Are you giving up commodities?

It's time for me to update my thoughts on commodities especially all the commodities are plunging. Crude oils take a hard hit, plunged to US $ 100 from all time high of US $ 147, no matter what threats you are talking about, hurricance, war, etc -- gravity rules.

CFTC released another report on Sept 11 blaming on index speculators.

The main argument was

$161 billion net notional value of commodity index business in U.S. markets on June 30, 2008, about 24 percent was held by ―index funds, about 42 percent was held by ―institutional investors, about 9 percent was held by ―sovereign wealth funds, and about 25 percent was held by ―other traders. The ―other category is largely made up of retail investors holding ETFs, ETNs, and similar instruments that are publicly traded.

While the net notional value of commodity index business in NYMEX WTI crude oil increased sharply over the 6-month period ending on June 30, 2008—by about 30 percent, the actual numbers of equivalent long futures contracts declined over that same period by about 11 percent. In other words, the sharp rise in the net notional value of commodity index business in crude oil futures appears to be due to an appreciation of the value of existing investments caused by the rise in crude oil prices and not the result of more money flowing into commodity index trading. This is illustrated in the following chart:

The recent sharp rise of commodity price is not something new. Look at this chart, there was a sharp rise in 1971 and subsequently continue to rise before reaching a peak in 1980. We got a big bang of 3.5X increased from 70s!!! Was there an index speculator then? NONE.



Generally commodity is correlated with economic outlook. In the 70s for example, when the annual % decline in 30 year Treasury bond lead to decline of commodity price. This is consistent with the expectation of poorer economic outlook.



In the commodity recession cycle from 1980 to 2000, you may observe a similar trend CRB is generally correlated with % changes of 30 year treasury bond yield.



The last chart that I want to show you is the last 10 years trend of long term bond yield and commodity. 30 year Treasury bond yield annual % change has been plunging since last 2006 which coincides with the US housing bubble bust, the rate of change in the CRB index has been staying high up but already turn south now to close gap with 30 year T-bond.


You may also note that commodity price is generally peaking before the headline CPI . With the recent plunging of commodity price, I am in opinion that we have reached a cyclical peak of inflation. Rates cut by central bankers will commence soon, when the market is finally get round this point, equities market will start to rally.

Don't fight the downtrend of commodity price now. When it reaches the bottom, it will create good trading opportunity like steel, oil and gas, plantation stocks but I will let the excesses to continue to shed.

Commodities and stocks bear market definition are different. 20% decline from top is a bear market for stocks. 50% decline from top is a correction in commodities world. Don't touch it if you don't have a stomach for it.

I have been wondering how did Warren Buffett navigated even more brutal environment from 1970 - 1980. I will be back, stay-tuned.

(click all images for larger and sharper image)