Fund managers cut commodity allocations as China demand doubts grow

Fund managers have cut commodities allocations to their lowest levels for three years in a shift that illustrates declining confidence in the outlook for Chinese demand for raw materials and fears that the global economy will enter recession.

Bank of America’s monthly global fund manager survey showed that a net 3 per cent of managers held an “underweight” position in commodities in May after canvassing the views of 247 institutional investors that together oversee $708bn of assets.

Investor sentiment towards commodities has weakened markedly, dropping 17 percentage points over the past two months, the steepest deterioration since August 2015, according to BofA.

Most major commodity prices, apart from gold, sugar and beef, have fallen over the past 12 months. The S&P Goldman Sachs Commodity total return index, the most widely followed commodities benchmark, has dropped 27 per cent since reaching a near eight-year high in June 2022

Francisco Blanch, BofA’s top commodity strategist, said commodity declines had been driven by a combination of rapid increases in US interest rates and the lenient economic sanctions imposed in response to Russia’s war in Ukraine which had allowed Moscow to minimise revenue losses from oil and gas exports.

“This combination of lax commodity sanctions on Russia and less money in the [global financial] system has contributed to a major commodity price pullback,” said Blanch.

Sentiment towards commodities has also been dented by evidence that the bounce in Chinese economic activity following the easing in November of coronavirus lockdown restrictions has fizzled out, with official purchasing managers surveys indicating that manufacturing activity shrank in both April and May.

“Growth is stalling in key China sectors, most notably the property sector,” said Duncan Wrigley, chief China economist at the consultancy Pantheon Macroeconomics.

Wrigley said he expected the Chinese government to introduce limited new measures to support economic growth but he cautioned that policymakers in Beijing remained wary of the risk of creating another debt hangover if they pursued another major stimulus programme on the same scale as the response to the 2007-08 global financial crisis.

Iron ore prices and some Chinese real estate stocks have rallied on expectations of a large property-related stimulus but Aakash Doshi, a senior commodities strategist at Citigroup in New York, cautioned that Beijing would aim “to prop up but not to pump up” domestic economic activity.

“Real Chinese commodities consumption appears weak for metals, energy, and grains, and is unlikely to rebound in the short-term,” he said. 

Ricardo Leiman, a commodity trading veteran who is now chief investment officer at KLI Asset Management, said a decline in investor activity, driven in part by the growth of algorithmic trading, had resulted in structural changes in commodity markets.

“The participation of investors has been severely reduced. If you look at the positioning in the market relative to open interest [active derivative contracts], then it is one of the lowest in the past 20 years,” said Leiman, a former chief executive of two commodity trading houses, Noble Group and Engelhart.