COMMODITIES NOW
inflation. However, as market action from 2008 through 2010 showed, it would still be difficult to say crude oil is the new safe- haven market.
Part III: Expansion of Commodities Means a Great Divide One of the more significant developments involving commodities over the last decade is how this market sector is now viewed as a legitimate, long-term investment strategy. Many of you have been in the business as long if not longer than I have, so do you recall how it made you feel when you first heard commodities described that way? I remember my reaction; a good hearty chuckle followed by a chill running down my spine. As the new decade dawned it seemed improbable the commodity sector would ever evolve beyond the short-term, volatile, casino-like organism it was. Who would have thought that a mere 10 years later, commodities would dominate market media outlets and Exchange Traded Funds would become the mutual funds of the future as we prepare to turn the calendar to yet another new decade. But how did we get to this point? As introduced earlier, many
to sink in 2008. Remember the high of $147.27 posted in crude oil? By December of 2008 the spot-month contract had plummeted to a low of US$32.48 as traders fled the markets like rats from a sinking ship. Another unintended consequence
of the move to an investment minded market was the disconnect that
Another unintended consequence of the move to an investment minded market was the disconnect that occurred with many underlying cash markets
view the 2005 change in rules regarding the number of contracts that can be held by a trading entity as the pivotal moment in the evolution of commodities. One long-time reporter on the floor of the Chicago Board of Trade summarized it this way, “The industry has sold its soul to the devil”. Looked at from an historic point of view, judging the industry by its intended purpose of passing price risk of the underlying commodity to traders on different levels, his thoughts were prophetic. As open interest skyrocketed in commodities, so did volatility.
Generally speaking, volatility is a measurement of how far and fast a market can move over a given period of time. As more investment money came pouring into the market, prices naturally moved higher. And the higher prices rose, so volatility increased dramatically. The effect of all these changes was to drive many small traders and hedgers (those looking to protect the value of the underlying cash commodity) out of the market because the risk was too great. With more commercial
hedgers driven from the market, open interest in many markets became more one-sided than had been seen in the past. From 2005 through mid-2008 the non- commercial classification in the Commodity Futures Trading Commission took control of commodities, holding an extraordinarily large percentage of total open interest. And we all know how that turned out as the global economic situation took a torpedo in late 2007 and began
occurred with many underlying cash markets. The move in cotton above 91 cents per bale in March 2008 seemed to defy commercial logic, much like the previously mentioned crude oil rally, putting some centuries-old cotton trading companies out of business and sparking a government panel to take a look at what happened. More dramatic though has been
the break between the futures and cash market in soft red winter wheat. Prior to the rule change, the differential between the two markets ran at an average of about 25 cents under (cash price minus futures price). By late 2006, the differential had weakened to almost $1.00 under, averaging about 75 cents under through the summer of 2008. Then the cash market collapsed, falling to
Figure 3: Crude Continuous Monthly Chart
Source: DTN Prophet X December 2010 7
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