Is That a Hissing Sound in Commodities?

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Commodities, Macroeconomics

Three weeks ago my colleague Stuart reported  that Goldman Sachs may have provided the market with its indication of where it sees commodities headed at least through the end of the year. Speaking about Goldman Sachs, Stuart posted, “The change is reflected in two ways, first, a reduction of 32% in their VaR (value at risk the sum of money a bank is willing to lose in one day of trades) to $27 million and a reduction in hiring for the commodity department. Now it appears as though the stampede to invest in commodities has started to slow, though $50b has made its way in according to this Wall Street Journal article the numbers on a quarter by quarter basis have declined from $22b in the first quarter to just $11b in the third.

The question becomes once the stampede stops, where will commodity prices go? According to the Journal, “¦ many investors are now worried the liquidity-fueled rally in commodities may soon be over. They say the weakness in the dollar, which has helped drive commodities higher, may soon come to an end. When it does, commodity prices may swing back drastically. In addition, regulations and poor returns from ETF’s may force investors to look elsewhere. We have long argued that basic supply and demand has not supported the metals commodity rally. But we all know that supply and demand, e.g. fundamentals no longer plays as critical a role in setting prices as they once did.

So why would investors fear that the weakness in the dollar may soon come to an end? After all, last week the Fed reiterated it plans to continue with its zero interest rate monetary policies to help spur the economy. We question exactly what that policy seems to be spurring. As economist, Nouriel Roubini, has both discussed and written about extensively, the Fed’s zero interest rate policy has fed a “mother of all carry trade bubbles that will eventually pop and take with it, commodity prices. The carry trade has become a vehicle for investors to borrow US dollars cheaply, sell the dollars and then invest in assets that will appreciate relative to the dollar. It has the effect of putting additional downward pressure on the dollar. Because commodities tend to move in an opposite direction from the dollar, savvy traders and investors have taken advantage of current monetary policy.

But as we have often said in these virtual pages, nothing kills high prices like high prices. When the music stops, the carry trade bubble will burst. The question becomes how hard and how fast.

–Lisa Reisman

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