Why commodities crashed

By Felix Salmon
May 10, 2011
Reuters special report on Thursday's commodities crash.

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If you want to see market reporting done right, I can recommend the 2,000-word Reuters special report on Thursday’s commodities crash. It doesn’t just pick a random news event or gesture vaguely at “worries about economic growth” while saying what prices did: it looks at the mechanisms behind the market moves and what might have caused them.

It’s worth underlining that Thursday’s percentage declines in commodities like silver and oil would count as a full-on disaster if they occurred in the stock market. Commodities markets are rowdier places than stock markets, however, and the only people who really got hurt are sophisticated investors who can take their medicine.

The move was certainly accelerated by the rise of algorithms and high-frequency traders, who have moved quite aggressively from stocks into commodities of late. These black boxes can go from being very long to very short in an alarmingly short space of time, and I suspect that many of them made money, rather than lost it, in the volatility.

But there was also a sense that this move had to happen. Between early February and early May, the yield on the 10-year Treasury bond fell from 3.7% to less than 3.2%. That’s a massive move in Treasury yields, which indicates that market fears about inflation are abating significantly. At the same time, however, the price of silver — a classic inflation hedge — rose from $27 to $47. One of those two markets was wrong — and it was much more likely to be the thin silver market than the Treasuries. Silver was bound to fall in price; the only question was when.

When the inevitable silver crash happened, it took down other commodities like oil with it. That’s because of all the speculation in the market, and the fact that funds which speculate in silver tend to be exactly the same funds speculating in oil. When you get a big margin call in silver (and margin requirements on silver had just been raised before the crash), then you have to sell some of your other holdings to meet that call. And your most liquid holding is likely to be in oil.

At times of volatility, correlations move towards 1. We saw that in every market during the crisis, and we saw it again in commodities on Thursday. Which is why protecting yourself with diversification is so dangerous. Just when you need the protection, it disappears.


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“…the only people who really got hurt are sophisticated investors who can take their medicine.”

I find this doubtful. Those who got hurt worst were likely retail investors who had finally capitulated and purchased silver at frothy levels, only to have their worst fears confirmed by huge back-to-back multi-day drops. Given their tendencies in other markets, they probably sold right before the inevitable rebound.

Posted by Pietro_F | Report as abusive

here’s the blogger who claims to have caused oil to tank:

http://politicalcalculations.blogspot.co m/2011/05/changing-outlook-for-oil-price s.html

Posted by rjs0 | Report as abusive

Too funny! We’ll have to go back and add a “satire” tag to our post so hopefully, nobody gets the idea that we actually have god-like powers over oil prices.

Still, it was fun to consider the possibility that a single blogger *could* have done it!

Posted by politicalcalcs | Report as abusive

@ rjs0 may 10 2.42 PM

You referred to a blog politicalcalculations, what I am missing here is the fall of prices from 4.00 till where they were talking about.
In this timespan the prices have fallen about U$ 3,50 it is mentioned that here should be a combination of Soros selling large qauntities of silver and probably also JP Morgan who has enormous short-selling in silver and it was time to rebalance their position.

Posted by rinia | Report as abusive

“China, the world’s fastest-growing consumer of commodities, also is tightening monetary policy to tamp growth rates and control inflation, raising the prospect of a slowdown in demand for oil.”

Surely Reuters means a slowdown in the *increase* in demand for oil? Oil demand in barrels won’t get smaller just because China’s needs this year are only 8% more than last year instead of 10% more, meaning monetary changes in China will not adversely affect the current price of oil, only the futures price. Overall, the oil price is unlikely to itself go down, based on fundamentals such as this.

Posted by FifthDecade | Report as abusive