Commodity funds bounced in the first quarter from a 2013 loss, with the top performers in the Lipper Global Commodity group racking up double-digit returns after rallies in agriculture, natural gas and nickel.
Supply disruptions provided opportunities across the asset class, but fund managers said only a few of these bullish fundamentals would persist into the second quarter and that some commodities are now over-valued.
The average actively managed fund in the Lipper Global Commodity sector gained 4 percent in the first quarter, compared with a loss of 9.98 percent in 2013.
"It got off to a strong start this year. Commodities outperformed equities for the first time in a while," said George Cheveley, co-manager of the UCITS-compliant Investec GSF Dynamic Commodities Fund, which was up almost 7 percent in the quarter. "When we looked at the outperformance for Q1, it came from all sectors."
Tighter supply and growing demand boosted commodity performance, attracting investor interest, Cheveley said. "World growth has accelerated. We are seeing improved consumption after a couple of years of lower prices for many commodities."
Benjamin Louvet, co-manager of the Prim Agriculture Fund , which came third in the Lipper league table, said investment flows came from those who saw 2014 as a year of recovery for commodities after the 2013 sell-off and from those who were rebalancing their portfolios.
Equities in developed markets made such large gains in 2013 that their overall weighting in investor portfolios increased, whilst the commodities weighting went down, he said. As a result, investors had to sell some equities and buy commodities if they wanted to get back to their original allocations.
It helped that supply fundamentals, particularly for agriculture, were working in the asset class's favour.
Lean hog prices spiked due to the deadly PED virus in the United States, while poor weather hit grain crops in the United States and the soybean crop in Brazil.
The S&P GSCI Agriculture index ended the quarter up 15.91 percent, the grains sub-sector index gained 16.12 percent, livestock was up 15.01 percent and soft commodities up 15.34 percent.
The Prim fund benefited from these rallies after the managers increased its overall exposure from 80 percent at the start of the year to 100 percent in mid-February.
Dry conditions in Brazil also affected coffee production , Cheveley said. The Investec fund's overweight to coffee helped drive outperformance in the first quarter, along with nickel, natural gas, platinum and palladium.
Indonesia's ban on nickel ore exports turned a big surplus market into a deficit market very quickly, Cheveley said. [ID:nL6N0N22AR ] "It's only in the last couple of months that people realised how serious they are."
A decision to stay overweight natural gas when others cashed out, thinking the severe U.S. winter weather was over, also paid off. "We had another cold snap, and it became clear that supply really had been disrupted quite badly," he said.
Going into the second quarter, some of these fundamentals are still in play, but others have run their course.
Louvet said he pared back his exposure to 60 percent at the end of March on expectations that some traders would begin profit-taking.
"There were good reasons for the market to go up, but unless there is another major weather event, we should see inventories replenished over the coming year," he said. "So we think the market is quite overvalued at this point."
He pointed to soybeans and soybean meal as exceptions and has raised his allocation for them. Louvet said it was unclear how soybean producers were going to meet their commitments with their current inventory levels.
Cheveley remained bullish on nickel, saying that price rises would encourage restocking. "If people think the price is going to be a bit higher tomorrow, they tend to order more today," he said.
He was also overweight platinum and palladium, which ran up in the last quarter due to strikes in South Africa. "We still think people are underestimating the disruption," he said, adding that even when the strikes are resolved, it will take a while for the mines to restart.
Managers are reluctant to hail first-quarter gains as the start of a sustained revival for the asset class. Louvet pointed out that base metals and energy, the two sectors directly linked to economic growth, were down or almost flat on the quarter.
"If you want to see some real interest from investors, we need those to really bounce," he said.
As long as there are concerns about a Chinese slowdown, there won't be a real pick-up in investor appetite, he said. "There has to be more confidence in economic growth for these commodities to go up."
(By Claire Milhench; Editing by Jane Baird)