Commodity Sell-Off Has Winners And Losers

The biggest decline in commodity market value since the financial crisis of 2008 looked like funds running for the exits, but big differences in open positions between oil, grains and other commodity markets will signal which markets may still be overextended.

Based on the decline in open interest – the number of contracts bought or sold that are not offset by sales or purchases – in 18 main futures markets, investors closed out positions with a nominal value of about $30 billion in the week ended Nov. 16, according to a Reuters analysis of exchange data.

The number of open positions across all commodity markets fell by three per cent, the biggest drop since September 2008, the data showed.

However, in many cases prices fell far more than open interest, indicating a change in ownership rather than straight fund liquidation. And because most markets had heavy or record volume during the sell-off, the fall in prices was not due to just a few players liquidating positions.

Most likely, commercial players – who normally short these markets for hedging purposes – bought on the break in prices. And speculative funds, after initially liquidating positions and taking some profits, may have bought back into many markets.

SPECULATIVE LONGS

During the run-up, many markets had attracted record speculative long positions.

The triggers for the sell-off were macro in nature, including a stronger dollar caused by euro zone debt worries and fears that China might curtail imports with tighter monetary policy. Still, the response among commodity futures investors was not uniform.

For example, the ICE sugar contract – which had surged 44 per cent in six weeks and was deemed one of the most frothy of markets – fell 20 per cent over the period of the study. But open interest only fell 2.5 per cent, despite an 81 per cent increase in margins.

“This indicates more of a change in ownership than an outright liquidation by the speculative crowd,” said Sterling Smith of Country Hedging Inc. “Commercials were there and looking for coverage as prices declined to a more choice level.”

BUYER MIX

Many viewed the collapse in prices as a healthy correction for markets that had recently set multi-year or record highs, from copper to gold to cotton.

As the froth began to subside, some markets like sugar found ready buyers at a lower price point.

The same could not be said of other commodity markets that witnessed more evident fund liquidation such as cotton and coffee, where prices and open interest fell by nearly the same percentage. Cotton futures fell 12 per cent while open interest sank 14 per cent and coffee fell nine per cent while open interest slid 10 per cent.

Trading volumes in cotton and coffee are about 10 per cent that of corn or gold – making these niche markets far more illiquid and vulnerable to fund liquidation.

“(In) coffee, which has been a longtime favorite of spec funds … prices and open interest dropped by a nearly equal amount, which would indicate liquidation coming from funds with little buying hedge pressure,” Smith said.

Fund liquidation could also been seen in the crude oil market – with both prices and open interest falling about five per cent.

GRAINS DROPPED MORE

In grains, prices fell on a percentage basis about three times as much as open interest declined. For example, U.S. cornprices tumbled nearly nine per cent but open interest fell only 2.5 per cent. Wheat prices fell 13 per cent while open interest slid 4.3 per cent.

“There are buy opportunities for those end-users,” said Frank Cholly, senior market strategist with Lind-Waldock in Chicago. “We’re going into the end of the year here so these trend-following funds are looking to book some profits.”

Long liquidation may continue to a lesser degree for the rest of the year, as traders aim for year-end returns and bonuses. However, a fresh infusion of fund money is expected to flood commodity markets in January.

“These markets aren’t necessarily bearish at all,” Smith said. “We may very well have to live with a sideways churn until January.”

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