Commodity Watch: A new way to get your chocolate fix?

<div class="grid grid--33-66-col"><div class="col"><img loading="lazy" data-fr-image-pasted="true" src="/getContentAsset/e4db1c4c-2687-44cd-adbd-db1eb849e5d2/cb87803a-320c-480f-ab75-7b9029eaaf79/Ahmad-Al-Sati-new.jpg?language=en" alt="Ahmad Al Sati" title="Ahmad Al Sati" class="fr-fic fr-dii" style="width: 180px"></div><span style="font-size: 12px"><div class="col"><strong>AHMAD AL-SATI<br></strong>PORTFOLIO MANAGER<br><br><p>Ahmad is the President and Portfolio Manager for Gemcorp Capital Advisors LLC, based in New York.&nbsp;<br><br>Ahmad has spent most of his career in the global credit markets. Prior to Gemcorp, Ahmad was President of Pandion Mine Finance and RiverMet Resource Capital, LP - a fund focused on investing in precious metals, where he was responsible for managing the investments and the day-to-day operations of the registered investment adviser.&nbsp;</p></div></span></div><hr><p>Commodity directional bets are not for the faint of heart. Just this week, Bloomberg reported that an established hedge fund lost over 50% of its assets under management this year betting on the cocoa market even as supply shortages persisted and demand for the main ingredient of chocolate remained inelastic.</p><p>The financialization of the commodities futures market that began 20 years ago continues to negatively impact commodities as an asset class. Numerous studies before 2004 argued that incorporating commodities into a portfolio enhanced return, hedged against inflation and provided general diversification benefits. Most of those studies, however, relied on data prior to the influx of speculative capital into the futures markets. Historically, commodity futures were used by farmers, miners and oil producers to hedge their inputs and products. That changed in the 1990s when hedge funds and index providers flooded the market. According to the CFTC (Commodity Futures Trading Commission), the non-commercial hedgers’ (speculators) share of open interest went up from 15% in 1990 to 42% in 2012. After remaining steady for over a decade, the open interest in agricultural products, for example, tripled between 2003 and 2008. Today, the nominal value of the commodities futures market is ~$60trillion.</p><p>The influx of capital from speculators fundamentally changed the nature of the market. Price discovery for each commodity based on supply and demand took a back seat to overall market sentiment and the risk appetites of investors. A 2023 study found that indexed commodities are more correlated to financial markets (and to each other) than are unindexed commodities. At the same time, commodity futures market returns became more correlated to US stock indices and financial markets. Correlation with US stock markets went from -0.026 before 2004 to 0.350 today. Commodities’ futures also developed a negative correlation to the VIX and, interestingly, to the US dollar despite having an almost zero correlation to the VIX pre-2004. Risk-off sentiment in other financial markets is now bleeding into the commodities markets and decoupling them from the fundamental supply-demand dynamics of each commodity. Commodities became another financial asset.</p><p>Commodities remain a large asset class that permeates every aspect of our lives (food, energy and infrastructure). The demand for capital across commodities is immense. But a better mousetrap is needed. In cocoa, for example, farmers, suppliers and traders still require capital to protect their farms, expand production and manage trade (regardless of the futures markets). Lending across that supply chain may not produce eye-popping returns, but it is closer to the actual hard assets than futures and indices. It also allows investors to generate consistent, reliable cash flows secured by those hard assets. In an era of increased geopolitical and economic uncertainty, a consistent stable source of return should benefit many a portfolio.</p>