The commodities 'Hokey Cokey'

As the latest round of banks and investment houses announce their retreat from commodities, it strikes me that we may have been here before. Some might be concerned that as well-known names like Barclays and JP Morgan withdraw from elements of their commodities business, this is an asset class with limited opportunities.

However, there is also a cyclical nature to these moves by the major banks and investment houses as well as specific issues each organisation is addressing. In addition, not all announcements are quite what they initially appear. As an example, despite JP Morgan initially being reported as exiting the commodities business in relation to selling their commodities operations (including the Henry Bath warehousing business) to Mercuria, it shortly afterwards transpired that JPM were merely re-focussing on "traditional" activities such as financing, hedging, trading warrants on the LME and vaulting of precious metals.

Barclays announced in 2008 that they were "very well positioned for the future and that the bank planned to 'scale up' in commodities, which was benefiting from "a compound annual growth rate in excess of 75%". So perhaps at some point in the future banks like Barclays will get back into the market.

There are two key underlying drivers which I believe will maintain, indeed requires, significant levels of activity in the commodities sector, even for the banks mentioned above:

The need for raw materials in the world economy and the associated financial activities which invariably accompany these activities (e.g. trade finance, commodity finance, hedging and speculative trading), and;

The increasing capital requirements as a result of being engaged in these activities.

I see the latter as especially pertinent, with Basel III coming up on the radar and the inevitable drive to increase capital and improve liquidity. Indeed, many commodities analysts believe that there is still plenty of untapped potential sources of additional capital in the commodities economy generally.

In terms of collateral, the opportunity to drive more value from both on-exchange and off-exchange physical assets could present itself in more innovative ways which we are yet to see. Indeed, firms which recognise the latent value in the physical economy may be poised to be the new leaders in this space.