Commodity markets in panic

This was a very negative week for commodity markets in general, not only for the metals. The fundamentals have not changed in such a way that plunging prices in most markets were justified. Academic research tried to convince that commodity prices follow purely the fundamentals and that speculation did not play any role for price movements. This research is based on tests of Granger causality. However, those tests are not appropriate to measure the influence of speculators on commodity prices. If speculators buy or sell commodities, it has an immediate impact on prices as soon as the buy or sell button is hit and the order is rooted to the exchanges. As prices change simultaneously with changes in the positions of large speculators, and not with a delay of one period, Granger tests conclude that speculation would not have an impact on prices. However, when the CFTC publishes its next CoT report on Friday, May 13, we would not be surprised to see considerable declines in the net-long positions of the non-commercials.

Silver already consolidated at the beginning of last week. It is not an unusual behavior that bulls would need to take a breather after reaching a long-term high following a strong rally. One argument was that small speculators liquidated long positions after the Comex increased margin requirements. It is quite normal that margin requirements increase if volatility rises or prices have risen strongly. This should not come as a surprise to speculators who have done their homework. It is also not a convincing argument that increasing the margin requirements would increase the costs of holding a position in a future as T-Bills could be deposited as margin.

The decline of precious metals and crude oil prices at the start of last week could also be explained by the death of Osama bin Laden. The market has regarded this as a reduction of geo-political and terror risks. However, this might be the wrong conclusion.

The economic data last week was dominated by the purchasing manager indices. While the manufacturing PMI in the US and eurozone came in higher than expected, the non-manufacturing PMI in the US dropped stronger than expected, but remained well above the crucial 50 mark. Looking at the various PMI charts, it should be obvious that readings above 60 are not sustainable for a longer period. They often come back to the mid-50 level, which still points to sustained economic expansion. Based on our models, we regard the manufacturing PMI as more important for the commodity demand and they are still at high levels.

The plunge in commodity markets set in on Thursday and might have been triggered by two factors. First, the weekly initial jobless claims rose to 475K, which was not expected and intensified fears of an economic slow-down. Second, at the same time, the ECB held its press conference. The market obviously speculated that the ECB would prepare the market for a rate hike in June. However, this was not a very rational expectation. At the start of a new tightening cycle, the ECB usually does not hike in a two month interval. Furthermore, at the June meeting, the ECB will present its own staff projections and the survey of professional forecasters. It was far more likely that the ECB would wait for new information at the June meeting and then prepare the markets for a rate hike in early July. Also the wording, inflation risks have to be monitored very closely, is an indication that another rate hike is in the pipeline. The outlook for the ECB refinancing rate has not changed. Many forecasters still expect that the refi rate would be at 2% in December or early January 2012. Therefore, nothing has really changed except that the next step might take place in July.

Nevertheless, as the ECB had not use the key words “strong vigilance” the markets panicked. At foreign exchange markets, the euro was sold off against the US dollar. A stronger US dollar then triggered also massive selling of commodities across the board. On Friday, markets initially stabilized and the higher than expected non-farm payrolls in the US were also helpful. However, then Spiegel-online, the web-site of a German weekly magazine reported that Greece would declare to leave the euro at a conference of EU finance ministers later in the evening, the euro dropped again and also some commodities came under renewed pressure. However, according to the treaties, Greece could not leave the euro without also leaving the EU. The Greece finance minister denied immediately that Greece would seek to leave the euro. Also eurozone finance ministers made it clear later that Greece can not leave the euro and that a debt restructuring is also not at the table. However, the damage was already done. Thus, still anybody believing that speculation has no impact on prices?