A Dichotomy Develops in Commodities Prices
Recently, the CCI (continuous commodities index/ equal-weighted CRB) has broken above a downtrend line, and delivered a brisk advance:
The CCI breaks out to the upside – somewhat surprisingly.
We last discussed the futures markets and commodities in general on March 3, taking a look at the biggest winners that have emerged so far this year. As we remarked in closing on that occasion:
“Quite a few commodities have "woken up" this year, but there is nothing that indicates that the market's views about global economic growth have improved. On the contrary, economically sensitive copper is one of the biggest losers year-to-date. Mostly the rallies seem weather-related, or are actually tied to signs of economic weakness rather than strength (gold, treasuries). The big exception in the industrial commodity space is crude oil, which has strengthened markedly again (natural gas prices have been driven by the cold weather as well). Crude oil inventories have recently delivered a few downside surprises, so the strength seems largely related to supply issues.”
In the meantime, this dichotomy has become even more pronounced. A number of slightly worrisome news emanated from China. It started with reports of a small, but meaningful corporate bond default in the "solar energy" space (it was meaningful because no bailout was provided this time). Chaori Solar, which on a previous occasion could still count on a local government bailout, was left hanging this time. Interestingly, analysts aren't taking the event seriously. Faith in the power of the planners to keep things under control evidently remains extremely high. For instance, the FT writes that:
China’s first corporate bond default is a symbolic moment in the country’s financial development, but analysts have downplayed suggestions it will herald a wave of further failures across the country.
On Friday, Chaori Solar became the first company in recent history to default on its bonds after it failed to make an interest payment. Some have expressed fears that the Chaori default could create a domino effect where investors quit the bond market altogether, sparking a liquidity squeeze or a credit crunch.
Rather than billing Chaori as an alarm bell in the credit markets, many analysts see it as a trial balloon being floated by the authorities as they seek ways to cut overcapacity in certain sectors of the economy.
“The government is trying to send a signal to the market that there are risks to buying investments. They are doing it carefully,” said Christopher Lee at Standard & Poor’s. “This company is so small and in trouble anyway – even if it defaults it is not going to impact the market much.”
Not going to impact the market much? If that's so, then someone forgot to tell the copper market, which went into free-fall in the wake of the news. This was exacerbated further by China posting a rare trade deficit in February, mainly due to tumbling exports. This actually tells us more about the economic health of China"s trading partners than that of China, but still, it was apparently interpreted as quite a negative surprise by the markets. Chinese stocks were incidentally under pressure again as well, but the low made last year continues to hold so far.
Here is the gruesome chart of copper:
Copper just about holds near a last ditch lateral support level, but in view of the gusto with which this wave of selling hit, it seems doubtful that it will hold beyond the short term.
It should be noted that the selling actually started in Shanghai. Since 2009 we have regularly heard about large above ground inventories of copper and other base metals being held in warehouses in China and employed as collateral for loans. The borrowed money is then reinvested in higher yielding assets like wealth management products (many of which look to be of dubious quality, to put it mildly). In other words, there is a sizable copper carry trade underway. There have also been on and off rumors that in a number of instances the same copper stock piles have been used repeatedly and fraudulently as collateral for more than one loan, although we cannot ascertain whether this problem really exists (it probably does …) and how big it is. It is clear though that there is more copper in warehouses than the official statistics below indicate. A lot of copper is held at off exchange venues, and these unreported stocks are rumored to be quite large.
China imports a lot of copper – but quite a bit of it lands in warehouses, whereby the data above only show inventories in exchange-licensed warehouses.
China's export growth since 2004 – the recent decline is rather ominous, considering the most recent precedent.
Weakness in Base Metals, but Ags and Softs Remain Strong
The weakness was especially pronounced in copper, but iron ore and Chinese rebar prices have weakened quite a bit as well. The ratio of GYX (GSCI industrial metals index) to the CCI has broken to a new low for the move:
GYX plunges relative to the CCI.
To be fair, GYX is actually quite heavily weighted toward copper. The current weights are: copper 47.1%, aluminum 30.9%, nickel 9%, zinc 7.3% and lead 5.7%. Aluminum is in a steep downtrend as well. As a result, the monthly chart of GYX actually looks rather ominous, as it is consolidating just above a long term support level:
GYX, monthly – this doesn't look particularly good.
Speculators are net short copper futures and sentiment is not exactly bullish either, but both positioning and sentiment data still have room to reach bigger extremes considering their history. In other words, it is quite possible that the selling will intensify once oversold conditions have been relieved by a short term bounce:
Copper, commitments of traders – big speculators are net short, but larger short positions have been observed in the past.
Aluminum, weekly – in a steep downtrend since 2011.
We already discussed the stellar performance of coffee in our previous commodities update (which has since then continued, with the active May contract closing above 203 yesterday, the highest level in more than two years and +80% year-to-date), as well as oats (+31.5% ytd.), but a number of other agricultural commodities have also done quite well. Soybeans, corn and KC red wheat have all gained more than 10% so far this year. Other big gainers were orange juice, cocoa, sugar, ethanol, natural gas, milk and lean hogs.
As you can see, most of this stuff is either meant to be eaten or burned for heating/transportation. In other words, the very things that have been excluded from CPI to construct the so-called "core" CPI. So there is still not going to be any "inflation" in the official data, even if the gains continue. A fortuitous coincidence for the merry pranksters guarding the printing press.
The recent strength in agricultural commodities is reflected in the performance of the Rogers Agriculture Index ETF RJA:
RJA, daily – many moons of losses are recouped within a few weeks.
Crude oil futures remain in backwardation at this time, and have been buoyed by a number of factors, such as a drawdown in inventories, the Crimea altercation and more recently, renewed infighting among various groups of gangsters in the failed state known as Libya (another one of those "democracy export" experiments that is going down the tubes real fast). The latest reports from Libya indicate that the government threatens to bomb a North Korean (!) tanker if it tries to ship oil from a port held by a competing faction:
“Libya threatened on Saturday to bomb a North Korean-flagged tanker if it tried to ship oil from a rebel-controlled port, in a major escalation of a standoff over the country"s petroleum wealth.
The rebels, who have seized three major Libyan ports since August to press their demands for more autonomy, warned Tripoli against staging an attack to halt the oil sale after the tanker docked at Es Sider terminal, one of the country"s biggest. The vessel started loading crude late at night, oil officials said.
The oil dispute is just one facet of the deepening turmoil in the North African OPEC member, where the government is struggling to control militias who helped topple Muammar Gaddafi in 2011 but kept their weapons and now challenge state authority.
A local television station controlled by protesters showed footage of pro-autonomy rebels holding a lengthy ceremony and slaughtering a camel to celebrate their first oil shipment. In the distance stood a tanker. The station said the ceremony took place in Es Sider. Prime Minister Ali Zeidan appeared on television to warn the tanker"s crew. "The tanker will be bombed if it doesn't follow orders when leaving (the port). This will be an environmental disaster," Zeidan said.”
It matters of course a great deal to all concerned who gets to fence the oil. Some of the Salafist djihadis who have fought against Gadaffi not surprisingly believe they have stolen it fair and square, and are eager to get their cut. Somehow we don't think they will be impressed by Zeidan's threats – which consist of lots of bluster with little back-up as it seems:
“"They are now trying to load oil," he said, denouncing it as a criminal act. Authorities have ordered the arrest of the tanker"s crew.
There was no immediate sign of the country"s armed forces moving towards the port. Analysts say the military, still in training, would struggle to overcome rebels battle-hardened from the eight-month uprising against Gaddafi. Zeidan acknowledged the army had failed to implement his orders last week to stop the protesters sending reinforcements from their base in Ajdabiyah, west of the regional capital Benghazi, to Es Sider.
"Nothing was done," Zeidan said, adding that political opponents in parliament were obstructing his government. He said North Korea had asked the ship"s captain to sail away from the port but armed protesters had prevented that. Abb-Rabbo Albarassi, the eastern autonomy movement's self-declared prime minister, said Zeidan"s government had failed to meet its demands to share oil wealth, investigate oil corruption and to grant the regional autonomy.
"We tried to reach a deal with the government, but they and parliament … were too busy with themselves and didn't even discuss our demands," he told the televised ceremony. "If anyone attacks, we will respond to that."
Last time these groups clashed, oil exports from Libya collapsed to a trickle, so the market may have some concerns about these developments. As an aside, it makes of course no sense whatsoever to say “Libya threatened, etc. ...” as is done in the report quoted above. Who is this "Libya"? Has anyone met him? Persons in Libya are issuing threats. One must try not to fall into the trap of country personification – government officials are not their country. They are people, acting in their own self-interest (everywhere and always).
Having said all that, speculators now hold the largest net long position in crude oil futures in history. That makes the recent rally actually quite vulnerable, in spite of the current backwardation. At the very least we would argue that should the backwardation either lessen materially or disappear, then this market may become ripe for a short sale on the idea that the speculative position is simply way too stretched by now. Of course geopolitical risk always remains a factor in the context of oil prices, so one needs to exercise the appropriate caution. First a look at the weekly chart of crude oil, which actually doesn't look bad:
Crude oil, weekly – going nowhere in largely uninteresting ways since 2011. The chart as such however doesn't look bad actually ... normally one would expect it to break upward, but the speculative position gives us pause.
And here is a depiction of the nosebleed level the net speculative long position has recently attained:
Big speculators pile into crude oil futures like never before.
Commodities overall look strong, especially in equal-weighted terms. However, the weakness in copper, iron ore and aluminum indicates that commodities are not rallying on expectations of economic growth. Specifically the situation in China appears to be a worry at this time (see also our recent update on China"s money supply and credit growth in this context). Crude oil and natural gas are exceptions among industrial commodities, whereby the latter has likely rallied for the same reason as foodstuffs, namely inclement weather. It is a bit more difficult to decipher what drives the crude oil market at present, but the large speculative long position in crude oil futures surely represents a warning sign for this market.
Charts by: StockCharts, Sentimentrader, BarCharts, WSJ, Factset