Poor commodities: An asset without a central bank backer

Commodity investors stung by the four-year bear market made one simple mistake: investing in an asset class not backed by a central bank.

Whereas equities and bonds have benefited from very meaningful support, direct and indirect, from central bank asset-purchase programs, commodities have not.

That may or may not be good policy; certainly you can argue that the current downdraft in commodities prices reflects a singular lack of inflation risk in the global economy. That might argue for more quantitative easing, but given that what we've had so far has neither generated much inflation or kindled demand for raw materials, it would be hard to be too sure that more central bank buying of financial assets would help commodities prices.

What the situation does underscore is the tremendous extent to which official policy, rather than performing analysis and bearing risks, makes or breaks investment strategy in the post-crisis world.

Commodities are in the midst of a four-year bear market that has only intensified in recent months. The Thomson Reuters/CoreCommodity CRB index, down 46 percent since April 2011, has fallen more than 30 percent in the past year alone.

The causes for the fall, are of course, complex. Not only have energy prices fallen sharply, in part due to weak demand, in part due to improved efficiency, and in part due to a strategic decision by crude producers to make life difficult for emerging producers of shale and other energy sources.

In addition, China's economy, which has been the dominant marginal buyer for most commodities for more than a decade, is both slowing rapidly and undergoing a historic shift away from investment and toward consumption, a change that implies less intensive demand for raw materials.

China has gone beyond this, stepping in to rescue its plunging equity market with an unparalleled ­intervention including financing lenders, which in turn lend money for stock purchases. And official policy in China has been calibrated to ease and support the transition to a more consumption-oriented economy, thus hastening the arguably inevitable dampening effect this has on commodities prices.

In this way, financial assets, as opposed to commodities, have simply been lucky in that they are one of the few levers central banks have left to attempt to kindle demand and inflation. None of this is to say that policy should have supported commodities prices, though it is superficially attractive to put money into the pockets of the less well off who produce commodities, as opposed to the better off who own securities.

At least in developed economies, the fall in commodities, especially energy prices, is a bit of a break for policymakers, putting money in the pockets of consumers who might spend more or pay down debt.

It may be too that central banks in supporting asset prices are fighting a battle they cannot ultimately win, both with inflation and with the very inflated expectations investors have about how much they should earn.

Investor William Bernstein has argued that as economies grow they naturally give rise to lower returns. Not only is there simply more capital, but technological innovation speeds up, making huge new investments obligatory. Society ends up wealthier but returns drop, though speculative bubbles tend to rise.

We all end up with much more of what we want, be it energy, steel or mobile phones, but outside small niches like Apple it becomes much harder to both pay for new investment and make good returns.

Much of this is self-reinforcing. So long as central banks see asset markets as useful tools for other ends the performance gap between financial assets and real ones may persist.