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Here's why commodities have sold off over the past several days

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March 20, 2008 – Comments (7) | RELATED TICKERS: USO , GLD

Look out below.  The prices of most commodities are falling faster Spitzer's pants at the Mayflower Hotel.  In my opinion, the main reason why commodities have sold off over the past several days is that hedge funds have been unwinding their over-leveraged positions.  A few major financial lenders recently instructed their hedge fund clients to reduce their “leverage” in the commodity markets.  Most of these hedge funds were very highly leveraged, holding the maximum number of futures contracts that their capital positions would support.  What started as the selling by a few hedge funds as theyn reduced their leverage snowballed into a mass liquidation of commodity positions as other investors got spooked and sold their positions to lock in their substantial gains. 

The CRB commodity price index which measures the prices of 19 separate commodities fell 4.6% yesterday.  Sugar futures fell more than 11% in one day. Coffee prices yesterday dropped almost 10%. Crude oil futures fell 4.1%. Gold prices have fallen $113 per ounce in the past 48 hours from a record high of $1,033 to $919.  Corn and soybean futures were down the daily trading limit. 

The selling in the commodity markets continued overnight.  The dollar is posting a strong recovery from the recent lows.  Gold prices fell another $25 to $920.  Silver is $1.20 cents lower.  Crude oil is below $100.  Soybean futures were down the limit again overnight.  Corn closed down the limit in all but the nearby May position.

After the selling in the commodity markets was well under way, financial reporters tried to come up with a fundamental justification for the sell-off, such as the U.S. economy is in a recession, the Fed might be done easing, the value of the dollar is rebounding, demand from China is slowing etc.  The fact of the matter is that over the past several months, hedge funds have bought a record number of futures contracts in all the commodity markets.  The positions held by these funds were so highly leveraged that only the slightest tightening of credit created a domino effect.  

In the past it has seemed to usually take at least three days for the fund selling to run its course when a major market correction occurs.  This time, given the massive size of the fund positions it may take longer.  Furthermore, today is the last day of trading before a three day weekend and many traders are always hesitant to hold their positions going into a normal weekend, let along an extended one. 

Keep an eye on oil and gold.  Once they begin to stabilize other commodities should as well.  We probably overshot a little on the upside on a number of commodities, but I plan on hanging on.  The long-term bull story for most commodities remains intact.  The demand for increasing amounts of and higher quality food in emerging markets isn't going anywhere, neither is the U.S. government's absurd ethanol policy (for now).  There haven't been any major oil discoveries or miracle breakthroughs in alternative energy over the past week that change the fact that the world's appetite for the finite supply of oil is going to drive prices upward in the long run.  The dollar will likely continue to fall as the bloated U.S. deficit continues to grow and the Fed has to cut rates again to fix the problems in the economy.  Times like this are painful, but they are inevitable.  Nothing ever goes straight up, even when there are such compelling arguments for why long term the prices of most commodities will increase in dollar terms. Have a great long weekend.  

Deej

7 Comments – Post Your Own

#1) On March 20, 2008 at 2:45 PM, CycleFreak7 (< 20) wrote:

I don't buy it.

Commodities were way overbought as investors panic-sold from equities, realized that interest rates on bonds, money markets, etc. were pathetic and then panic-bought into commodities.

The prices do NOT reflect real demand. As the U.S. rushes headlong into a big recession, demand for everything drops. This includes gasoline, most food products, textiles and ... well, everything.

OPEC sent a fairly clear signal when they elected NOT to boost production (though some say it is because they can't) despite the record crude oil prices.  The reasoning: Surplus supply and weakening demand.

Looks like they were right.  Oil will "correct" considerably. And gold? What the hell good is that stuff anyway?  It is only worth what someone else is willing to pay - it has no intrinsic value.

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#2) On March 20, 2008 at 2:59 PM, TMFDeej (99.41) wrote:

Thanks for sharing your thoughts CycleFreak7.  I agree with you that many commodities were indeed overbought in the short run.  Long term though I think that we are still in the early stages of a long term bull market for many commodities. 

In my opinion, you hit the nail on the head when you said "though some say it is because they can't" about OPEC's decision not to increase production.  I personally believe that many OPEC members, especially the big one Saudi Arabia, no longer have the ability to significantly increase their oil production over an extended period of time without risking doing major permanent damage to their fields.  Not to mention the fact that OPEC loves high oil prices.  It's a scientific fact that all of their fields will eventually run dry, it's just a question of when...10 years from now...50 years from now...100 years from now.  If the world proves that it can handle 100/barrel oil without falling into a crushing recession why not keep it there?  I would if I was in their shoes.

The global demand for food and oil will increase over the next several years.  If you are looking at commodities in terms of the next couple of weeks or months then by all means sell.  However, if you are looking at the price of food and energy over the next several years I believe that you will be rewarded by holding on.  At the very worst owning some stocks that benefit from high oil and agricultural commodities prices provides you and your family with a hedge in case things really do take off.  That's one of the ways that I am looking at them.

Deej

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#3) On March 20, 2008 at 3:04 PM, dwot (67.78) wrote:

I've been talking to myself about this in my comments on my last post...

I couldn't believe that the same moron responsible for the 1998 Capital Management disaster is at the center of attention again.. 

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#4) On March 20, 2008 at 3:06 PM, DemonDoug (85.04) wrote:

"And gold? What the hell good is that stuff anyway?  It is only worth what someone else is willing to pay - it has no intrinsic value."

And I guess little pieces of paper with Washington, Lincoln, Hamilton, Jackson, Grant, and Franklin have intrinsic value due to the artistic portraits that are visualized on them?  Or is it the intrinsic value of the heat generated by burning them?

Short term hedgie unwinding gives you a great opportunity to jump in, because all this new money the Fed is pumping in is going to go to hard assets, the only things that will maintain value in a highly inflationary monetary policy.

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#5) On March 20, 2008 at 4:17 PM, retailsails (94.15) wrote:

Also, keep in mind today was quadruple witching for options expiration, and quarter-end next week for a lot of the funds which are taking profits to lock in gains...

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#6) On March 20, 2008 at 9:40 PM, lquadland10 (< 20) wrote:

Now the dollar will go up and just who is proping up our dollar. We are bankrupt just read my other blogs. Soverin wealth funds will have to step in. the g-5 or g-7 bankers are manipulating the market in my humble thinking. They just don't want people to withdraw their money from the banks because the whole system will crash. If they can't cover city bank can they cover any bank? The answer is no they can't. Even if it FIDC insured. Just the cold hard facts. The country is bankrupted. Do the homework. With this week's bailout's we are stone cold broke in my humble thoughts.  Pay cash for what you want and does anyone have savings to get you through the rough time?

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#7) On March 20, 2008 at 11:54 PM, nuf2bdangrus (< 20) wrote:

Commodities acted a store of value.  They don't pay interest, thus in good times, they are driven strictly by fundamentals.  The dollar's hold will be temporary, and the bull will continue.  With a CB that is abusing FIAT currency, and strong demand, it's a perfect storm.  I lightened up a bit, should have sold much more, as I thought it was getting frothy, didn't expect the reaction for .75 bps to be so ugy, thought it would be mildly neutral.  Sold GLD having lost half my gains.  SOld SUY last week.  Sold DBA, and bought SJT too early on a limit order I forgot about.  Sold UNG and bought back too early.  Waiting for a chance to buy SLV, as I  issed the first run.

 

FInancials won't hold, the dividends are WAY too high, see BAC CFC, WB C etc. THey have 50% more downside.  Great trade pre rate cut.  Shoulda known and done more, having seen it happen twice.  SHame on me.

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