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Commodities Slump Prompts Investors to Rethink

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Investors are reassessing commodities after sharp price falls and years of poor returns, but traders say the long-term outlook is still promising for those with specialized expertise.

Global demand for raw materials will continue to increase as the populations of China and other emerging economies consume more, offering support for prices and creating local shortages and price imbalances that can provide attractive margins.

But those margins will be best captured by professionals in the big trading houses and specialists in investment banks or funds, rather than through passive investment funds that just track indexes.

"Some investors have been looking again at the markets in the last six months," Ian Taylor, president and chief executive of the Vitol group, said on the sidelines of an FT commodities conference in Switzerland.

"There is a realignment going on in the attitude to markets," Taylor said.

(Read More: Cramer: The Gold Market Is 'Frozen')

Price falls have already taken their toll on some managers of commodities investment funds, he said. "We have already seen some funds going out of business."

Gold fell to two-year lows on Tuesday, while oil slumped to its lowest for nine months as disappointing data from China and the United States fueled worries about demand.

(Read More: Why Some Gold Bugs Are Still Hanging On)

Commodities indexes have underperformed other financial markets for several years, curbing enthusiasm for purchases of raw materials such as oil, metals and agricultural products.

Passive investors have been badly burned as total returns on the two big commodity indexes—Standard and Poor's Goldman Sachs Commodity Index and Dow Jones-UBS Commodity Index—both have shown losses of around 4 percent this year, while the S&P 500 equity index has risen 12 percent.

'Rethink' Passive Investments

On top of outright falls, the structure of many commodities markets has hurt passive investors.

If nearby months in futures markets trade at a discount to later months, investors at the front of the price curve have to pay to roll their investments forward when front months expire.

Over the last decade many financial institutions have set up funds that track movements in commodity indexes, saying these would offer investors a hedge against inflation and a chance to diversify risk away from equities and bond markets.

This view is now under heavy scrutiny.

"We see some revisiting of that rationale," said David Fyfe, head of market research at trading house Gunvor SA. "Arguments for portfolio diversification may have diminished. Investors are certainly rethinking the passive side of the business."

Vitol's Taylor agreed: "The argument for buying commodities as a hedge against inflation or for diversification are not as strong now."

But some of the underlying arguments for commodities remain intact as global population growth powers consumption and underpins a long-term growth in prices, traders say.

"Chinese economic growth is slowing down, but they will definitely stay on a growth path, and that is not going to stop," said Marco Dunand, chief executive of Mercuria, one of the world top five energy traders.

Alberto Weisser, chief executive of food trader Bunge Ltd., agreed: "Agricultural products demand is growing all the time."

Rising demand for food, fuel and the raw materials to build homes and infrastructure will create shortages in some areas that will need to be filled by surpluses elsewhere—price imbalances that offer profits for traders and other investors.

So the onus is on skillful active management of assets.

"The skill that matters today is in the analysis, interpretation and the insight derived from (an) openly available mountain of knowledge," Greg Page, chief executive of agricultural trading giant Cargill, told the conference.

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