During last week’s roller-coaster ride on markets, most of the focus was on the wild swings in the value of equities, bonds and currencies. Almost overlooked was the fact that commodities also had a shocker of a week.

According to Reuters, long positions in commodity futures were slashed by $US21 billion — nearly 20% — even as financial markets generally were just starting to seize up. With the share prices of local resource companies ending the week 16% below their year-highs and commodity prices generally sliding through the week, it would appear safe to assume that particular rout continued.

That there was a sell-off isn’t surprising. Behind last week’s turmoil in markets was a general dialling down of risk and a flight to US treasuries that pulled the rug from under most financial assets where there was a perceived trade off of risk for enhanced returns, including the Australian dollar.

What it does point to, however, is an acceleration in the unwinding of speculative exposures to commodities. Earlier this year there was a lot of discussion about whether there were elements of a “bubble” inherent in commodity prices, with hedge funds driving up prices in carry trades exploiting the ability to borrow at no real cost in the US.

The Federal Reserve Board monetary policies, with zero official rates and the quantitative easing programs that left the markets awash with liquidity were, of course, designed to encourage investment in riskier assets.

If there were a bubble in commodity markets, it started to deflate in June as the Fed’s QE2 program neared its end and then really gathered pace this month amid the broader market mayhem.

While that probably reflects simply the general retreat to perceived safety for the speculators, the gloomy outlook for global growth created by the public debt issues in Europe and the US and considerable discussion about China’s ability to sustain its growth rates within a global slowdown and concerns about its inflation rate would also have been influences.

Earlier this year, Glencore’s Ivan Glasenberg referred to “froth” within the commodity markets and indicated it would not be such a bad thing if some of that speculative activity was blown out of the markets.

It’s doubtful that he was looking for quite what has transpired, given that Glencore’s share price is now down more than 23% from the levels at which it was floated only three months ago (although the cynics will say that suspicions Glencore floated because its principals wanted to cash out some of their holdings at the top of the market have been confirmed).

Lower commodity and resource company share prices aren’t, of course, necessarily a bad thing for Glencore, China or the established resource houses. It ought to mean that marginal mines are even more marginal, or uneconomic, and that smaller resource companies without the cash generation of the majors will find it more difficult to get their resources into production. It could create a backdrop for further consolidation of the sector.

Those could be positives for the longer-term supply-demand equation and the sustainability of prices that still represent a major departure from historical long-term trend lines, while taking some of the edge off the pressure that raw material costs have been exerting on China’s economic settings.

Commodity prices could be turned around if concerns about the stability of the eurozone and the US economy were to subside, or the Fed embarked on another round of quantitative easing — although, given that the value of the trillions of dollars that were parked in treasuries last week is already being eroded in real terms, that by itself could set off another even more unpredictable round of fear, loathing and hyper-volatility.

*This first appeared on Business Spectator.

Peter Fray

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