Commodities Take a Spill

Almost one year to the day of the Flash Crash, commodities took a spill.



The cause? Simple. More sellers than buyers (love that answer). Why? People have been piling in to commodities (a trade you can apply a ton of leverage to) for the past 10 months. As a result, it should be of no surprise that the dollar rallied today as part of the unwind - see more here. For everyone claiming this is a crash, forget about it. Commodities, including silver, are still way up in bubble territory.

Bubble or not, I did dip my toe in and bought a bit of CEF near the close at what turned out to be a 8.5% discount on the theory of an oversold market (hat tip Kid Dynamite).

Source:Bloomberg

More on Contango

FT Alphaville with a great post "Is ‘cash for commodity’ the biggest trade in town?" explaining why commodity curves are in contango (demand from passive indexers) and the benefit to producers (a cheap source of financing). I have been sitting on the below post explaining how this translates into an investment in a passive commodity strategy (hint... not good) so I thought the time was right to finally post it.

Wikipedia explains roll yield, so I don't have to:

The roll yield is the yield that a futures investor captures when their futures contract converges (or rolls up) to the spot price in a backwardated futures market. The spot price can stay constant, but the investor will still earn returns from buying discounted futures contracts, which continuously roll up to the constant spot price.

Note that in case of a market in contango, the roll yield is negative - since the price of the futures contract trades higher than the spot price, and rolls down to converge towards the spot price.

Said another way, backwardation means the futures price is below the current spot price (i.e. the curve is downward sloping), thus the investor gaining exposure via futures will outperform the underlying spot market (all else equal). Contango means the exact opposite situation (this was explained recently regarding the VIX ETN VXX in the EconomPic post When ETNs Attack). In addition, as explained by FT Alphaville, this negative drag is the "subsidized financing" received by commodity producers "selling" their commodities in the futures market.

How much of an impact does this have? Let's take a look at the impact via the excess roll yield of the S&P GSCI Commodity Index futures vs. spot.



As can be seen above, the futures market has consistently underperformed the spot market since mid-2004. By how much?



A lot...

Coffee Crisis? Not really...

FT reports:

Caffeine addicts face higher prices for their daily fix as the wholesale cost of both coffee and sugar rise sharply because of poor crops and robust demand.

“We are in a dangerous situation,” Andrea Illy, chief executive of Italy’s leading coffee ­company, told the Financial Times, warning that prices could “explode” due to supply shortages.

His comments echo those of other industry players – and point to a sharp shift in sentiment among analysts.

Until recently, it was widely assumed that the global economic crisis would damp consumption and prices for coffee. However, that forecast proved wrong, since demand for coffee has remained high, even while consumers have moved from cafés to home drinking.

International coffee prices last week hit a seven-month high, rising to $1.28 per pound, up 22 per cent from their December low, in New York trading.

Scared me for a second.



It looks like coffee has gotten hit by the recent rebound in commodities, but that's like saying "oh no, gas is back to $2 a gallon". Lets just be thankful that coffee isn't back to the equivalent of $4 a gallon.