The commodities trading landscape has significantly changed since the financial crisis, to a large extent due to regulation (Dodd-Frank act, MIFID II) and to a lesser extent because of sharp price drops in oil and metals at the end of the China driven supercycle in 2011, which left institutional investors weary of commodities.
Large banks have closed or reduced proprietary desks, limiting the depth of the commodities futures and options market leaving more scope for price distortions. As a backdrop, this has created opportunities for smaller and niche players to exploit the price discrepancies created by these new market conditions.
Arion Investment Management, a London based commodities trading hedge fund focusing on base metals and founded by former Morgan Stanley executive, Gerardo Tarricone has stepped into this niche metals arbitrage space to take advantage of these distortions.
An example of this is LME/COMEX Copper Arbitrage; “We trade the differential between the LME copper and COMEX copper in New York. Although copper is always copper, and the two contracts have an extremely strong correlation, the basis between the two moves around a lot” says Darius Tabatabai, former global head of Precious and Base Metals at Bank of America Merrill Lynch and lead portfolio manager of the Raptor Commodities Fund.
Although a new comer in the space, Arion Investment Management has already caught the eye of investors and its strategy was shortlisted as finalist at the ABN AMRO’s Factor award in Amsterdam Investment Forum this March.
In the past a market maker would show a price that was not dissimilar in liquidity terms to the price that had been traded on previously, but now there is a tendency to move that price very quickly once it has been traded on. The net effect on the market is reduced short term liquidity which creates price distortions, particularly in options.
Goldman Sachs Group Inc, for decades Wall Street’s dominant commodities trader is more bullish on commodities than any time since the end of the super cycle in 2008. “The environment for investing in commodities is the best since 2004-2008,” they wrote in a recent research note.
According to Jonathan Goldberg, the founder of one of the world’s largest energy-focused hedge funds BBL Commodities in a recent Reuters article, the world will face a number of tectonic changes relating to commodities in the next few years that will be so big that they will allow the trading of entire countries based on them.
Looking at what is happening across other markets the investment case for commodities is becoming stronger, not only because prices are rising but also because other markets may have overheated. Either way, valuations for all asset classes are now front and centre as the free cash that flooded the market is withdrawn and investments made are no longer propped up by central banks around the world.