Monday, July 07, 2008

Sure, Gas Prices Are High Now, But You Might Get It All Back When You Retire, Or Maybe Not?

1-Year Return: DJ Commodity Index vs. DJIA

WASHINGTON POST -- Soaring fuel prices that are burning a hole in the wallets of consumers are not only benefiting oil companies and Middle Eastern producers. They are also lighting up the investment returns of pensions funds, which millions of ordinary Americans are counting on for their retirement (see chart above that compares the +40% return over the last year for the Dow Jones Commodity Index to the -20% annual return for the Dow Jones stocks).

California's public employees' pension fund, the world's largest, made its first investment of $1.1 billion into oil and other commodities early last year, and since then, Calpers has seen it soar 68%. Fairfax County pension managers have enjoyed a 61% return from a similar move over the past 12 months, far outpacing any other segment of the fund's portfolio.

Other pension funds are rushing to get in on the action as the prices of oil, precious metals, corn, uranium and other vital goods continue to reach record highs. Montgomery County officials are in the process of shifting 5% of their $2.7 billion pension fund away from stocks and into commodities.

These funds are part of a tidal wave of investment dollars that has flooded commodity markets in recent years and, critics say, contributed to the run-up in prices.

Investors, including pension funds and Wall Street speculators, have sharply increased their commodity allocations since 2003, from $13 billion to $260 billion, making financial actors an even larger force on these markets than farmers, airlines, trucking firms and companies that buy and sell the physical goods to run their businesses.

For decades, trading commodity contracts was considered taboo by most pension funds because the market is so volatile and risky. Most fund managers relied on their stock and bond investments to enlarge their pools of retirement money.

That changed after the stock market crashed in 2001. Fund managers realized they needed more diversified portfolios that would perform well regardless of whether stocks did. At the same time, new financial products simplified trading by allowing big funds to buy into commodity indexes, which work like mutual funds, that were run by Wall Street firms.

MP: Sure, you're paying higher prices at the pump today, but you might get it all back when you retire, since record-high commodity prices might significantly boost the return on your retirement portfolio?

Well maybe not, see this Boston Globe story "Investors' Anxiety Builds as Retirement Nest Eggs Show Cracks."

HT: Ben Cunningham


At 7/07/2008 8:33 AM, Anonymous Anonymous said...

How does this information jive with the post showing flat futures volume? How are they getting this exposure? If commodities are a zero sum game, who are the sellers?

It seems like the increased allocation to commodities is a result of their negative correlation to the stock indexes – the fundamentals of the commodities themselves seem secondary. It will be interesting to see how these trades work out for them over time.

At 7/07/2008 8:35 AM, Blogger K T Cat said...

Do you believe that this is a bubble? It looks like another case of mass hysteria, just like the dot com bubble and the real estate bubble.

Massive pension funds all rushing to invest in one thing or another seems to be a cause of concern.

At 7/07/2008 9:04 AM, Blogger David Foster said...

"For decades, trading commodity contracts was considered taboo by most pension funds because the market is so volatile and risky"...on the other hand, nothing prevented these funds from investing in the stocks of commodity-producing companies. These are surely highly correlated with commodity would seem logical that their correlation with the non-commodities portion of the stock market would be relatively low.

I suspect that most of the funds only became interested in commodities *after* much of the run-up had already occurred.

At 7/07/2008 11:06 AM, Anonymous Anonymous said...

"I suspect that most of the funds only became interested in commodities *after* much of the run-up had already occurred."

If you look at the money weighted returns for technology mutual funds over the past decade they are a fraction of the time weighted returns suggesting that there was a good deal of buying late in the rally. No doubt this could be the case with commodities. That said, supply and demand factors support some increase in commodity price.

The equity markets don't seem like they are in a high return environment. Commodities is a 'save' place to park capital and can remain so for some time.

At 7/07/2008 4:45 PM, Blogger OBloodyHell said...

> "My portfolio lost $18,000 in the first quarter, and I just shrugged," Gonzalez said. "I don't fret about it. If it doesn't come back, then everyone's going to have some real problems."

Geez. $18,000 it probably gained in the last two years.

Paper gains are exactly worth what they are on -- paper. Anyone who thinks that they have an inherent "right" to whatever they have magically gained in a bull market is an idiot.


Notice where it was just back in 1995 (to say next-to-nothing of 1985). Now go off in the corner and whine like a pissy little bitch because it's down a whole 10%. Yeesh.

At 7/07/2008 5:13 PM, Anonymous Anonymous said...

Don,t worry this bubble is going to burst too, it's just a matter of when. No one is against the traditional speculation/an essential component of the liquidity of markets. We didn't have unregulated index/pension speculation before the "Enron/London loophole", commmodities modernization act 2000,this came before the stock crash of 2001.. before anyone can say this is just supply and demand-(zero sum game) - you need tranparency which we don't have anymore on the ICE intercontinental exchange. "The infamous December 2000 'Enron loophole' is the topic du jour in Congress. That legislation didn't just make it easier for savvy traders to buck the system. It exempted entire over-the-counter electronic exchanges (where trading takes place directly between parties, without an intermediary broker) from regulatory oversight by the Commodity Futures Trading Commission.

As a result, capital zoomed to new unregulated exchanges like Atlanta-based ICE, an American firm operating under U.K. regulation, where trading volume tripled from 2005 to 2008, representing 47.8% of global oil futures trading. And participants in the new electronic markets didn't even have to file "large trade reports" with the CFTC, obscuring trading details across the fastest growing exchanges. That's scary murkiness.

In addition, while the 1936 Commodity Futures Exchange Act once curtailed excessive speculation, the Enron loophole redefined who a speculator was, and more importantly, wasn't. If investment banks could claim they were "hedging" certain derivative trades, they could avoid speculation limits set by the exchanges altogether." Please read the whole article:

At 7/07/2008 7:55 PM, Blogger procol said...

There's a possibility that these funds will be the butt of the oldest joke on the street.

After running up a stock as the lone manic buyer, he calls to sell.

" Sell, Mr Jones, to whom?"


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