I’ve been asked to follow up on an article I wrote on March 10, 2008 about commodity prices and the effect that I felt(feel) commodity ETFs have on the underlying commodity.
Please read the whole thing by clicking here. Here is the second half with some key points highlighted:
In my opinion, the real cause of this problem is easy to identify. It is a combination of monetary and fiscal policy of the United States Government coupled with investment demand, much of which is a result of those failed policies. The reality is the main thing that has dramatically changed since August is the credit crisis and now, the stock market declines.
Commodities is the last main asset class that is not declining so it gets a massive increase in demand for hard assets. Capital leaving fixed income and the stock market have to go somewhere. As long as the Fed and the Treasury devalue the dollar, it will continue. As long as bond markets are in disarray and stocks slide, it will continue. This asset allocation demand is a very powerful force. Just remember it works in both directions. When it reverses, I expect that 33% declines will be common.
We’ve had commodity prices rise before, but when that happened in the past, most commodity ETFs did not exist. Increasingly since 2005, retail investors and their advisors now have a convenient choice to park capital and in my opinion, the existence of the commodity ETFs traded in the US and on the LSE are having a significant impact on prices. Just look at the assets in the Gold ETFs - they have increased approximately 100% from about $10 billion of the yellow metal last year to almost $20 billion now.
Some commentators expect the final thumping in financial markets will come from a decline in the commodities (the last hope for capital appreciation and preservation). If margin calls and forced deleveraging require that commodities are sold to generate capital, I agree that could be a catalyst for their demise.
If any or all of the following happens, I would be looking to exit commodities: the economy stabilizes, the credit crisis abates, the stock market bottoms and the dollar appreciates. Until then, I think the commodity ETFs will feed on themselves and head higher.
I like Commodity ETFs as an investing and hedging option, but they are contributing to the inflation that Bernanke is ignoring (maybe because he is largely responsible for causing it.) I am watching for divergences in underlying price growth and the asset values in the ETFs to figure out when the run is ending. When investors decide to pull money out of commodities to reallocate to stocks and bonds, these commodity ETFs will get whacked.
Retail investors who came late to the commodity party have gotten hurt (if they held on). In that post I mentioned my expectation that “33% declines will be common.” That was a general observation based upon some technical work that I do, and after reviewing what has happened from the peaks to the current pullbacks, I am going to stick to those numbers. However, each commodity has its own supply and demand factors as well as correlations to macro economic factors, such as failed US monetary and fiscal policies as well as their own asset allocation issues. I don’t do firm price targets, so I’ll just have to wait until the market tells me they are reversing direction.
As for my theory about watching for fund flows into the specific commodity ETFs to see when the bullish run was getting tired and ready to rollover…. if you check the daily dollar trading volume for a couple year history (pick GLD, SLV, DBC or other examples to test) you will see two periods of a few days each where there was a surge in daily trading volume. One was mid-March and the other was mid-July. Obviously, both of those involved interventions by the Treasury and Federal Reserve and corresponding moves in the US dollar.
As a result, I am comfortable with the actual results of my original theory, although there were many other coincident factors that question the standalone value of this analysis. Regardless, you can pull up the HEDGEfolios profile of any of these Commodity ETFs and see how my signals correspond to those dates and the surges in dollar trading volume. Here is one example (click here for the SLV).
Okay…so now what? Note that this past week, I gave UP signals to the gold ETFs (IAU and GLD) and on August 25th, I gave USO an UP signal. Obviously, that was not good timing so far with all three being down significantly. I’ll adjust if I need to, but so far I am getting less negative on commodities. Other than the three I just mentioned, I have DOWN signals on all the other commodity ETFs I cover.
I’ll be watching the fund flow info to see if it plays out again but mostly, I am getting less bullish on the US dollar and consequently, less bearish on commodities.
First, the idea that all this is the Fed's fault because it gave "investors" low interest rates is nonsensical. If they had been real capitalists instead of charlatans they would have gone out and found investments that added value instead of finding ways to milk the last dollar out of housing.
Second, we already know what the problem was: Lemon Loans. PRIVATE banks sold loans based on inflated assessments and deliberately defrauded investors by trying to pretend they actually believed "stated income" figures - a story that doesn't pass the laugh test. They had every reason and every responsibility to know better and they chose not to because it was profitable.
If Fannie Mae was allowed to purchase assets that were too risky, crooked bankers were willing to sell them junk Alt-A paper and that - by the numbers - is what destroyed the GSE balance sheets.
Finally, commodities were clearly in a bubble and you clearly shouldn't be advising anyone on whether to buy or sell anything if you don't see that. You may think that there is no such thing as bubbles and that fundamentals always rule, but you're obviously wrong.
Gold? Gold couldn't be headed down any faster. If it takes more than a month for gold to dive through $700, I'd be stunned. Oil? If OPEC doesn't save your long positions in oil, they can't be saved. The question is not whether oil is headed to $80/$85, but whether it can even stay there for a week or so before plummeting.
Are you a lunatic?
The threat of negative govt regulations & legislations, or the promise of special favors, are what keep corps buying reelections for the quid pro quo.
If the Fed's sole raison d'etre was to level out the boom/bust the "business" cycles that were ALWAYS caused by banks anyway, then it has failed miserably.
The FED IS the business cycle as plain as day.
PLUS it unconstitutionally charges interest on fiat it creates from nothing, plus it's printing press robs the people's buying power in a secret fashion that confuses the average gullible stupid pathetic govt indoctrinates like yourself dlaw!
Here's a suggestion: learn something about the law before you opine as to what is and is not unconstitutional. Otherwise, you will continue living in darkness.
The possibilities for futures/options/OTC derrivatives vs physical arbitrage vs ETF holdings are staggering. Whipsaws in price are extremely profitable when you know they are coming. Anyone watching COT's, Comex and CB activity must now look at ETFs in a whole new light. (Don't forget to look at volume changes of different ETF's on the same commodity such as GLD vs smaller ones like CEF, etc at volume break points before this indicator 'disappears'.)
Thar's a new sherrif'n town. He'd be call'd ETF. An' he'd be a wild'un.
To the contrary, the year-long study by the CFTC that was released about 10 days ago shows that the percentage of futures contracts attributable to speculator/investors has DECLINED over the past two years. The increases in commodity markets were attributable to the entrance of more and more commercial hedgers, NOT speculators.
The CFTC study showed that the commodities that have experienced the sharpest price rises were the commodities that had the least speculator/fund influence, and the commodities that showed the smallest price increases were the ones with the largest percentage of speculators/funds. This is because speculators are a moderating influence on prices; because of their sensitivity to high prices, speculators are the first market participants to short the market when prices are overbought. Commercials tend to cause prices to escalatte more rapidly because the higher the prices go, the more frenetic becomes their buying, as they panic to buy more of the commodity that they need in their business before it goes even higher. This is why, as speculators exit the market, as they did late last year, prices tend to rise faster and higher.
Just watch! As Congress imposes more restrictions on commodity trading (higher margins, smaller positions, more restrictions), the size of commodity markets will shrink, and prices will become more erratic, the Dollar will decline faster (capital flight), prices will spike much higher (the commodities will flow to places where people are willing to pay market prices), and shortages (lines at the gas stations) will become commonplace in those places where governments attempt to control the markets.
I know that this is counter-intuitive, but as fewer market participants are allowed entrance to the marketplace, a few large players can exert greater influence on the smaller market size. A few big fish in a smaller pond can throw their weight around. The more market participants there are and the larger the market pool, the more impossible it becomes for "big fish" players to manipulate those markets. Smaller markets benefit large participants MORE (ala Hunt Bros. in the silver markets 20 years ago) rather than restricting them. The Hunt Bros. lost their shirts when more and more market participants finally caused a collapse in the silver markets. As silver prices rose, more people entered the market to sell silver, including even housewives who sold their silverware for a quick buck. The Hunt Bros. never anticipated that this would occur and that the market would expand so large with so many new participants. As the market became larger and more participants entered, the Hunt Bros. could no longer corner the market, and they eventually lost their shirts as the price collapsed. The point is that the larger and more liquid a market is, the more it keeps extreme prices in check. Bigger markets are better markets! Bigger markets keep extreme prices in check.
EMERGENCE OF INVERSE COMMODITY ETFS
One aspect of the subject of "ETF influence" that wasn't covered here is that over the past six months, there have emerged many new ETFs that also SHORT commodities. Early this year, I was writing many of the ETF provider to beg for these, since I saw an opportunity coming when commodity prices became overbought. Interestingly, these inverse commodity funds emerged at just about the time the commodity prices topped out, suggesting the possibility of some influence, although it may have been merely coincidental, as I mentioned earlier in my post. This, we may find going forward, will likely have an even greater moderating force on commodity prices. In fact, my own research has shown that these inverse commodity ETFs have grown much more rapidly, and are now much larger, than their long ETF twins. (There is also now a rather unique commodity ETN that takes both long and short positions in the same fund!)
The best examples of these paired long/short ETFs are the family of Deutsche Bank ETNs. The short and 2X short ETNs are much larger and more liquid than their long/2X long twins, in some cases by more than 10 times the size of their long-fund twins! DB has matched short/long ETNs in oil, commodities (in general), precious metals, ag/grain commodities, and base metals. In each of these cases, the short funds are currently significantly larger than their long twins. However, as commodity prices show more signs of bottoming out, this phenomenon is beginning to shift. The existence of more of these inverse funds, I expect, will play a moderating role in the commodity sector in the future. I am glad to see these short ETFs to counter-balance the (purported/supposed) inflationary impact of the long-only funds. There are new players in the game now, and their presence is sure to be felt.
Thanks all, for sharing your thoughts/perspectives.
Calling someone a "lunatic" because you disagree with them is unbecoming a professional. It suggests that since you can't make a case for your opinion, you resort to denigration of the author of the opposing viewpoint. Weak minds and poor arguments must resort to profane and denigrating language because they can't express themselves forcefully any other way than through the shock value of crude language. It would be better to make your case with reasonable and powerful arguments rather than denigration!
Furthermore, your use of such language tells me NOTHING of the author of this article. However, it speaks MULTITUDES of your character -- or lack thereof! We learned more about YOU in your snide posts than than we learned about the author of this article!