The "violent" fluctuations of commodities have spread to the real world

The sharp fluctuations in commodities and raw materials have caused consumer spending to soar.

Recently, U.S. commodity prices have risen more than historical prices in the modern trading era, and this "violent" volatility is shaking up futures markets that were designed to ease global raw material volatility.

This complicates the businesses of individuals and companies that actually produce and use natural gas, zinc or soybeans. This will "clear" speculators and others. A large number of investors left, which in turn led to more violent volatility and higher prices.

The Russian-Ukrainian conflict has exacerbated the chaos, especially in the energy and food sectors. Bad weather and supply chain issues complicate deliveries in some regions.

When rising prices have "drowned out" rising consumer spending, it has undoubtedly increased the pressure on the Fed to raise interest rates.

Everything is going crazy

In 2022, U.S. natural gas prices rose 79 percent. Usually, these gains disappear in the mild spring weather. Oil prices have fallen about $23 a barrel from their recent highs, but U.S. benchmark oil prices are still up 34 percent this year.

Coal, soybean oil, oats and rapeseed in the Appalachian Mountains; natural gas in the Netherlands, wheat, gasoline, diesel, propane, palm oil, copper and tin in Paris and Chicago all hit new highs in 2022. Soybeans, lean pigs, frozen pork belly and zinc didn't deviate too far from their record.

Consumer demand during the pandemic has driven this surge. After all, they are ready to spend with plenty of savings and government stimulus.

Factories, mines, drillers and farmers are working to increase supply. Conflicts between two of the world's largest commodity exporters threaten the production and delivery of important markets such as corn, oil and wheat. Continued weather changes have dried up farmland and depleted fuel reserves.

Tracy Allen, a commodities strategist at JPMorgan Chase &; Co., believes that inventories in various sectors such as energy, agriculture and metals are at extremely low levels. He expects the prices of these commodities to remain high until 2023. "There doesn't seem to be a good way to solve this problem." She said.

In the spring of 2020, commodity markets plummeted as much of the world was locked down due to the pandemic. U.S. oil futures fell into negative territory for the first time in April 2020, closing at negative $37.63/b. Some sellers are desperate enough to pay buyers to ship away their oil inventories.

It was also that summer that the stock market began to show early signs of a rebound. Quarantine measures are driving Americans' willingness to rebuild their living environments. Homebuilders across the country are lined up with buyers looking to build backyards and home offices and enjoy the lowest mortgage rates in history.

The timber futures market, which has been half-dead, began to rise wildly. In the summer of 2020, timber futures prices rose nearly threefold before falling back. In May 2021, the price of 2x4 wooden squares rose more than four times, and then fell to pre-pandemic levels in the summer. In the winter, the price has shown an upward trend.

Although this was the most lucrative period of the modern sawmill industry, volatility still made trading timber futures dangerous. Resolute Forestry, a large Montreal-based timber and pulp producer, also liquidated its futures positions after a $49 million trading loss in the spring of 2021.

A company spokesperson said Resolute made up for the loss by selling large quantities of spot wood, but then the company decided to exit futures trading. This is probably a huge loss for a market with fewer players.

More recently, open interest, which measures the level of market activity, was about a quarter of what it was in May 2018, when timber futures hit the previous index high.

In the period since, the price of timber futures has fluctuated dramatically, resulting in transactions being locked within the daily volatility limit and unable to continue trading. This also slows the liquidity of timber futures, as traders cannot unpledge, and these transactions are made to protect the value of warehouses filled with timber. Instead of being transported to construction sites, the timber is used to hedge potential trading losses.

Chain Reaction: "Double Reduction" of Transactions and Capacity

Other, more commodity markets, began to heat up in 2021, beginning a series of chaotic transactions.

China and other importers began to increase inventories, a move that drove up the prices of soybeans and corn. Bad weather has reduced harvests in South American growing areas. The La Niña weather phenomenon has led to droughts in the northern grasslands and poor harvests of wheat and oats.

The oversupply that has been pulling down U.S. natural gas prices for years disappeared last year. At the time, the hottest heat ever spurred demand for electricity for air conditioning, and the drought cut hydropower production in the west, creating more demand for natural gas.

Last fall during the heating season, natural gas rushed to its highest price since shale gas poured into the market more than a decade ago. Low inventories in Asia and Europe, approaching winter, and russian-Ukrainian conflicts have sparked a global scramble for LNG.

At the end of December last year, LNG replaced Russian natural gas and prices were inflated. The benchmark European gas price at one Dutch trading center soared more than 10 times a year. Electricity prices are also rising. Natural gas "big consumer" fertilizer plants, unable to bear the high cost, began to cut production.

Exchanges and banks that facilitate trading respond to rapidly rising prices by increasing the margin required of traders. This collateral, known as margin, can protect banks and exchanges from losses in the event that a wrong bet causes a trader to default.

Exchange operators, Intercontinental Exchange Corporation (ICE), have raised margin rates for European gas futures trading several times, reaching six times this year.

Even if interest rates were cut late last month to match a dip in oil prices, buyers and sellers would still have to submit €70.70, or about $77, as collateral for gas per megawatt-hour, compared to 3.87 a year ago, when the transaction price was one-fifth of what it is now.

This is an extreme situation, but the overall profit margins of commodity markets have improved, driven by exchanges and transaction management banks. Rising profit margins have led to fewer funds that traders can use in the market, and many traders have closed their positions instead of hoarding more cash.

ICE said the margin required for the Brent crude oil futures monthly contract was $11,920, or $11.92 a barrel. That's more than double the profit margin a year ago. When the latest profit margin was announced three weeks ago, the price of a barrel of oil soared from around $63 to around $115.

Traders and analysts say the increased cost and risk of trading commodities has depleted market liquidity — the ability to trade at the expected price without causing large price fluctuations or trading chaos.

Over the past year, the public interest rate ( i.e. market participation ) on major U.S. oil futures contracts has fallen by 25 percent, less than half of what it was two years ago. Public interest in U.S. natural gas and wheat benchmark futures has also fallen by more than 20 percent over the past year.

JPMorgan Chase's Allen estimates that as investors and trading algorithms move away from volatile markets, the entire commodity market, measured in value. Its opening price fell about $94 billion in the week ending April 1. "The number of contracts traded in these markets has dropped dramatically." She said.

Quantitative Brokers LLC uses algorithms to represent hedge funds, banks and asset managers.

Shankar Narayanan, the firm's head of research, said that because traders are careful in the illiquid market to avoid rash moves or large fluctuations, they are breaking down large transactions into small sizes, making prices difficult to determine.

Narayanan said the larger gap between buying and selling offers means higher volatility in almost every commodity.

Narayanan calculates that the average buy and sell offer size of U.S. crude futures is down 81 percent from a year ago, to its lowest level since 2008. The size of the offer for U.S. natural gas futures fell 62 percent year-over-year. Corn futures quotes shrank by 75 percent.

Maximum one-day gain

Last month, Christopher Salmon, chief financial officer of commodities trading firm Trafigura Group, said at the Financial Times Global Summit in Lausanne, Switzerland, that "this inefficient futures market will affect physical markets." "Companies like him would rely on futures markets to manage the risks of global commodity shipments." Reduced trading volume means less shipments and higher prices.

In the United States, chaos in the futures market has pushed up consumer prices. At the end of January, expiring natural gas futures contracts rose 46 percent, the biggest one-day gain ever.

In the afternoon, as oil prices plummeted, the "circuit breaker mechanism" designed to maintain market order also began to fail, and bitcoin trading was interrupted more than a dozen times.

The timing and precision of the move, as well as the number of trades involved, suggest that speculators who have been wrongly bet on price movements begin to buy futures at the 11th hour of trading. This situation, known as a short-term squeeze, has little to do with market fundamentals but can lead to a sharp rise.

According to the American Public Gas Association, a representative of hundreds of gas companies, much of the gas sold to residential users is related to futures prices, which have risen sharply, meaning that the cost of heat and electricity that many Americans will pay in February will increase significantly.

"These higher fuel costs must be passed on to consumers." Trafigura President Dave Schlieffer wrote in a letter to the Commodity Futures Trading Commission calling for an investigation into the spike in oil prices. A spokesman for the Commodity Futures Trading Commission declined to comment.

Energy cost increases have been particularly severe, leading to a general strain on household budgets. Data released tuesday by the Bureau of LaborStatistics showed that energy commodities rose 48 percent year-on-year in March. Headline inflation rose 8.5 percent, its highest level since December 1981.

According to the Food and Agriculture Organization of the United Nations, global food prices jumped to all-time highs in March.

Subsequent

Economists at Goldman Sachs Group Inc. estimate the past year. The increase in commodity prices accounted for 1.9 percent of U.S. consumer spending. Before the 2008 crash, the percentage was 1.8 percent.

When the Gulf War doubled oil prices and plunged the U.S. economy into a brief recession of 1990-1991, that was 1.2 percent. Commodity prices also soared during the Arab oil embargo in the 1970s, consuming a larger portion of the U.S. budget.

While strong wage growth has helped consumers keep pace with rising costs, Goldman Sachs economists expect commodity prices to limit economic growth this year.

Central banks are responding by raising interest rates. Last month, Fed officials approved the first rate hike in more than three years, raising the benchmark rate to between 0.25 percent and 0.5 percent, and expecting further rate hikes this year.

Investors are fleeing risky investments to those they expect to follow commodity price increases, offsetting the corrosive effects of inflation elsewhere in their portfolios.

Higher interest rates introduce opportunity costs and reduce the attractiveness of tech stocks for "speculation." Tech stocks stopped outperforming for years, causing the Nasdaq Composite to fall 15 percent this year.

Of the S&P 500, the 21 best-performing stocks this year are all energy, fertilizer or other commodity producers.

"Everyone is looking for hedging," said Louis Navier, chief investment officer at Navier Asset Management. The fund manager from Renault, Nevada, has been buying shares of oil producers, such as Conoco-Felm and EOG Resources Inc., which have risen 39 percent and 40 percent, respectively, so far this year. In addition, shares of fertilizer producers such as CF Industries also rose as much as 55%.

This article originated from the Alpha Workshop Institute