in 2016 and now rising at an accelerating rate.


However, why is this? Are people buying because the fundamental supply/demand equation has turned bullish, or are they buying because other people are buying?

Alternatively, are we once again subject to George Soros’s Theory of Reflexivity (Table 2), in which observers in a system are;

  • subject to bias,
  • are participants in the system observed,
  • where their biases influence outcomes, and
  • the system itself is, therefore, subject to self-fulfilling boom & bust cycles?

Chart 2

There is indeed a degree of influence exerted by short-covering in commodities by the financial community, which has started to go long. Nonetheless, it is my opinion that the reflation trade is indeed now on. If this is so, it is of course extremely beneficial for commodities. Conventional inflation measures e.g. CPI consist of goods and services and the ‘goods’ are commodities.

Not only has demand improved, as per Jeff Currie’s comments overleaf, but there have also been significant disruptions to supply of some primary commodities. Unlike previous attempts, the agreement to reduce production by OPEC and friends has enjoyed record compliance this time. From Chile to Indonesia, the two largest copper mines in the world have ceased production for an indeterminate time due to wage negotiations and regulatory changes respectively.

Why is all of this relevant to investors?
Because, if the reflation trade is back on, commodities will play an increasingly important role in both goal-based and liability-matching portfolios.

….Including commodities in a portfolio reduces tracking error. If you don’t know what basis risk is, you should.

Look it up:



Basis risk is the financial risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. This imperfect correlation between the two investments creates the potential for excess gains or losses in a hedging strategy, thus adding risk to the position.

Offsetting vehicles are generally similar in structure to the investments being hedged, but they are still different enough to cause concern. For example, in the attempt to hedge against a two-year bond with the purchase of Treasury bill futures, there is a risk the Treasury bill and the bond will not fluctuate identically.

To quantify the amount of the basis risk, an investor simply needs to take the current market price of the asset being hedged and subtract the futures price of the contract. For example, if the price of oil is $55 per barrel and the future contract being used to hedge this position is priced at $54.98, the basis is $0.02. When large quantities of shares or contracts are involved in a trade, the total dollar amount, in gains or losses, from basis risk can have a significant impact.
[Source: Investopedia – February 2017]


Financial Banting?


MitonOptimal International Limited
Les Vardes House
La Charroterie
St Peter Port
GY1 1EL​
Channel Islands

Regulatory Information

MitonOptimal International Limited is registered in Guernsey (Registration No. 51561) and is the overlying holding company of the companies that make up the MitonOptimal Group.
Send this to a friend