Commodities Tank

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We’ve been sayin’ the commodities runup and the fixation on inflation looked like a rerun of spring 2008: a liquidity-fueled hunt for inflation hedges when the deflationary undertow was stronger. That observation is now looking to be accurate.

But what may prove different this time is the speed of the reversal. With investors acting as if Uncle Ben would ever and always protect their backs, markets moved into the widely discussed “risk on-risk off” trade, a degree of investment synchronization never before seen. All correlations moving to one historically was the sign of a market downdraft, not speculative froth. And as we are seeing, that means the correlation will likely be similarly high in what would normally be a reversal, and that in turn increases the odds that it can amplify quickly into something more serious.

The only way to stem this unhealthy pattern of cross market connection is structural measures, meaning measures to reduce the tight coupling of financial markets which allows developments in one market to propagate quickly to seemingly not so closely related markets. But we are a long way away from seeing the authorities consider, much the less act, to stem the free flow of capital, which has long been depicted as virtuous. The work of Carmen Reinhart and Kenneth Rogoff on financial crises shows the reverse, that high levels of international capital flows are strongly correlated with larger and more severe implosions. But we may have to test the current system to destruction before we can develop the will to fix it.

From Bloomberg:

Commodities plunged the most since 2009, led by oil and silver, and stocks posted the biggest three-day drop since March as selling of energy futures drove down equities. The dollar strengthened and Treasuries jumped.

The Standard & Poor’s GSCI index of 24 commodities sank 6.5 percent at 4:01 p.m. in New York and lost 9.9 percent this week. Oil tumbled 8.6 percent, the most in two years, to $99.80 a barrel. Silver dropped 8 percent, extending the biggest four-day slump since 1983 to 25 percent…..

Selling swept commodities markets as investors sold positions following gains of more than 23 percent in 2011 through April 29 by silver, oil, gasoline, coffee and cotton. The dollar, which slumped 13 percent versus the euro between Jan. 7 and May 2 as the S&P 500 Index rallied 7.2 percent, strengthened against all 16 major counterparts except the yen after European Central Bank President Jean-Claude Trichet signaled he will wait until after June to raise interest rates.

“It’s panic,” said Michael Shaoul, chairman of Marketfield Asset Management, which oversees $1 billion in New York. “You have those super crowded trades. Now you’re in liquidation mode. There’s nothing to do with weak U.S. economic data. It’s not a global financial crisis. It’s a classic liquidation move in a crowded trade.”

It’s premature to call this anything other than a sharp correction. Recall in February 2007 that a plunge in Chinese stock markets produced two weeks of jangled nerves and roiled markets, and May 2010, the first serious dose of Euromarket sovereign debt worries, was no party either, yet the markets appeared to shrug those events off. But the underlying financial system has been patched up with duct tape and baling wire, and the thorniest issues, namely, undercapitalized banks and global imbalances (both China-US and within the Eurozone) remain unaddressed. The “It’s not a global financial crisis” sounds awfully reminiscent of “subprime is contained.” It was until it wasn’t.

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  1. MyLessThanPrimeBeef

    When they were going up, it was not due to speculators. I assumed, then, that it was due to real, honest to goodness demand.

    Today, they are going down due to panic liquidation, and not becuase of some sharp decline in demand from yesterday.

    1. ScottS

      The floods in Pakistan and fires in Russia pressed Ctrl-Z, and with Bin Laden dead there’s no more strife in the Middle East. Food and energy demands are gone. You’re welcome.

      Or it could be like I saw on the news ticker that the US credit downgrade is the reason.

      Which seems plausible? (Hint: neither one).

  2. Jimbo

    No one has been able to explain to me how we can have substantial inflation without wage growth. And with the real median wage having decreased 1% over the last twelve months, I don’t see how we can have inflation. Instead, we’ll have working class families putting off a trip to Walmart so that they can fill their gas tank.

    1. traderjoe

      Way to cherry-pick a time-series.

      Why don’t you do a 5 or 10-year chart and then overlay it with the SPY?

      1. Philip Pilkington

        Here’s one since ’71 for gold:

        Ah reckunz the pattern is pretty clear. When investors get spooked due to monetary operations they fear/don’t understand — which is what happened in 1980 (that had little to do with the Soviet invasion of Afganistan and everything to do with certain monetary policies being pursued in certain Anglo-Saxon countries) — they run for gold to hide under the mattress.

        The key here to understand is that the ‘permanent store of value’ myth is actually a variable in gold and silver prices. I think that’s a rather interesting — not to mention ironic — observation.

        1. Philip Pilkington

          Oh, and I should also mention that I think the boom after 2004 was for similar, but not identical reasons. I reckon this was due to people seeing speculation in housing take-off in a big way. This euphoria, coupled with the loading up of household debt, had all the ‘hard money’ types at their laptops logging onto obscure ‘permanent store of value’ sites.

          Once again, we have the myth generating price instability.

          Maybe we should start referring to gold and silver as ‘anxiety investments’. Then the plan would be to take continuous surveys of investor anxiety levels — we might post these surveys to psychotherapists and yogis, for example. In time of ‘low investor anxiety’ we simply keep an eye out for spikes in ‘investor anxiety levels’. When these start to climb throw all your money into gold and silver, wait for the price to double or triple — depending on how ‘anxiety provoking’ events appear to be — then pull out of the market and move to Bermuda.


      2. ScottS

        As you wish, traderjoe:

        What’s your point? Still looks like a bubble. Looks even more like a bubble, actually, when compared to SPY.

        But don’t let me stop you. Call Glenn Beck up and trade your worthless dollars for gold. Or better yet give your dollars to me and I’ll give you my gold & silver fillings. Porcelain fillings look better anyway.

        1. Philip Pilkington

          Excuse my crippling ignorance — but what in the G-man’s good name have gold prices to do with the stock markets?

          Sorry, ScottS — I’m not saying that you’re putting this forward… I just don’t get the logic. I mean isn’t it a completely arbitrary comparison?

      3. Philip Pilkington

        Yeah, there seems to be a lot of confusion about exactly what indicators to use to ensure that you’re a winning gold speculato… I mean, there’s a lot of confusion as to exactly why gold is the safest investment you’ve ever made.

        So, I’ve put together a chart to indicate exactly what’s going on in as simple and least confusing a way as possible:

        Send me €€€s when you make a fortune.

        1. ScottS

          Haha, I have no idea. I just don’t want to be accused of “cherry-picking.”

          My offer still stands. If anyone wants to give me their worthless dollars, I’ll be happy to accept them. If I see any shiny rocks on the street, I’ll send them as repayment.

  3. justa70'scaveman

    I don’t get HFT. It scares me. But, it does seem like the market does figure out a way to say accurately “it’s different this time,” so that nobody can actually know WTF – ever, except that if they’re big enough and powerful enough, it doesn’t matter anyway. In other words, there’s always a reason why “it’s never the same thing as it was before.” The market seems determined, among other things, to beat the metal bugs like Ringo beat his drums. And like Ringo’s beating, it may not be virtuosity, but it has a certain perfection to it.

    I wish it were the 70’s again, but I can wish in one hand and crap in the other, and I’m pretty sure which one will have heft first.

    1. Lil'D

      HFT itself isn’t scary, it’s the perpetrators.

      And HFT isn’t one thing – it’s several. Some are attempting to make tight markets and earn market-making profits, some are scalping, some are borderline manipulative, in showing/canceling to entice other algos to react…

  4. Robert Dudek

    Precious metal decline is the result of 5 margin increases in a short span of time. In a few weeks they will resume their relentless climb upwards. The fundamentals have not changed. Bernanke will continue to print money, interest rates will remain near zero.

    Jimbo, you can have substantial inflation if you debase your currency fast enough. The cost of imports will then skyrocket. People will have to spend more and more on the necessities (but that doesn’t mean the prices of other goods are declining to offset that). The nation becomes poorer unless they can increase their income from exports. I’m not saying the US is bound for hyperinflation, merely that it is more than possible to have high inflation and a stagnant median wage.

    1. rd

      This week, I think that we have answered the question about whether or not Bernanke has been fueling speculation by funneling 0% financing to TBTF institutions. This market action, especially commodities, shows that a fair amount of the past year has been artificially induced by the Fed and other government policies. The Chinese government focus on full employment has probably also been a major factor.

      The next year is likely to be interesting.

    2. traderjoe

      5 margin hikes in silver in one week but they allow an intra-day doubling of the downside limit in crude. This was a calculated, coordinated take-down of “those” commodities.

      It’s hard to reach much into the “market” action (because it is not a market anymore) – except to say that the TPTB are in charge.

      They will do what they want, when they want. Until the cartel gets broken.

  5. Dean Sayers

    You keep calling on the authorities for some type of action. But Glass-Steagall isn’t coming back, and we won’t get anything like it unless rival blocs of firms emerge and the dominant one favors a market structure that just happens to provide for stability for the rest of us.

    But the bankers have stability. Without even a slap on the wrist, public funds were transferred to the same guys who caused the mess… and you know the rest. So, why expect anything else?

    Furthermore, what is the point in calling for expanded regulations in the public interest? It seems clear to me that banks will quickly find ways to work around them, and that any such regulations will quickly be gutted by bank-friendly legislators, regulators & managers.

    I think a major aspect of the financial crisis and continued downturn is the accumulation of wealth in the hands of a few. Not only does this make the public impotent re: ‘democratic’ policy, but it also makes the public weaker in terms of financial leverage. If you’re small time, you just don’t mean as much as the millionaire next to you. And there haven’t been so many of those millionaires to harvest recently (since 07 or so, there are half as many millionaires, but net value of all millionaires grew!). What will the working public do alone against the bankers?

    Is there any way to solve the crisis besides the redistribution of economic power? Do you really believe that anything short of that can really be effective now?

  6. Ron

    leverage and easy money, the story of our current and recent financial history with profits being booked today on commodities its worth looking at the housing market which is currently moving into another bust cycle its clear that the easy money crowd has left the market creating a large hole that first time home buyers cannot fill giving banks,RE agents, mortgage brokers,title companies all wondering how this current air pocket in sales will impact their life. The millions of first time home buyers who have used low down FHA financing the last few years based on the coming turnaround might be looking for an exit as their investment goes South.
    The easy money run ups are always exciting with plenty of financial media support but the big air pockets created at their departure is a good reminder of what the game was all about.

  7. JCC

    I think the 5 margin increases in less than 3 weeks, one after another, have far more to do with this “correction” than anything else, driving out the low-margin long speculators. And now it’s feeding on itself, as far as paper silver is concerned anyway.

    From ZeroHedge:

    “Some believe the recent general commodities pullback was triggered by the series of CME margin hikes on silver within the past week, after the recent exponential run-up in silver prices. Whether or not that is true, holders of leveraged long commodities positions should have warily watched the action in the silver market. Some silver speculators may not have seen the margin hike as a constraint on lending, but it should have been a red flag for any speculator with a leveraged long position. Moreover, after silver markets closed, silver prices were getting “banged” lower in what looked like suspicious market manipulation.”

    Then there is this from Harvey Organ (the crux of the problem):

    “The key to the silver market is unavailable silver and that continues today. I am amazed that only 135 notices has been filed so far this month which kind of shows you how little silver the dealers possess inside the comex vaults.”

    In other words, paper is being driven down by the shorts to cover, but there is still a very strong demand for physical silver, so it seems the prices “need” to be lowered.

    No matter what is going on, it’s interesting to watch :-)

    It’s too bad that there were not margin increases in housing (i.e., down-payments) during the housing run-up from 2000 through 2006, but that just goes to show who controls these markets and where the profits are.

  8. Das letzte Hurra

    Elementary, My Dear Watson. Strong dollar buys more stock, more commodity, more call options. Strong dollar from shrinking money supply from excessive tax revenue from 15 March. Trash is cheap when cash is dear, is dear and strong. Monetary policy was sound but fiscal policy disgusting.

    Is March always a random march?

    U B Judge!

    U B Thurgood

  9. Shell

    I’m very happy that the commodities drop confirms speculation only plays a minor role in the price of oil.

    This move proves only supply and demand matter, and that the big banks are in no way pushing up the price of oil.

    I personally witnessed long lines of cars pulling off to the side of the road yesterday. The owners just walked away!

    1. Deus-DJ

      Dude…what planet do you live on?

      So demand suddenly dropped or supply suddenly rose to explain this rapid fall in price? Are you really trying to trick yourself here?

        1. Deus-DJ

          ah, right, I kept looking at his name and rather than it giving me the impression that he was trolling I kept thinking of “Shell oil” associated with the words “ƒuck you”

  10. Lyle

    Of course this will never happen but the silver behavior suggests that margins should be raised to 50% on all commodities trades. Farmers could use actual grain and the like for the margin. Also perhaps the commodity ETF’s need to be reined in. But of course this would be at a cost to the great god of liquidity, who rules all and must be appeased at all costs. Then go to the rules in some of the ag pits where there are real price swing limits, so we get more limit up and down days when trading ceases.

  11. Herman Sniffles

    Thirty odd years ago I read something that has stuck with me. The author of the article (Harry Ruff?) said that in the end stages of a debt base economy like ours, the system begins to run “like a high powered racing car engine with a fuel injection problem.” When the fuel (money) is flowing you get a wild ride, but let off on the gas pedal just a touch, and the engine just dies. Mixing metaphors just a bit, it’s like the end stages of alcoholism. When the drunk was just becoming a drunk, he/she got hours and hours of fun in the bar. At the end, as the old liver turns wurst, the happy time is cut to about five minutes that comes between the dt’s and the screaming wild drunk nearly out of their mind. I wonder what Gentle Ben’s nightmares are like. I bet he has a doozie once in awhile.

  12. Hugh

    I was writing about excess speculation in oil back in 2007-2008. As I like to point out, this made me early to the party in one sense since there was almost no one else talking about this at the time, but also late since this kind of speculation (for financial purposes only and divorced from any price discovery) dates back to 2004. Indeed later someone steered me to this Senate report from June 27, 2006 on this speculation:

    I always invite people to look at oil near futures from 2004 onward

    and try to relate them to historical events or supply and demand. Hint: there is an underlying rise with no fall back beyond and often despite the absence of any of these.

    The bet is essentially that oil demand is inelastic and that politicians will stay on the sidelines. This leaves a considerable length of time in which speculators can bank their profits. It is not so much that when demand does begin to respond to price pressure the speculators back off. Rather it is about this time political pressure begins to build. So well before politicians are finally pushed into action by public pressure, the speculators back off, for a while, until the push for action cools. Then they are set up to move again.

    This is a recurrent bubble but I tend to look at it less as one run against other market players and more one run against consumers. I also see most of the potential to blow up other bubbles more in the recession inducing effect of the upward rise in the oil bubble. The reason I say this is that markets have become so manipulated and fixed that it is only effects that they can’t game that can have effects counter to the fixing.

  13. nonclassical

    “We may have to test the market to the point of destruction”..

    which is exactly the “way” capitalism has always “recovered”..after total destruction. Unfortunately,
    said destruction will be ever worse, following attempts to put Humpty-Dumpty back together..

    1. F. Beard

      which is exactly the “way” capitalism has always “recovered”..after total destruction. nonclassical

      I know! Let’s have a single, government enforced monopoly money supply for all debts. That way we can synchronize the boom-bust cycle across the entire country.

      Ooops! We already have one.

      Never mind.

      If a single money supply is so convenient then why must everyone be forced to use it? Hmmm? Wouldn’t folks pick it voluntarily? Instead they are doing such primitive things as driving up commodity prices to try to preserve their wealth.

      1. nonclassical

        Actually, F.B.,

        THIS is what is driving up commodity prices:

        ..lightning fast computer-trades of millions of shares, moving at speeds to make portions of dollars=extreme profits, as markets move…MONOPOLY, by the usual suspects,
        who go so far as to sell back and forth to one another, for no other reason than to raise prices.

        This activity historically documented back to 1800’s, in Geisst’s book, “Wall Street-A History”..

        1. Mark P.

          Indeed, HFT is a large part of it. It enabled a Potemkin stock market through 2008 and 2009.

          Which Bernanke and the Obama administration were happy to have, and happy to allow the ‘usual suspects,’ as you say, to use HFT to effectively shave cents off every deal that went down.

        2. F. Beard

          Technology is not to blame. The bankers have wrecked the economy causing a “dearth of investment opportunities”. And now what is left but speculation on essential commodities?

          And then there is precious metals speculation. PMs are a primitive money form at best but at least they can’t be printed at will by desperate central bankers.

          If we had genuine private money alternatives then the private sector would be insulated from government/central bank monetary mismanagement and thus commodity prices would be insulated too.

  14. Economista Non Grata

    Just a well coordinated, twenty first century shake out (down) of the “dancing fools”… That’s all… No big deal folks, just update your lenses…. This will all blow over in a couple of days….



    Best regards,


  15. bluffraise

    The wild card was where will the money go when the Fed primed the pumps. Next wild card to drop could very well be a contagion in commodities across the board called deflation.

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