Commodities bubble begins
It is a good time to be a commodities banker. Investment banks are queuing up to hire staff as they seek to meet greater demand for commodities products from investors and companies.
There are good reasons to believe the bull run has further to go but the days of easy returns, and easy revenues for banks, could be drawing to a close. Investment banks pumping money into commodities could be in for a nasty shock.
A survey published by the Centre for the Study of Financial Innovation shows worries about commodity prices have in the past year risen sharply up the list of big risks cited by bankers and regulators.
John Hitchins, UK banking leader at PwC, which sponsored the survey, said: "No bank will be prepared to say it is worried about the risk it has on its books, but if you talk to the industry as a whole, there is a definite fear that a big market correction could lead to widespread losses - and not just among speculators.
"The worry is there are banks out there that could get it badly wrong and will be caught holding more risk than they can handle, even if they have tried to hedge that exposure with derivatives."
Concerns are focused on the proprietary and principal trading activity of investment banks, which are notoriously opaque. The worry is that banks are chasing the trend and committing resources to commodities at the wrong time. Many are hiring staff to meet the demands of investors seeking exposure to the asset class and corporates looking to protect themselves against price risk.
Edouard Neviaski, deputy head of commodities trading at Société Générale, said the bank expected to increase its trading team to 200 from 140 by the end of the year. "There is a great deal of demand for good commodities trading staff with a number of banks re-entering the business and also with commodities hedge funds launching. There is a shortage of the right people," he said.
Société Générale has hired traders from rivals and corporates, including some of the big oil companies. In spite of the increased commitment to commodities, Société Générale remained wary of over-extending itself, Neviaski said. "We are careful to ensure we have the right number of people to sustain profitability, even if there is a correction."
David Burns, head of commodity markets at Commerzbank, has built a team from scratch this year. He had to persuade numerous internal departments of the strength of his business plan before he was given the go-ahead.
He said: "Investment banks have huge numbers of internal controls to stop them over-extending and they are not chasing a passing fad. People are talking about extending their commodities capabilities over the course of years, rather than months. There has been a spate of hiring recently but it is no truer of commodities now than credit five years ago.
"When you hear about masses of people being hired, you have to ask where they are coming from - it's not from thin air. Staff are being moved into commodities from other areas, such as equity derivatives or from the fixed income/currency side of the business. In other words, investment banks are allocating resources to market segments they think are going to grow."
Burns previously worked in equity derivatives at Commerzbank, a background he shares with Amine Belhadj at BNP Paribas, who this year was transferred from New York, where he was head of equities and derivatives for the Americas, to London to head the bank's commodity derivatives business. Belhadj said there was a big appetite for commodity exposure from investors familiar with structured products.
"I would not be surprised if the division generated revenue growth of more than 20% a year for several years to come," he said.
Belhadj believes recent converts to the asset class will not easily be turned off by a slump in commodity prices. He said: "Even if there is a change in the direction of the commodities markets, we will be left with high levels of volatility and a lack of correlation with other financial markets.
These are attributes that will ensure commodities continue to emerge as an asset class that provides a good hedge. If there is a correction in the market, it will have a short-term effect on the business. But overall interest in the asset class is driven by volatility, not direction, which will ensure there is continued interest no matter what happens to the market."
Diversification and the lack of correlation with other asset classes are cited by investment banks as a defence against suggestions they are over-committing to an overheated market. However, a recent study by Société Générale suggested commodities were in the middle of a speculative bubble and were, in fact, highly correlated to other asset classes.
Frédéric Lasserre, head of commodities research at Société Générale, said there was a speculative bubble in commodity prices but it was not incompatible with the asset class being in a supercycle that would see prices moving higher over the long term.
He said: "In a couple of years, we will look back and say this was a brief period in which the market was over optimistic about the prospects but that it was a blip in an overall upward trend.
"The issue of correlation is one of timing. Correlation with other asset classes is high at the moment but if you are a pension fund looking to make an allocation to commodities for 20 years, the chances that you will enjoy the benefit of the lack of correlation are high."
Timing is an important consideration for the banks that are committing greater resources to commodities.
Neviaski said: "There is no doubt that an increased commitment to commodities is sustainable for investment banks. The danger is for the newcomers and the banks that have reopened commodity desks.
"They have to start from scratch when people are hard to hire and expensive. It is these banks that are going to be most vulnerable if there is a market correction."