Have you ever tracked a metal price and watched it peak or trough for no obvious reason? Or read of some fundamental development in the supply or demand landscape for the metal, only for the price to behave in some unexpected way?
You are not alone. A recent article in the Financial Times suggests that in at least some situations technological developments may be influencing price behavior in ways that they would not historically have done.
The Financial Times reports that automated trading systems (or algos) account for large volumes of transactions in commodity markets, with 49% of grains and oilseed trades handled by automated trades of one sort or another, 54% of precious metals and a whopping 63% of crude oil, quoting figures from the US Commodity Futures Trading Commission.
Some automated trades are simple buy or sell orders that are executed when the price reaches a certain level, but others are the result of sophisticated Blackbox algorithms that make decisions based on a multitude of variables known only to the developers.
The article quotes Doug Duquette, an executive at Chicago-based Vertex Analytics, whose software analyses automated market orders.
“The whole notion of fundamentals on any given day, for weeks at a time, months at a time, has completely gone out the window these days,” Duquette said. “You get momentum of algos playing upon algos upon algos, and it will just drive markets to extremes that don’t seem to correlate or line up with fundamentals on any given day or time period.”
While John Saucer, vice president of research and analysis at Mobius Risk Group in Houston, is quoted as saying “It makes it more difficult to be a purely fundamental trader. In the past you had to take into account fundamental considerations, technical considerations and seasonal considerations — I do think (now) you have to take into account transactional considerations and algos.”
The article and most sources are careful not to blame automated trades with fundamentally undermining the process of price discovery, but many acknowledge that the result of their rapid rise in use has been an increase in volatility and a skewing of liquidity to short-dated futures, leaving long-dated contracts lacking liquidity. Indeed, Ernest Scalamandre of AC Investment Management is quoted as saying that by withdrawing standing offers to buy or sell when another trader tries to transact with them, automated trades create a mirage of market depth — adding volume but not liquidity, he said.
For better or worse, automated trades are here to stay. With the rapid rise of artificial intelligence, automated trades are likely to get ever more sophisticated and come to dominate markets in years to come as hedge funds, speculators and even the trade turn to AI in an effort to reduce perceived risks, or simply to get one step ahead of the market.
Where this leaves the rest of us remains to be seen. But it does appear that long-term fundamentals are likely to have less impact on short-term volatility compared to the actions of these automated trades than they would historically have done.