Technical University Munich Commodities as an Asset Class - risklab

1 Introduction
Investing in financial assets was for a long time an exclusive and covered business
which was reserved to institutional and selected wealthy investors. The introduction
of the internet and direct brokerage made transaction costs falling and hence
investment became available to the broad public. While the investment volume in
stock and bond markets grew steadily in America over the last 20 and in Europe
over the last 10 years,, commodities did not play a major role in financial investment
owing their low prices and in-transparency. But the situation has changed over the
past 5 years. Industry has grown to close to 9 billion traded contracts in 2005. 1
Due to low performance of stocks and bonds, the time period from 2000 to 2003
boosted the growth of financial commodity markets in particular. The total amount
of traded contracts has nearly tripled during this time. There are two dimensions
which foster the development: hedging and investing. The former is mainly driven
by structural changes in the global economy and the remarkable demand during the
1980s and 1990s: Certain industries lowered their resource intensity noticeably or
became more efficient. This applies for instance to the automobile industry which
has steadily reduced the proportion of metal in their cars. Something similar can
also be noted for farm outputs which could be increased considerably by means of
technological improvements. For this reason, producing commodities became a less
attractive and low profit business. This development led, however, to a decrease in
production and falling inventories. After the collapse of the communist system, approximately
three billion people, accounting for almost 70% of world’s population,
entered into global trade. Their cheap labor costs attracted low educational work of
the producing business or IT-services of international acting companies. This way
of proceeding boosted their economic growth and hence the need for more energy,
new infrastructure, diversified food and thus, for commodities. Caused by the recession
in the commodity producing industry during the 1980s, the business was not
prepared for the sudden demand and prices went through the roof. This forced companies
to focus on commodity price risk management what fuelled the demand for
financial risk hedging products. On the other hand, the low performance of stocks
and bonds between 2000 and 2003 moved investors to look around for new, more
attractive return sources. Rising prices of commodities since 2001, have stimulated
their interest and thereupon, the demand for products to enable investment in this
market.
On the following pages, we introduce commodity markets from the investment’s
1 See Futures Industry Magazine Jan/Feb 2006, Figure includes contracts on financial assets.
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