The commodity bubble of 2008 was a textbook bubble. Multiple
markets participated and supply and demand had nothing to do with value.
Commercial traders were losers when the prices traded did not reflect their
view of market fundamentals. When oil reached its high of $147 per barrel,
there were tankers circling the delivery ports, killing time as prices rose,
waiting for instructions to enter and unload. Many commodities were witnessing
a flood of new capital in the form of Exchange Traded Funds. The oldest pure commodity
ETF, the SPDR Gold Trust, started trading in 2004. Since that time, more than
$1 trillion dollars has flowed into commodity based ETF’s. A recent calculation
suggests that energy ETF’s control the equivalent of 1.6 million futures contracts,
which is equal to the total futures market open interest.
There are two easy money policy events that spurred this on.
The first was September 11th. In the face of tragedy and
uncertainty, the government and the Federal Reserve Board instituted an easy
money policy to prop up demand in a shell-shocked population. This, in turn,
fueled the housing boom and the cash out mortgage refinancing boom. Excess cash
found its way into all investment vehicles until it all unraveled in the
economic collapse of late 2008. The institutions’ response was the second event
that brings us to where we are – easier money, QE1 and QE2.
The result of easy money is cheaper dollar based commodities
in the face of growing global demand. We can see the devalued Dollars’ effect
on commodity prices in the face of the economic collapse of ’08. Commodity
prices put in a higher floor than they had from September 11th
through the bubble top in ’08. The ’08 bottoms in the commodity markets have
simply served as a new, higher floor price. The market has since traded higher
on growing global demand, ETF investment and a falling Dollar. Therefore, the
recent rallies are not bubbles, and that is the scary part.
I’d like to point out that my preference is for sound
economic policy and rational investment strategies. These would include curbing
U.S. spending, allowing China’s currency to freely float and opening up foreign
commodity exchanges to cross hedging. However, given the current architecture
and political leanings we will trade as if we’ve witnessed a two- year basing
and consolidation pattern with the major rally yet to come. This is where
things get stupid.
When measuring things we can’t get our heads around it helps
to use analogs. This is when we compare something we’ve already experienced and
know to something we’re presently trying to understand. You’ll hear this in the
markets as, “This wheat market is trading like the Australian drought of ’07.”
Or, when the market collapsed in ’08, people were comparing it to the crash of
1929 and the depression was to follow. Traders also use this to compare charts.
We disregard the scale numbers on the charts and simply try to find similar
patterns. Comparing patterns allows us to measure amplitude, the size of the
moves and the rhythms of the markets.
Using analogs, chart pattern recognition and a little
quantitative analysis, we come up with bubble targets we can’t quite get our
heads around. Here are some examples: Corn – $11 per bushel, Wheat – $22 per
bushel, Cattle – $1.50 per pound, Sugar – 47 cents per pound, Crude Oil – $250
per barrel. Some markets have already hit their targets like gold, silver,
coffee and cotton. Therefore, the end prices of these markets will end with the
old adage, “The only cure for high prices is, high prices.” How high will just
have to be seen to be believed.
This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.