The death of markets

The investment bank, Macquarie recently posted a note describing how the shifts in financial markets of all kinds are no longer based on fundamentals, but instead are driven by an over reliance on central bank intervention. The result is that, in Maquarie’s view this makes macroeconomic calls much more difficult to call.

The last several weeks witnessed one of the strongest reversals since the GFC. Following Brexit, the virtual implosion of the Italian banking sector and May poor payrolls, investors had to absorb a jump in Jun payroll and full panic mode by CBs, including: (a) flagged BoE easing; (b) a potential Japanese “helicopter drop”; (c) growing calls for public recapitalization of Euro banks; (d) easing by a plethora of countries; and (e) acceptance that Fed cannot tighten.

The result was a jump in asset price correlations, with both risk-on and risk-off assets delivering strong returns: (a) equities re-captured pre-Brexit highs on the perception that CBs would panic sufficiently not to worry about asset bubbles, and hence if corporates can squeeze some EPS, the stage would be set for a rally: (b) global bond yields collapsed across the entire term structure for both DMs and some EMs. Term premiums collapsed as investors accepted that risk of tightening is zero whilst there are very few signs of any inflationary shocks; and (c) gold rallied, driven by understanding that current policies would ultimately lead to either deflation or stagflation or hyperinflation. …can one make sense of these erratic changes? No

This has important implications for commodity markets. In theory higher prices should indicate to producers and consumer that there is higher demand and/or lower supply. Futures markets have always diverged from underlying fundamentals. But if markets are no longer providing signals based on these fundamentals then the trust in them as a ‘signal’ is broken.

We believe that global economy and investors are residing in the twilight zone between an era of relatively free market capitalist economies (with its own set of signals) and a new environment which is likely to be completely dominated by the state. Although most market signals (such as spreads) have already been degrading for a decade, we maintain that over the next year or two, free market signals would finally perish to be replaced by state-driven credit, spending and capital formation funded by CBs (what we call “nationalization of credit”). It would take the form of state-sponsored stimulation of consumption, investment, R&D and rescuing what essentially is a bankrupt financial super structure (i.e. banks, insurance, life and pensions). Whilst similar to FDR’s New Deal, it would be a far more distorted world than either the 1930s or the 1960s-70s, with brand new investment signals.

How do we know whether we have arrived at this state-driven paradise of public sector money and demand multiplication? As highlighted in our notes, we have four doorstep conditions for such a dramatic public sector shift, with high volatility and discontinuities being the most important. We don’t believe these conditions are yet satisfied, but the chances are high that they would be over the next 12-18 months. In the meantime, we still expect half-hearted “stop and go projects”. Japan is likely to be the first to ‘jump’ and wholeheartedly embrace this merger of fiscal, income support and monetary policies but others would eventually follow. It is just a matter of time. How does one invest? Ignore noise & stick to fundamentals.

Unlock commodity market insight now and subscribe to our email updates, follow on Facebook or

I think what this implies is that investors and physical agents in commodity markets need to adopt a much longer term view of how fundamentals could play out, i.e. the longer term impact of population growth, environmental degradation, rather than more short term factors. But this is no use for a farmer wanting to hedge next season’s crop or a manufacturer wanting to know a what price to buy aluminium for an upcoming order.

We maintain that conventional mean reversion strategies cannot work in the world of no conventional business/capital market cycles and broken market signals. At the same time, we maintain that macro calls are no longer possible (as cross-currents are too unpredictable) and would not come back until the new world of direct state sponsored growth arrives.

Originally posted on Macrobusiness

Buy the book Commodities: 50 Things You Really Need To Know from Amazon (US and UK), iBooks, Barnes and Noble, Google and Kobo. If you like the book please leave a review on Amazon. Reviews really do make a difference. Thanks.

Why the devaluation of the Chinese yuan poses the greatest threat to commodity prices

Since the UK voted for Brexit, prompting a sharp drop in the Pound, the Chinese yuan has fallen by 12% against the US dollar to 6.65 yuan per dollar – its lowest level since late 2010.

Last August a slump in the yuan to 6.6 to the US dollar sparked fears that the Chinese economy was in worse shape than investors believed. The move sent fresh shock waves through global markets, sending commodity prices further into reverse as traders feared the move could also ignite a currency war that would destabilise the world economy.

Unlock commodity market insight now and subscribe to our email updates, follow on Facebook or

The Brexit vote and the resulting financial fallout have sparked speculation that the US will delay increasing interest rates and that other countries may renew or expand quantitative easing programs. Despite the outlook for the global economy appearing weaker, industrial metal prices have risen sharply since the Brexit vote on hope of further stimulus.

According to Bank of America a 1% depreciation in the Chinese currency leads to a 0.6% fall in commodity prices. The relationship with the currency is the strongest for commodities such as copper and platinum, of which China is the world’s dominant consumer.

A cheaper yuan will erode the purchasing power of the Chinese potentially leading to reduced import growth. The move will also encourage greater exports. China has emerged as major exporter of mildly beneficiated commodities, such as aluminum and steel products and refined fuels. Taken together the fall in the yuan should push prices down, outweighing any benefit from easier financial conditions that a devaluation may bring.

The main impact of yuan devaluation is that it also causes currencies of commodity producers to decline. This lowers the cost of production, in U.S. dollars, thus allowing them to remain in business for longer in the face of low prices. Any sustained yuan devaluation, as long as it’s matched by currencies in commodity producers, will allow commodity prices to remain lower for longer, thus inhibiting the rebalancing of oversupplied markets.

Buy the book Commodities: 50 Things You Really Need To Know from Amazon (US and UK), iBooks, Barnes and Noble, Google and Kobo. If you like the book please leave a review on Amazon. Reviews really do make a difference. Thanks.

Why have zinc prices been so strong in 2016?

Since the start of 2016 zinc prices have increased by over 30% to over $2000 per tonne. Its nearest challenger is tin, up 18% while aluminium and nickel have only posted gains of 10%. Copper and lead meanwhile have barely changed since the start of the year.

2016-06-30_0532
So what has been behind the strength in zinc prices and what does it mean if anything for other base metals?

Unlock commodity market insight now and subscribe to our email updates, follow on Facebook or

Falling production: Several large zinc mines have closed in recent years as reserves have dried up. Meanwhile over the past year other mines have cut production, finally reacting to the earlier fall in prices. According to the International Lead and Zinc Study Group (ILZSG) mine supply outside of China is forecast to contract by 9.4% this year due to a combination of mine closures and price-related cutbacks.

Declining stocks: Refined zinc stocks in LME approved warehouses have declined by almost 60% over the past year. However, some in the market believe that stocks have just been moved to other warehouses rather than actually being used by industry.

Higher Chinese demand: More than half of zinc production goes into coatings to protect steel from corrosion. According to the World Steel Association Chinese production hit 70.5 million tons in May, up 18% from January/February levels. Indeed, China’s imports of refined zinc climbed about 45% in the first five months of the year.

The concern is that any further rebound in the price will discourage other miners from cutting production, or indeed those that have already cut from ramping up output. Indeed, a look at historical base metal price cycles suggests that zinc prices just haven’t stayed low enough, for long enough to create the necessary environment for a sustained rebound in prices.

2016-06-29_2101

Copper and nickel prices tell a different story.

Related article: History points to nickel leading rebound in base metal prices

Buy the book Commodities: 50 Things You Really Need To Know from Amazon (US and UK), iBooks, Barnes and Noble, Google and Kobo. If you like the book please leave a review on Amazon. Reviews really do make a difference. Thanks.