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Making money in the commodities sell-off

WHAT a difference a speech makes! The world of finance was mesmerised by ECB President Jean Claude Trichet’s Press conference not because the Eurozone’s economics data flashed a recession SOS but because the central bankers in Frankfurt finally acknowledged the economic softness in the data. Meanwhile, the commodities bubble has collapsed with a vengeance, along with the New Zealand dollar, a scenario I outlined just last week.

The collapse of the Euro-dollar, arguably the most overvalued major cross rate in international finance, collapsed as panic stop losses orders were triggered and dollar bears were skinned alive. For all the Jim Rogers/Goldman self serving superspike propaganda, I believe we have just witnessed yet another old fashioned financial bubble that has now burst. Crude oil could well fall as low as $50 in the next six months if global GDP growth contracts – and why not? Oil was, after all, $64 in January 2007 when the world’s credit markets were not in a nuclear winter.

The collapse of the Euro must be viewed in context of its spectacular rise since September, when Bernanke’s monetary helicopter kept showering dollar bills as subprime Armageddon engulfed Wall Street. So it was no coincidence that the Euro soared from 1.30 to 1.60 against the greenback even as crude oil prices skyrocketed to historic highs above $140 in July and the Fed’s overnight borrowing rate fell from a pre – crisis 5.5 per cent to a meagre 2 per cent now. The dollar is strong not because the US economy or banking system has emerged from its woes but because the market herd psychology has finally zeroed in the relative softness in the Eurozone data. Confidence indicators and factory orders in Germany, French manufacturing PMI and Spanish industrial production all have fallen off the proverbial macro cliff. While Trichet talked tough on “inflation expectations” and “second round effects”, the fact remains that even he could not ignore the macro softness message of the data. The result? A violent sell off in the Euro, sterling, crude oil, Aussie, Brazilian real and kiwi dollar. Yes, the commodities bubble was doomed. The odds of an ECB or Old Lady interest rate hike is now negligible, meaning my recommendation to buy short sterling call options are deeply in the money. Implied volatilities, naturally, are a screaming buy when big macro moves happen.

Of course, it is premature to bottom finish in the commodities market but Nathan Mayer Rothschild did make a fortune buying when blood was flowing on the Street. Take crude oil. Emerging markets demand is still strong so the increased Saudi production after King Abdullah’s Jeddah energy summit has not resulted in huge inventory builds, despite the slump in US gasoline and airline jet fuel demand. Shifts in the demand curve cause as wild swing in crude oil prices as swings in the demand curve. Joe Sixpack in America is selling his gas guzzler SUV’s, his job prospects are uncertain, his credit lines are slashed, his home is now financial leprosy, not an ATM cash machine. So even though US crude and product inventories are at low levels, prices have declined by more than $30 a barrel since mid July. The obvious conclusion?

One, higher Saudi production volumes were offset by production declines in the North Sea, Venezuela, Russia and the Gulf of Compeche. Two, emerging market demand has still not tanked, (no pun) despite the tight credit, slashed subsidies, inflation woes in India, China or Southeast Asia. But as an oil trader I never forget that high price demand elasticity in black gold cuts in both directions. If $140 crude softens demand, $80 crude could well stimulate it. The same equation holds for soybeans and corns, which soared on the Iowa floods and tanked when harvest returned to normal.

The capitulation trade in WTI and North Sea Brent is not over and speculators have been wiped out in from the futures pits of Chicago of the commodities bucket shops hours of the UAE. The bucketeers are a very special kind of hedge fund manger. Their payout is a per cent of the client’s losses because their “trades” are phantom accounting book entries, not real trades transmitted to a commodities exchange via a credible clearing broker, not Chop Suey Commodities, Licensed to Kill, Shear and Slaughter/Leader.

I have argued that $147 crude oil was not demand for oil tankers but demand for oil futures, options and indices by speculators. But the CFTC has now cracked it whip in Chicago. Crude oil traders must slash long positions, hedge their negative gamma risk on put sales, scramble to escape the Congress axeman. Natural gas prices have been massacred since last month crashing from $13 per million BTU in early July to barely above $8 now. This is insane and a NYMEX nat-gas call spread is the obvious money making strategy as downside risk-return calculus is overwhelmingly in favour of this trade. I have to be short as Dr. Copper is a loser as US housing remains in Deadbeat City and the Baltic Freight index, an indicator of Chinese shipping demand, is in free fall. ‘08-08-08 was obviously not Super Duper Auspicious Number for base metals prices, nor for the Shanghai A shares casino that dropped 5 per cent on Chinese civilisation’s biggest coming out party in 5000 years. Stay short lead, nickel and zinc on the LME. I still believe gold prices will fall below $800 an ounce in the next month as some central banks in Europe are cheating on the Washington Agreement and Indian bridal budgets have been hammered by the (blush, blush) Sensex.

LME aluminium could be the long against short nickel or lead (inventory glut, lousy fundamentals). GCC gas shortages, Chinese and South African power generation woes could well support prices above $3200/mt.

Even when the grizzlies roar in the world of commodities, money making trades rhyme if you listen hard enough in real time.