Yesterday was quite a weak day in the commodity markets, with a few staging 'outside reversals' on their charts.  It appears some (much?) of this weakness was due to a report by the very influential Goldman Sachs to close out a trade they had offered to their client base in December 2010.  Obviously we won't know until down the road if this was a 1 day hiccup, or the start of something bigger. As QE2 comes to its conclusion in June, and traders begin to front run that event, the price action in commodities the next few months should be very interesting.  We also need to see if the dollar can show any signs of life in the coming months, as part of this commodity trade is simply a direct correlation to the weakness in the currency.

  • Oil and metal prices fell back ... after Goldman Sachs warned that the recent commodities boom is probably running out of steamFour months after advising its clients to put their money into crude oil, copper, cotton and platinum, the Wall Street firm declared that they should close the trade. The CCCP basket, as it is dubbed, has delivered profits of around 25% since December, when Goldman tipped it.  Goldman is the world's biggest commodities trader.
  • Although we believe that on a 12-month horizon the CCCP basket still has upside potential, in the near term risk-reward no longer favours … the basket, said Goldman's commodity team in a research note.
  • Goldman argued that the high oil price, and the economic damage caused by the Japanese earthquake and tsunami, is likely to dent demand for copper and platinum. Copper also remains vulnerable to slowing observed demand as high prices and tight credit motivate tight inventory management from key consumer China, it added.
  • The recommendation knocked nearly $3 off the cost of a barrel of Brent crude oil, which fell to about $123.40. US crude fell by a similar amount, to $109.20. Platinum and copper, which had been trading near recent highs, also fell back.
  • The CCCP basket has a 40% weighting in oil, 20% copper, 20% platinum and 10% cotton. The final 10% of the trade is devoted to soya beans, which Goldman believes are likely to keep climbing in value. Soya bean imports to China have risen by 51% in the last year, as the country feeds its growing number of pigs and other livestock.

Part of Goldman's issue is the level of speculation in commodities markets; every Tom, Dick, and Harry is in the same trade and we saw in 2008 what happens when that reverses.

  • Critically, Currie highlights the sheer level of speculative bullish bets in the oil market. Any number of bearish catalysts could lead to a disorderly unwinding of such record speculative length, and a sharp retreat in prices.   Not only are there now nascent signs of oil demand destruction in the United States, but also record speculative length in the oil market, elections in Nigeria and a potential ceasefire in Libya that has begun to offset some of the upside risk owing to contagion, Currie noted.
  • Goldman estimated in a research note on March 21 that every million barrels of oil held by speculators contributed to an 8-10 cent rise in the oil price.  
  • ....investors accumulated the equivalent of almost 100 million barrels of oil between mid-February and late March on top of their existing positions, adding approximately $10 to the 'risk premium', Goldman said.
  • The U.S. Commodity Futures Trading Commission said that as of last Tuesday, hedge funds and other financial traders held a total net-long positions in U.S. crude contracts equivalent to a near record 267.5 million barrels.
  • Using Goldman's estimates, that indicates the total speculative premium in U.S. crude oil is currently between $21.40 and $26.75 a barrel, or about a fifth of the price.  (wait, I thought speculators only contributed to liquidity in commodities aka God's Work, and did not affect price? or so that was the argument in 2008) :)

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