More and more retail investors are being drawn into commodities trading after two consecutive years of record returns, despite fears they could face huge losses or disrupt the complex and volatile markets.
Trading volume in retail commodity futures and the largest commodity-focused mutual funds increased sharply in 2022. But while activity has been buoyed by commodities’ much better recent performance than stocks and bonds, some market participants and analysts have expressed fears that retail traders may be wading into a highly volatile market dominated by specialist players.
Daily average trading volume in CME’s micro-contracts for gold, crude oil, silver and copper — which it uses as a proxy for retail activity — was up 93 percent year-on-year at the end of November.
Trading volume of Invesco’s $6 billion PDBC ETF — the largest broad-based commodities fund popular with retail investors — rose more than 60 percent and was nearly three times what it was in 2020. Volumes across the broader range of Commodity funds rose 50 percent.
“Last year we got everyone’s attention because people were nervous about inflation,” said Kathy Kriskey, commodity ETF strategist at Invesco. “And then, after the invasion of Ukraine, people started focusing on geopolitical risks [too].”
The burst of trading activity came as the S&P GSCI commodity price index rose nearly 9 percent last year as the war in Ukraine curtailed supplies, in stark contrast to more than $30 trillion in losses in stocks and bonds formed.
Commodities have been the top-performing major asset class in each of the past two years, according to Bank of America, and were one of only two asset classes, along with cash, to post gains in 2022. Commodity-related companies were also the only sub-sector of the US stock market to gain, with the energy sub-index S&P 500 gaining 54 percent on December 21.
Although full year returns have been strong, commodities trading remains risky as markets experience extreme volatility that can surprise retail investors. In April 2020, for example, the main US oil contract traded below zero for the first time. Many retailers and platforms had failed to consider the possibility of negative prices, and retail brokerage firm IBKR lost $88 million to cover margin calls for customers hit by the price drop.
Trabue Bland, Intercontinental Exchange’s senior vice president of futures exchanges, warned at a recent industry conference that “these are very challenging markets to lose in. . . whatever you endure with yours [broker] a matter of minutes”.
Aside from the risks to the retailers themselves, Bland said he was also concerned about the impact they could have on other market participants, from airlines to farmers.
“People rely on us at these prices. Building retail products around something people make billion-dollar decisions about. . . is not something you should do lightly. People don’t want to see betting geared towards what is essentially their livelihood,” he said.
Modern indices like Invesco’s have updated their strategies to avoid some of the problems that beset early commodity funds, which sometimes lost money even when prices rose due to quirks in futures contract pricing.
“We’ve gone to great lengths to educate the investor base because . . . People either have never touched commodities and don’t understand them, or they knew them 10 years ago,” said Invesco’s Kriskey.
She emphasized: “You don’t need much for it [commodities] to be effective in your portfolio. . . We talk a lot about 5 percent exposure, we don’t want investors to come and say, “I’m 15 percent commodities.”
Some companies have encouraged riskier bets. Hong Kong-based fund provider CSOP Asset Management announced late last year that it would begin offering leveraged exposure to an index of major oil and gas stocks to retail traders. Leverage allows investors to multiply their potential gains, but can also quickly wipe out capital when stock prices fall.
One of the most popular tactical ETF providers among retail investors, ProShares operates eight funds that offer leveraged exposure to commodity futures. Its leveraged short exposure natural gas ETF is down more than 93 percent year-to-date.
Michael Sapir, Chief Executive of ProShares, acknowledged that trading leveraged commodities could be risky, but said retail investors deserve to have the same options available to institutional investors.
Exchange-traded products, which offer inverse exposure to oil and gas, have fallen nearly 90 percent since the beginning of the year, according to Morningstar, as prices have risen on the back of the Ukraine war.
“Commodities can go up or down without investors being prepared, more so than stocks,” said Todd Rosenbluth, research director at VettaFi. He said retail investors deserve to have the same options available to institutional investors. “But is it good for regular investors to have exposure and have to manage the rolling costs and volatility that come with commodities? That is a valid question.”