Geopolitical tensions and supply chain disruptions are reshaping price formation across commodity markets, creating opportunities for trend-following strategies that focus on physical rather than financial market drivers, according to Jonty Field, co-head and chief operating officer of GreshamQuant, the London-based arm of Gresham Investment Management.

"You're seeing the physical world suddenly having an effect in a way we haven’t seen over the last few years," Field said, speaking on the sidelines of FIA's International Derivatives Expo (IDX) event in London last week. “The wider market has not really needed to worry so much about the physical world.”

Field said the firm's investment approach focuses on markets where prices are driven by physical supply and demand dynamics rather than financial flows.

"Our thesis is that trend following, which is our core signal, works best on markets where the underlying market is more physically driven, less financially driven," he added. "If you think about coal, you've got to dig the coal out of the ground, you then have to ship the coal and move it around. If you have a coal mine, coal prices go down, it's hugely expensive to shut the coal mines. You often run at a loss for a bit of time."

Field said markets influenced by physical constraints tend to generate stronger and more persistent price trends than highly financialised contracts.

"The underlying physical market tends to drive prices more over time, this makes it easier for us to harvest from an alpha perspective," he said.

Cotton illustrates supply chain effects

Field pointed to cotton as an example of how geopolitical developments can ripple through commodity markets.

"Cotton becomes a little bit unfashionable, you get all these polyfibre based materials, but a lot of those materials, all those polyester materials are dependent on oil inputs, and hence oil prices," he said.

"When you see the inability to ship that oil out of a region, and a lot of the regions that were getting oil from the Middle East - the far east countries were producing a lot of these polyfibres. Those prices went through the roof. They just didn't have the input."

Field said that shift can increase demand for cotton, but the agricultural supply response takes much longer.

"So then what happens? Cotton becomes relatively attractive,” he added. “This leads to substitution demand for cotton. The problem with cotton is you have to plant cotton, grow cotton. To grow cotton, you need fertilisers. What's not coming out of the Gulf at the moment? Fertilisers.

"You have basically two drivers of cotton price. You see cotton prices spiking, but what's interesting is that the cotton price today has actually come down a bit, but next year's cotton prices are going to be affected by next year's crops, and next year's crops are going to be affected by the fact that you weren't planting as much this year."

Climate change creates market divergence

Field said climate change and geopolitical tensions are increasingly causing commodity markets that once moved together to behave differently.

"When you throw geopolitics into the mix, and then you throw climate change into the mix, what you'll find is the same thing in different regions will be behaving very differently," he said. "We think that's an opportunity for what we do, as much as it's a challenge for global trade, this is ultimately the convexity we’re positioned for."

The firm focuses on a range of less-correlated commodity and physical markets, including South African yellow maize, Japanese electricity and uranium, alongside more established futures contracts. Field said diversification remains a key part of the firm's strategy.

"We trade South African yellow maize, we trade Japanese electricity, we trade uranium,” he said. “The correlation to those things is not financially driven, it’s more consistent even in times of stress, as they are very different markets."

Field's comments build on themes previously highlighted by GreshamQuant. In August 2024, GreshamQuant portfolio manager Scott Klipper said geopolitical events, including disruptions in the Middle East and Red Sea shipping routes, were driving a "regionalisation" of energy markets as previously correlated contracts became increasingly disconnected and traders sought exposure to more localised commodity markets.