Are investors set to flee “risk” assets? Maley

So-called “risk” assets, such as shares and commodities, were sold off heavily overnight, as investors worried about the damage that high commodity prices are inflicting on global growth, and fretted that the US central bank’s $600 billion bond buying program is drawing to a close.

Investors were also unnerved by a note from Goldman Sachs commodity strategists that warned that the “risk-reward” calculus was no longer propitious for the bank’s most profitable commodities trade – buying a basket of crude oil, copper, cotton, soyabean and platinum, and then waiting.

The bank – which is Wall Street’s leading commodity trader in terms of revenue – first proposed buying this basket, known as CCCP, last December. In just four months, it’s delivered investors a handsome 25.3% return.

But Goldman now sniffs a change in the wind. “Although we believe that on a 12-month horizon the CCCP basket still has upside potential, in the near term risk-reward no longer favours being long the basket and we are recommending closing the position,” it said.
 
Alarmed by Goldman’s cautious stance, investors sold off commodities across the board, from crude oil to wheat, cotton and metals.

Goldman also warned that with that there were signs that high prices were reducing the demand for commodities, especially oil.
 
“Not only are there now nascent signs of oil demand destruction in the US, but also record speculative length in the oil market, elections in Nigeria and a potential ceasefire in Libya that has begun to offset some of the upside risk owing to contagion, leaving price risk more neutral at current levels,” the bank said.

The bank also pointed out that copper and platinum prices faced “headwinds”, as high prices were curbing demand for the metals, at the same time as global supply chains have been disrupted in the wake of the disastrous Japanese earthquake and tsunami. Platinum, which is used for catalytic converters in car engines, is particularly exposed to disruptions in the global automobile industry.

At the same time, investors are increasingly worried that the US central bank’s $US600 billion bond buying program – dubbed QE2 is drawing to a close. Many fear that when the Federal Reserve stops buying government bonds, bond prices will fall, pushing bond yields higher.

They argue that the price of “risk” assets – such as shares, junk bonds, commodities and emerging market assets – have benefitted spectacularly from QE2. The whole aim of QE2, they point out, has been to artificially boost the price of US Treasuries, and to suppress their yields. As a result, investors who want to earn a satisfactory return on their investments have been forced out of “safe” havens such as US government bonds, and into riskier assets. This has pushed the price of “risk” assets higher, and in turn reduced the future returns that investors can expect from holding these assets.

But now they say we’re about to see this whole process turn around sharply. When the US central bank stops artificially suppressing bond yields, investors will have less incentive to buy riskier assets.

What’s more, the returns that investors are currently earning on these assets will start to look a lot less attractive once US bond yields start to rise.

As a result, they say, investors will likely soon start stampeding out of risk assets, which will cause the prices of “risk” assets to slump. Could last night’s action be the beginning of this flight from risk?

This article first appeared on Business Spectator