E Making Sense Of The Commodities Rout -

E Making Sense Of The Commodities Rout

Dec 08, 2015Jeremy ParkinsonFinance0

Making Sense:

There is a rout going on in the commodities space. Some of this is based on fundamentals. Some of the rout is due to technical factors. Investors and advisors need to understand this before trying to become an asset class hero or consider stepping out.

Asset Class Hero

Commodity prices have been beaten down for more than a year. However, it is in the past several months that conditions have deteriorated dramatically. As with most asset routs, the crash in commodity prices begin with fundamentals. These fundamentals include:

Lower-than-expected demand (or demand growth) for many commodities.

Significant over supply of many commodities.

Crowded trade conditions. Many investors and money managers bought into the China/EM growing to the sky scenario and moved into commodities en masse. Now many investors and managers are attempting to exit (for a variety of reasons) from a market with very poor liquidity.

The collapse of OPEC. Many member nations rely on oil sales for the majority of government revenues. They will continue to pump to help pay government expenses. Some revenue is better than no revenue. Since OPEC is no longer the swing producer, cutting production would likely result in a loss of market share, possibly greater than any price increase which may result.

A bet on China growing in the high single-digits or low double-digits caused an expansion of production capacity. There is probably enough production capacity to supply the markets if China was still building like mad. (1) (5) (6) (7)

Happy Christmas (Liquidity is Over)

Do not underestimate the effect of a lack of market liquidity on the price plunge among commodities-sector corporate bonds. I have written, on several occasions that the size of the high yield bond market has doubled since before the financial crisis. At the same time, the ability of proprietary trading desks to hold bonds has been halved. This has the potential to leave investors at the mercy of aggressive speculators.