Dubai: Momentum chasing and lack of investor efforts in diversifying their portfolios amidst market turmoil have led to the big surge in investments in commodities and their prices, Lehman Brothers, a leading Wall Street Bank said in a special report on Saturday.
"We unsurprisingly find [low] dollar returns, weakness in equities, and higher inflation expectations to be important drivers of index inflows to commodities, consistent with a story of strategic diversification. But we also find a potentially alarming degree of past performance-chasing momentum," the report said.
During the past few years, commodities have attracted billions of dollars of investment from financial investors seeking exposure to its diversification and return properties.
"We estimate that roughly $98 billion of new financial inflows have entered commodity index funds since January 2006 alone. The concurrence of record high and volatile commodity prices and massive investment inflows on commodity exchanges has led to a politically charged debate about the causality between the two," said the Lehman report.
Many market watchers and politicians have taken the coincidence of high commodity prices and financial activity as prima facie evidence of the role of speculative activity in driving up prices, particularly for oil.
Counter argument
A counter argument to this is that prices driven above the fundamental equilibrium price by speculators would cause a market imbalance and excess supply, which must appear in inventory build.
According to analysts led by Edward Morse, Chief Energy Economist, the reality is more complex than either ideological extreme.
"We argue that while prices must reflect fundamentals in the long run, they can deviate considerably in the short run because of price inelasticity, informational imperfections, and behavioural herding," the report said.
To take the example of oil, supply and demand for oil are highly inelastic and difficult to measure precisely.
The extreme inelasticity of supply and demand causes violent price responses to small physical imbalances, making it difficult to formulate price expectations.
For oil, there are simply no credible data available for key aspects of the fundamental balance, such as the amount of Saudi Arabian spare capacity or the size of Chinese inventories.
"The shortage of information also leads market observers to focus inordinately on the handful of available signals, such as weekly changes in US inventories. Markets may interpret a sharp drop in US crude inventories as a bullish statement, lending more credence to theories of supply shortages and peak oil, even though the reality may be that global inventories are rising in places where we cannot measure them," the report said.
