Hedge funds may be falling back in love with commodities

SHANGHAI (Bloomberg) -- Hedge funds are raising their exposure to commodities as prices rally and investors respond to macro shifts including the prospect of accelerating inflation under U.S. President Donald Trump, according to Citigroup Inc.

“After two years of scaling back exposure to commodities, the fund community finally appears to be growing interested in the sector again,” the bank’s analysts including Aakash Doshi and David Wilson wrote in an emailed note sent Feb. 27. They attributed record net-long positions, or bets that prices will rise, in markets including Comex copper and Nymex crude oil, at least partly to increased allocation of fund money.

“Higher inflation expectations, particularly on the back of President Trump’s election, have bolstered the case for commodities as an inflation hedge or a bullish inflation wager,” the Citigroup analysts wrote. Commodities are also more attractive as a way to diversify a portfolio after becoming less correlated with other assets, according to the bank.

The Bloomberg Commodity Index advanced 11% last year, its first annual increase since 2010, with Citigroup predicting further gains in 2017. Steady demand growth in China, as well as signs of an end to years of structural oversupply in key commodities, are improving the broad outlook for prices.

To be sure, the rush to go long on commodities may already have gone further than is justified by physical fundamentals, Citigroup said. On positioning in the Brent and WTI crude oil markets, “the math doesn’t quite add up” given prices are trapped in a tight range and there’s a consensus that U.S. shale output will cap prices, the bank said.

The latest net long position of 78,511 contracts for Comex copper on Feb. 21 “looks extremely stretched compared to historical positioning,” even after retreating from a record high on Jan. 31, the analysts wrote.