Commodities trading boom raises fear of big losses among retail investors

Growing numbers of retail investors are being drawn into commodity trading after two consecutive years of bumper returns, despite concerns that they could suffer huge losses or disrupt the complex and volatile markets.

Retail trading volumes in commodity futures and the largest commodity-focused investment funds surged in 2022. But while activity has been spurred by commodities’ much better recent record than that of stocks and bonds, some market participants and analysts have voiced fears about retail traders wading in to a highly volatile market dominated by specialised players.

Daily average trading volumes in CME’s micro contracts for gold, crude oil, silver and copper — which it uses as a proxy for retail activity — were up 93 per cent year on year as of the end of November.

Trading volumes in Invesco’s $6bn PDBC ETF — the largest broad-based commodities fund which is popular with retail investors — jumped more than 60 per cent and were almost three times as high as in 2020. Volumes across its broader suite of commodities funds climbed 50 per cent.

“We got everyone’s attention last year because people were nervous about inflation,” said Kathy Kriskey, commodities ETF strategist at Invesco. “And then after the invasion of Ukraine, that’s when people started focusing on geopolitical risk [too].”

The burst of trading activity came as the S&P GSCI index of raw materials prices jumped almost 9 per cent last year as the war in Ukraine restricted supplies, drawing a stark contrast to the more than $30tn in losses for equities and bonds.

Commodities have been the best-performing major asset class for each of the past two years, according to Bank of America, and were one of just two asset classes to make gains in 2022 alongside cash. Commodity-focused companies were also the only subsector of the US stock market to advance, with the S&P 500 energy sub-index advancing 54 per cent as of December 21.

However, while full-year returns have been strong, commodity trading remains risky, with markets liable to extreme swings that can catch retail investors off guard. In April 2020, for example, the main US oil contract traded below zero for the first time. Many retail traders and platforms had not considered the possibility of negative prices, and the retail brokerage IBKR lost $88mn covering margin calls for customers caught out by the price collapse.

Trabue Bland, senior vice-president for futures exchanges at Intercontinental Exchange, cautioned at a recent industry conference that “these are very sophisticated markets where you can lose . . . whatever you put up with your [broker] in a matter of minutes”.

Besides the risks for retail traders 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 for those prices. Building retail products around something that people are making multibillion decisions on . . . is not something you should do lightly. People don’t want to see betting on what is essentially their livelihoods,” he said.

Modern indices such as Invesco’s have updated their strategies to avoid some of the problems that afflicted early commodities funds, which sometimes lost money even when prices rose due to quirks in the pricing of futures contracts.

“We’ve made a huge effort to educate the investor base because . . . either people have never touched commodities and don’t understand them, or they knew them 10 years ago,” said Kriskey at Invesco.

She stressed that “you don’t need a lot for [commodities] to be impactful in your portfolio . . . we talk a lot about a 5 per cent exposure, we don’t want investors coming in and saying ‘I’m 15 per cent commodities’”.

Some companies have encouraged riskier bets. Hong Kong-based fund provider CSOP Asset Management announced late last year it would start offering retail traders leveraged exposure to an index of large oil and gas stocks. Leverage allows investors to multiply their potential gains, but can also quickly erase capital when share prices fall.

ProShares, one of the most popular tactical ETF providers with retail investors, operates eight funds giving leveraged exposure to commodity futures. Its leveraged short exposure natural gas ETF is down more than 93 per cent since the start of the year.

Michael Sapir, chief executive of ProShares, acknowledged that leveraged commodity trading could be risky but said retail investors deserved to have the same options available to institutional investors.

Exchange traded products offering inverse exposure to oil and gas have been hard hit, down almost 90 per cent since the start of the year as prices have risen because of the Ukraine war, according to Morningstar.

“Commodities can spike or crash without investors being prepared, more so than equities,” said Todd Rosenbluth, head of research at VettaFi. He said retail investors deserved to have the same options available to institutional investors. “But is it good for everyday investors to have exposure, and to have to manage the roll costs and volatility that come with commodities? That’s a fair question.”