London, 2 July 2010

"To every thing there is a season, and a time to every purpose under heaven," according to the Book of Ecclesiastes. For most commodity futures, the first half of 2010 was a time to be short. Shorts were rewarded by a strong contango as well as spot prices that moved sideways or lower.

In contrast, longs paid a hefty price to roll their positions forward, and saw tepid if any price gains. Of 24 contracts included in the Standard and Poor's Goldman Sachs Commodity Index , 16 provided negative returns to long investors in the first six months of 2010, after roll returns, spot prices and interest payments on collateral are taken into account. The worst performer was sugar (where losses totalled 40 percent). Long investors in zinc (-32 percent), lead (-30 percent), natural gas (-22 percent) and corn (-20 percent) were also punished by the loss of a fifth or more of their invested capital.

WTI crude oil (-13 percent), Brent (-9 percent), copper (-12 percent), aluminium (-14 percent) and soybeans (-12 percent) were also big losers.

In contrast, there were just four star-performers managing to notch up double digit returns: silver (+10 percent), gold (+13 percent), feeder cattle (+14 percent) and coffee (+18 percent).

Because so many commodity futures contracts performed so badly, diversification did not help investors much in the first six months.

Investments in the benchmark GSCI index cost investors 11 percent of their capital during H1. Investors in the energy (-11.4 percent) did slightly worse than investors in non-energy futures (-10.8 percent) but the difference was marginal.

Inflation risks failed to materialise. Instead retail and institutional investors mostly subsidised producers, banks and merchants to build and carry high levels of inventories of everything from crude and heating oil to farm products.

Respected oil expert Philip Verleger has noted that interest from investors who want exposure to commodity prices but do not actually consume the raw material is financing higher levels of stock and giving the market a more comfortable buffer against unexpected supply and demand shocks. Investor interest is therefore helping damp volatility.

In return, investors get protection against an upsurge in inflation. Paying finance and storage costs in the meantime, via rolling futures contracts in a contango market, was likened to the premium for inflation insurance by the California State Teachers Retirement System (CalSTRS), which last month approved a small allocation to commodities starting next year.

Whether the insurance is worth it depends on a comparison between the eventual payout during an inflation upsurge and the amount of premiums paid in the interim. In H1 2010, that inflation insurance proved expensive.

Meanwhile, physical merchants and investors with short positions were rewarded handsomely.

Ends --

By John Kemp, Reuters market analyst - for Commodities Now.

The views expressed are his own.