Commodities After The Crash, No Way But Up

By: Andrew_McKillop

After a suspiciously short and likely programmed commodities crash we can only have the right hand leg of a "V" profile for commodity prices - until and unless big things happen with the major currencies and national debt crises of most OECD countries, or we have a global economic crash. To be sure, this is the context for highly classic speculative frenzies, where fundamentals are put on the back burner, and the front burners are turned to full on.

By May 9, after a week of slaughter on the precious metals, energy, food and metals exchanges there was no place else to go but up. The commodities rout of April 29-May 6 knocked at least US$ 90 billion of nominal or paper value off the estimated value of all 24 commodities included in the S&P GSCI index. The value of market tradable paper in this group of leading commodities fell to about US$ 805 billion on May 6, from around US$ 891 billion on April 29, according to Bloomberg.

This was a classic - and short - bear squeeze needing very large falls in the nominal value of "underlying assets", commodities themselves, to temporarily drive out the speculators who had been bidding up prices. Signalling the probable degree of advanced preparation and warning for informed players - some call them insiders - Goldman Sachs Group Inc. added its own weight to the rebound. After forecasting the plunge and adding its weight to it in the days preceding April 29, it was predicting price recovery for commodities (announced as "a possible recovery" by GS Group Inc.) exactly one week later, on May 6.

WHAT HAD CHANGED ?

Through March and April in a process dating from the start of 2011, investment funds made near-record bets on commodity price gains, pushing indexes like the Rogers RICI, the CRB, CMCI and the S&P GSCI to their highest levels since late summer 2008. Commodities beat stocks, bonds and the dollar to the end of April, the longest winning streak in at least 14 years. Behind the euphoria was the spectre of penury, with relentless industrial growth in China and India, and other Emerging economies pressuring natural resource production capacities and stockpiles.

More realistically and carefully excluded from market-correct explanations, and even closer behind the euphoria, the continuing fall of the US dollar's world value - the dollar being used to price and transact more than 72 percent of the world's total commodity trades - can only intensify any fundamental factor levering up commodity prices. Retreat of the Eurozone-16's money, the euro, from its current unsustainable highs (measured against the structurally weak dollar) will also tend to bolster commodity price gains against stocks, bonds and currencies, due to the euro now being used to transact - if not price - increasing volumes of physical commodity trades.

THE DOLLAR REMAINS WEAK

To be sure, the Obama team's hunting-and-shooting triumph in Abbotabad followed by a fishing trip to the Oman sea could only drive up the world value of the dollar, but long-term trends and economic reality show the true trend. The US dollar index, measuring the dollar's performance against 6 other currencies, but weighted to give the dollar's performance against the euro some 58% of index weight shows long-term decline as the only main trend - until and unless the euro falls.

Taking performance of the US dollar index July 2010 we have this read out:

The Abottabad adventure is signalled by the 1.2% upward blip on the chart's right hand edge, above, but rather little in this chart allows us to believe there can or might be a longer-term upward recovery in the dollar - although the index will improve considerably when or if European Union monetary disorder goes into higher gear, and the overvalued euro moves backward.

OIL FRENZY
Oil prices best reflect the weakening US dollar and the onrush of central bank "injections" - rather than hits and misses on presidential palaces in Tripoli, and hits on demonstrators in a range of countries from Bahrain and Yemen to Syria and Tunisia, with the largest focus always on possible civil unrest in Saudi Arabia, potentially affecting oil production and exports. Oil prices also reflect claims by the OECD's International Energy Agency and large oil companies like Total, claiming Asian oil demand is very strong, while the US Energy Department's TWIP shows relatively high US oil inventories, and European oil consumption is in many countries still 5% - 10% below 2008 demand level.

The one-liner marketspeak for this context of fundamentals which can be read any way, and unknown geopolitical trends is that the balance of risks and fundamentals still points to a supply-constrained world, not only for oil but almost all other commodities, except US-only shale gas. The financial and monetary risk of a sudden plunge into steep recession, as in 2008, driven by national debt funding crisis, also generates so much new liquidity on financial markets, including commodity markets, that until the global economy crashes commodity price must rise.

Taking estimates for Quantitative Easing by the US Fed, Europe's ECB, Japan's BOJ and other central banks as 20 trillion dollars since end-2008 we can relate this to the world value of the physical oil trade at a year average barrel price of US$ 100. The issued money and near-money covers more than 12 years of world total traded oil supplies. Oil is by far the world's biggest traded commodity, priced and transacted to a dominant extent in dollars - so the real question, here, is how can its price not rise ?

The unnatural fall in oil prices during the Apr 29 - May 6 crash is shown by the US benchmark West Texas Intermediate falling nearly US$19, and the rest-of-world benchmark Brent falling US$ 21 in the 5 days of last week. From the bottom point of the "V", rebound could only be as much as 3.5%-per-day in a technical rebound offering zero risk gains for the best-informed market makers and players.

THE REAL GATEKEEPERS
To be sure there is no watchdog in a mass speculative bidding spree that favours commodities more than equities, but the very small size of most commodity markets makes for self-limiting feedback. This size limitation applies firstly to value and turnover, relative to vastly bigger equities markets, and to the special characteristic of commodity markets: physical deliveries and transactions.

Silver is the best recent example - despite the fantastic drubbing taken by silver prices during the Apr 29 - May 6 crash, the largest global silver market, the Comex, is in permanent physical shortage of the metal. Several of the food commodity markets are highly vulnerable to cornering and to physical under-supply. With rising prices, soothsaying of the Goldman Sachs type will give way to physical rigging, producing what many analysts already claim is happening: market movements with no relation at all to underlying fundamentals.

The twist is these analysts usually judge commodity prices as overpriced and likely to fall back 10%, or 20% or even 30% from current levels, without warning. The opposite is also possible, and more likely under current conditions: that is massive unexplained price rises in a few days of frenzied trading.

The gatekeepers are the precious metals. When or if gold prices rise above US$ 2000 per ounce, and silver prices attain some level above US$ 65 per ounce, this is a deadly challenge to the US dollar, and its fiat friends and also-rans, starting with the euro, which is already seriously overvalued. From high and sustained gold and silver price levels, the gates of inflation will very surely open wide - making panic rises of interest rates, and slump into global economic recession almost inevitable.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2011 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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