Mercer Warns Pensions about Commodities

In a press release, MercerIC explains that, while commodity prices rose significantly in the year ending March 31, 2006, the return on commodity futures was flat.   This was because the market has been (and is now) in ‘contango,’ where commodity futures prices are higher than current ‘spot prices.’ According to the release the typical situation where futures prices are lower than ‘spot prices’ is more likely to create positive ‘roll’ returns for pension funds with passive investments in commodities.

Andy Green, European Director of Investment Policy at Mercer, said in the press release that the increase in the number of investors purchasing commodity futures pushes prices up and could be one of the reasons why markets have fallen into contango.

If cash flows into commodity markets remain high, there is a risk that commodities futures will stay in contango, Mercer said. In April and May, the contango was a drag on the return of the GSCI, the main commodities index, at an annualized rate of over 10%.

According to Green, “On balance, demand for commodities is likely to remain strong, at least in the short term.   But, it is questionable how long prices of both oil and metals, which make up over half of the main commodities index, can persist before supply increases. The scope for disappointment is high for investors that passively track a commodity futures index. Given current market conditions, passive investment in commodity futures may not be as beneficial as investing directly in energy and mining shares or in actively managed strategies.”

The paper ‘Buying commodities?   You’ve been contangoed!’ is available at  www.merceric.com .