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ALTERNATIVE INVESTMENTS


“The clear separation between commodity beta and commodity alpha helps investors focus on what is most important to them”


CHART 5


The success of momentum strategies depends crucially on the degree of statistical persistency found in returns


t-statistics of previous month performance for DJ-UBS ER sub-indices Alum


Copper WTI


Heal oil Nickel


Gasoline Sugar


DJ-UBS ER Cattle Zinc Corn


Nat gas Soy oil Soybean Cotton Silver Wheat Hogs Gold


Coffee -4 -3 -2 -1 0 Last 10 years 1 2 Last 5 years Source: BofA Merrill Lynch Global Commodity Research 3 4 Statistically


insignificant at the 10% level


Among market participants, producers tend to hedge their long positions on the back end of the curve, often accepting a lower price than they would expect in order to secure the profitability of their investments. In contrast, consumers tend to hedge their short positions on the front end of the curve, often accepting to pay a premium for the physical ownership of the commodity. Finally, index hedgers provide systematic buying and selling pressure, selling the front-end contract and buying the second most nearby contract, more or less independently of the price level. Curve placement strategies benefit from this market segmentation by rolling long positions into contracts further out (facing the producers as they search to offload their natural long-price risk) while rolling short positions into contracts close to maturity (facing the buying pressure created by consumers and the index hedgers in the front end of the forward curve). Curve placement strategies can also take


CHART 6


Momentum can be used to select which commodities to go long to enhance beta exposure


Using the shape of the curve as a momentum signal in combination with other commodity alpha strategies


750 650 550 450 350 250 150 50


01 02 03 04 05 06 07 08 09 10 11


Monthly Outperformance of MLCXAKLE over DJUBS(rhs) Curve momentum+curve placement+seasonality(MLCXAKLE) Curve placement+seasonality(MLCXLDAE) DJUBS ER


Source: BofA Merrill Lynch Global Commodity Research 70 FAMILY OFFICE: ASIA TOMORROW


8% 6% 4% 2% 0% -2% -4% -6%


advantage of seasonality in commodity production and prices. Because of seasonality in production, certain commodities tend to come into the market at a very specific time of the year. For example, corn tends to be harvested in the northern hemisphere between August and November. Inventories reach their lowest point in Q3 just when the corn harvest starts. Hence there is seasonality in the cost of storage. There is also seasonality in the hedging needs of consumers and producers. Corn producers have to decide how much to invest in seeds, fertilizers and other production inputs during the planting and growing seasons. In order to fix their margins, they increase their hedging demand during the planting season and decrease it during the harvest season. In particular, producers start closing down their short corn futures positions on the September contract (when harvest starts coming in) during the months of June, July and August, exerting some buying pressure on the September contract during those months. Similar patterns can be found in a variety of


commodity markets such as livestock, refined products, natural gas, grains, sugar and coffee that exhibit strong seasonal behavior. Seasonality can then be used to enhance the risk-return profile of curve placement strategies by leveraging on the seasonal patterns of contract liquidity and market segmentation.


Momentum strategies These can be used by commodity investors as a source of alpha in many different ways. Momentum alpha is the reward for taking price risk from market participants ahead of the market, using the fact that commodity prices and inventories follow persistent fundamental economic trends. In particular, roll returns are closely linked to inventory cycles. Given that changes in inventories are the differences between supply and demand, momentum in commodities is ultimately the result of persistence in the levels of


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