They have created a traders’ paradise, with oil on a particularly wild ride. But this has not been based on supply/demand fundamentals. Instead, it has been due to hedge funds jumping back into the commodities market. They don’t care about supply/demand balances – these are irrelevant for them.
They only care that the US Federal Reserve has again been trying to push down the value of the dollar against the Japanese yen and the euro – just as it did after the Crisis began in 2008:
- So they have rushed to buy globally traded commodities like oil and iron ore, traded in US$
- These are supposedly “stores of value” against a weaker dollar
- Natural gas isn’t globally traded, and so isn’t part of this revival of the “correlation trade“
- Therefore its price has stayed low, and in line with fundamentals
But the Fed is no longer alone in trying to push down the value of its currency.
- The Bank of Japan (BOJ) is desperate to devalue the yen, which has been surging since January – when the Fed backed off its promised interest rate rises and began to push the dollar lower. Friday saw Bloomberg report that the BOJ might offer negative interest rates on some bank loans. This caused the yen to have its biggest fall versus the US$ for 17 months. It was down nearly 3% during the week
- The European Central Bank (ECB) is also desperate to lower the value of the euro, and is now threatening to further reduce interest rates – which are already negative – in order to achieve this.
So the world’s 3 major currencies are on a collision course, and this is creating major volatility in commodities:
- The volumes traded in currency and interest rate markets dwarf commoditiy markets
- $5tn is traded every day in currencies. That isn’t a misprint – it is $5 trillion
- Only a small proportion needs to leak into commodity markets to destroy genuine price discovery
- $80bn found its way into commodity markets during the Fed’s last stimulus policy – and, of course, the growth of high-frequency trading multiplied its impact.
Oil markets are therefore acting as the proverbial “canary in the coalmine”. Their rising volatility (Brent prices fluctuated by an astonishing 13% last week) is warning that a new crisis may be on the way.
Essentally, chemicals are the flea on the tail of the “currency/interest rate dog”. As central banks wag the commodities tail, so chemical markets jump around, out of control – as the major petrochemical products have more than a 95% correlation to oil
- When the Fed tries to devalue the US$, oil prices rise
- And when the BOJ and ECB try to devalue the yen and euro, they fall
The decline of the US$ has been the main reason why oil prices have risen 50% this year – even though oil inventories have reached record levels – as the central banks have destroyed true price discovery.
In turn, their current behaviour creates great risks. The IMF meeting earlier this month saw an open argument between the USA and Japan. And in Europe, German Finance Minister Wolfgang Schäuble has warned the ECB:
“There is a growing understanding that excessive liquidity has become more a cause than a solution to the problem.”
None of us can know how these arguments will end. But we do know that it would be very dangerous for the world economy if Japan continues to fight the USA, and the ECB continues to defy the Germans.
When elephants fight, those around risk being trampled.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 58%
Naphtha Europe, down 55%. “Sentiment is supported by renewed buying interest from West Africa, although sales are being hampered by Nigeria’s payment difficulties”
Benzene Europe, down 53%. “numbers saw some gradual upward movement over the course of the week, in tandem with some gains on crude oil”
PTA China, down 40%. “Liquidity has dipped slightly on vigorous buying in recent weeks. Most are covered for May-shipment cargoes.”
HDPE US export, down 31%. “China’s domestic PE prices were on the downward trend in the week mainly due to weak demand.”
¥:$, down 9%
S&P 500 stock market index, up 7%