Oil trade’s winners now reap the wrath

Investing in commodities has been a brilliant move in this decade -- so brilliant that the strategy has attracted untold numbers of large and small players, particularly in the last few years.

What do you suppose all of their buying has done to the price of oil? Pushed it down?

With crude surging above $130 a barrel this week for the first time, a long-simmering issue is threatening to boil over: the role these new investors, often derided as rank speculators, have had in stoking the prices of oil and other commodities.

Their standard line has been, “It’s not our fault.” They point to rising demand for raw materials in China and other developing nations and to tight supplies as the main drivers of prices.


But at a Senate hearing Tuesday, a hedge fund manager named Michael Masters offered a different viewpoint.

He branded institutional investors such as pension funds as “one of if not the primary factors affecting commodities prices today.”

Assets devoted to commodity-index investing, Masters noted, have mushroomed to $260 billion from $13 billion in 2003. It can’t be a coincidence, he said, that the prices of the 25 commodities that make up key market indexes have rocketed by an average of 183% in the same period.

Without mentioning them by name, Masters was criticizing pension funds like the California Public Employees’ Retirement System, which invested $450 million in a commodity index fund in March 2007 as part of a diversification strategy.


It was a good move for CalPERS -- though maybe not for the poor schlub trying to fill his gas tank these days and have money left over to put food on the table.

Index-fund investors don’t buy physical commodities. They trade in futures contracts, which are agreements to buy or sell a specific amount of a commodity at a set price by a specific date. Futures, then, are benchmarks for prices across commodities markets.

An oil refiner may use futures to lock up a quantity of oil for delivery at a later date. A farmer may use them to guarantee a price for his crop.

But an index fund investor, Masters noted, is interested in only one thing: riding a price trend by trading in contracts.


The motivation is the same for one of the most popular commodity-related mutual funds available to individuals -- Newport Beach-based Pimco Commodity Real Return. The $14-billion-asset fund, which has rewarded its shareholders with a 24% gain this year, invests in complex securities designed to replicate the performance of a Dow Jones commodity index.

So investors in the fund aren’t financing new oil wells that could boost global crude supplies. They aren’t putting up money for a new copper mine in Zaire. They’re just reaping whatever price gains can be had in commodity markets.

And, as Masters noted, success in commodity-fund investing feeds on itself. Investors’ interest in the funds “increases the more prices increase.” To put it another way, he said, investors’ “profit-motivated demand for futures” is the opposite of what you would expect from consumers, who tend to buy less of something as it gets more costly.

Masters, who said he didn’t trade commodities, said he agreed to appear at the hearing of the Homeland Security and Governmental Affairs Committee “as a concerned citizen.” The focus of the event, called by Sen. Joe Lieberman (I-Conn.), was the effect of speculation on commodity prices.


It wasn’t one-sided. Masters was rebutted by Jeffrey Harris, chief economist for the Commodity Futures Trading Commission, which regulates commodity markets. Harris contended that “the economic data show that overall commodity price levels . . . are being driven by powerful fundamental economic forces and the laws of supply and demand,” not by speculation.

Certainly, big investors make convenient whipping boys. It’s easier for politicians to attack them than to remind Americans how incredibly wasteful they are about energy. Imagine a Senate hearing called to excoriate recent buyers of mega-SUVs. Not going to happen.

And if this still is a free country, as SUV buyers might testify, why shouldn’t investors have the right to put their money into commodity funds?

When I asked CalPERS how it would defend its commodity investments in light of what has happened to prices and the pain those costs are inflicting on ordinary people, a spokesman noted that the goal of the 2-year-old program was to diversify the fund’s $242-billion portfolio and hedge against inflation, thereby helping to protect benefits for state retirees.


“Ours was a long-term investment plan for the coming natural-resources-constrained decades that was developed well before the recent jump in commodities pricing.” Well, OK then.

If the commodity surge has become a bubble, as many Wall Street pros believe, it will end the way all bubbles end -- with a crash that will humble those who came late to the party. There’s probably no need for politicians to get involved.

But a hands-off approach may be impossible if oil keeps climbing in the near term, exacting a heavier toll on struggling consumers.

As for investors who have turned to commodities for diversification, consider this: If their buying helps drive oil prices high enough to trigger a deep recession, the devastation in the stock portions of their portfolios could far exceed the gains they rack up in commodities. There’s an irony waiting to happen.