Traders Falter in Worst First Half For Commodities Since 2010

By Stephanie Yang Features Dow Jones Newswires

Oil prices are having a tough year. So are some commodity traders.

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Major commodity players such as banks and hedge funds have stumbled, as low volatility and a faltering oil recovery derailed returns during the first half. The S&P GSCI commodity index slumped 10.2% in that period, the worst first-half performance since 2010.

Part of the troubles come from a lack of volatility this year that has made trading more challenging, traders said. Range-bound markets offer little opportunity for investors and traders to profit from major price moves and arbitrage divergences.

Low volatility also leads to less demand from clients who want to lock in prices or investors looking to bet on market trends, both major components of banks' commodities businesses. While commodity prices have rebounded slightly in July -- the S&P GSCI index is up 0.2% so far this month -- a snapback in price swings hasn't occurred.

Goldman Sachs Group Inc., historically a major commodity trader, reported its worst-ever quarter for commodities trading in its earnings report Tuesday. "Commodities is a story of challenges on all fronts," Chief Financial Officer R. Martin Chavez said on a conference call after the release. When trading revenue fell during the first quarter from a year earlier, the bank had also blamed trading in currencies, commodities and corporate bonds.

Bank revenue from commodities broadly has been on a decline. Global revenue from commodities at the 12 biggest investment banks totaled $4.3 billion in the 2016 fiscal year, down from a peak of $14.5 billion in 2008, according to research and analytics firm Coalition Development Ltd., which measures trading and financing revenue.

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Increased regulation has caused Wall Street banks to retreat in recent years from commodities, including activities in physical oil and gas.

An unexpected drop-off in oil prices this year has contributed to the malaise, after many banks and hedge funds had expected gains.

Veteran oil traders such as Pierre Andurand and Andrew Hall, both hedge-fund managers, lost money this year after betting that production cuts among members of the Organization of the Petroleum Exporting Countries would boost oil prices, The Wall Street Journal has reported.

According to S&P Dow Jones Indices, energy's performance has lagged behind the returns in other commodities by the most in 27 years. The S&P GSCI Energy Total Return index lost 18.8% in 2017 through June 30, marking the sector's worst start to the year since 1998.

"Overall, the trading market is a little bit tricky right now," said Marc Fontaine, an independent consultant and former head of commodity derivatives for the Americas at BNP Paribas. "There is a lot less volatility, and that makes it much more difficult not just for the Goldman Sachs's of the world but the large merchants like Mercuria to trade and to trade well."

Returns from commodity-trading advisers, funds that trade futures including commodity contracts often based on market trends, have also suffered this year. Société Générale's SG CTA Index, which tracks performance of the funds, is down 3.45% this year through June, the worst first-half return since 2011. While CTAs trade futures in all asset classes, some in the sector attribute losses to a lack of major moves in commodities.

"You get a market where you're bullish at the top and bearish at the bottom. And those are tough markets to trade," said Tai Wong, head of metals trading at BMO Capital Markets.

Among longer-term investors, the lackluster returns in oil and other commodities have damped enthusiasm. While typically volatile, net flows into commodities in the first half totaled $9.5 billion, an 86% drop from the first half of 2016 when net inflows totaled $69.8 billion, according to RBC Capital Markets.

"As we see the oil price continue to decline...we definitely see a lot of negative sentiment in commodities," said Darwei Kung, portfolio manager of the $2.7 billion Deutsche Enhanced Commodity Strategy Fund.

Hedge funds and other speculative investors have pared down their bullish bets on crude-oil futures after they reached a record high earlier this year.

Ebele Kemery, head of energy investing at J.P. Morgan Asset Management, said the drop in oil prices has prompted clients to focus more on holding commodities as an inflation hedge and a tool for diversification, rather than look for price gains.

Ms. Kemery also sees more opportunities in soft commodities and industrial metals, which may benefit from an improved macroeconomic outlook.

"What it has done is make our investors turn back to basics," she said.

Write to Stephanie Yang at stephanie.yang@wsj.com

(END) Dow Jones Newswires

July 19, 2017 08:14 ET (12:14 GMT)