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Fri 16 Jul 2010 04:14 PM

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Oil markets and those who trade them

Arabian Business looks at some of the main buyers and sellers of oil, as well as of other commodities.

Oil markets and those who trade them
Oil has traded a narrow range since the start of this year, stabilising after a sharp recovery from the crash that followed a more than six-year bull run, ended with the record highs of mid-2008.

The historic bull run coincided with the arrival of new types of investors and traders that made oil more like other financial markets.

The market's traditional participants include oil companies and airlines, who use futures contracts and derivatives mainly for hedging exposure to physical oil. (Bloomberg Images)

(Text on all slides: Reuters)
Oil markets and those who trade them
All participants have grown increasingly sophisticated, moving from passive to active and to various types of structured products that can generate returns unrelated to price direction and market structure.

The following are outline details of the main buyers and sellers of oil, as well as of other commodities, and some of the ways they gain exposure: (Getty Images)
Oil markets and those who trade them
PENSION FUNDS STILL ARRIVING

As raw materials gained popularity as portfolio diversifiers, some of the pension funds, the most naturally cautious investors, devoted up to five percent of their portfolios to the asset class.

Equities still form the bulk of investment portfolios, but the balance has shifted as fund managers have increased their exposure to emerging markets, fixed income and alternatives, which notably include real estate as well as commodities.

Fund managers say investment is still flowing into commodities, but so far this year, many say inflows have been relatively modest. (Getty Images)
Oil markets and those who trade them
INDEXES AND INSTITUTIONAL INVESTORS

For institutional investors, including pension funds, the traditional way to gain exposure to commodities has been through equity stakes in resource-holding companies, such as oil major BP and miner Rio Tinto.

Once they have decided to move into commodity markets, typically they have taken exposure through long-only commodity indexes.

(Getty Images)
Oil markets and those who trade them
SECOND HALF 2008 ONWARDS

A consequence of recession has been that asset classes have tended to move in tandem - again weakening the value of commodities for institutions because they have lost their appeal as portfolio diversifiers.

The unusual positive correlation was marked last year when a wave of cheap money generated by economic stimulus measures led to a wave of cross-asset buying.

It has continued this year as risk appetite and risk aversion have alternately swept across nearly all sectors. (Getty Images)
Oil markets and those who trade them
HEDGE FUNDS Hedge funds have injected liquidity into oil and other commodity markets. They include London-based Clive Capital LLP and New York-based Touradji Capital Management LP, which invest in a range of commodities.

Traders have said many oil-focused passive funds have been underperforming so far this year, compared with last year, but some active funds should have made good returns from taking short positions and precious metals funds have also done well. (Getty Images)
Oil markets and those who trade them
LONG-ONLY INDEXESThe two main long-only indexes are part of the family of Dow Jones-UBS and S&P GSCI indexes.

The S&P GSCI Commodity Index invests in 24 commodities. (Getty Images)
Oil markets and those who trade them
ETFs An alternative to the indexes are exchange-traded funds and notes, which have been particularly popular in the gold market, but have also gained significance in oil.

Exchange-traded funds (ETFs) are equity instruments in which investors buy "shares" in a limited partnership or trust that in turn invests the proceeds in commodity futures and options (more rarely in the raw material itself).

Exchange-traded notes (ETNs) are debt instruments in which investors make a loan to the issuer (usually a bank) in return for a stream of interest payments (often zero) and repayment of the principal at the end of the loan period (but where the amount repaid is linked to performance of a commodity index). (Getty Images)