Commodity markets were intended for commodity producers and end-users to limit volatility and risk in their business models. Manufacturers are only ready to continue producing when they can sell their products at a profit, and end processors are only ready to buy them if they succeed in making a profit from the sale of the goods they have completed. The creation of retail space for goods provided the only place to record these transactions at standardized times and qualities. Unfortunately, producers of goods want to sell only at high prices, and consumers of goods want to buy only at low prices. This has created market makers, floor traders and speculators who have entered the markets to provide liquidity by providing offers and offers between producers and end users. This week, we focus on creating commodity indices and exchange-traded funds created by the banking sector and what is the effect of the current period of low volatility and falling prices on the banks that created them.
The evolution of the markets has created an expanding network of commodity-related jobs through the staff needed to manage trading companies and direct the standardization of commodity contracts, storage and processing. Off-the-shelf companies such as the storage, supply and financing sectors have always been seen as ancillary to the primary objective of making raw materials accessible to end-users. Following the tragic events of September 11, the US Federal Reserve Board has begun to accept easier financing conditions for just about everyone. The cheaper money made it more convenient to borrow money and build a storage room to either fill up or rent a place to store others. This process was partly responsible for the commodity rally in 2008. The subsequent 6 years of lower price actions combined with forecasts of rising horizon deliveries have eroded the profitability of this model and are now contributing to commodity decline, just as the jump made at & # 39; 08.
The two commodity sectors that received the most heat during this period were the grain and energy markets. Food and fuel, life is sometimes so simple. These are also some of the easiest markets to store your physical goods. Major commodity companies such as ADM, Cargill and Monsanto have taken heat from the general public for what is essentially a business (albeit at higher prices). However, JP Morgan & # 39; s, Deutsche Bank, UBS, Morgan Stanley, Barclay & # 39; s, etc. they used their banking experience to get into the flow of commodity revenue. Initially, they participated indirectly through the practice of replacing the physical for the future risk of the underlying commodity and playing the role of intermediaries in the mediation process. Many of these companies have taken it to the next level by engaging in the physical holding and distribution of goods around the world, as start-up financing has become an insignificant expense for physical business in a zero interest world.
Wild volatility, cheap interest rates and generally high commodity prices have attracted more players than ever in the commodity markets. It became a party that no one wanted to miss. His latest appeal seems to be for many of those late arrivals and they are quickly getting out the door as lack of inflation, lower commodity prices in general and tighter regulation suck the profitability out of this once low-hanging fruit. Barclays, Deutsche Bank, Chase and Bank of America are currently limiting their commodity interests or leaving the sector completely amid tighter regulations and slow, shrinking markets. According to Bloomberg, raw material profit for the top ten banks in 2013 was about $ 4.5 billion compared to the high water mark of $ 14.1 billion in 2008.
We have published several charts that illustrate this point, as well as the true effectiveness of commercial traders in trading in the current climate. Commodity markets are reverting to their previous way of trading, which should take advantage of real commodity traders and leave emerging banks time to lick their wounds before missing the next big rally in commodity markets.
One of the main business models of the banking sector introduced for commodities was the ETF. ETFs such as COW and OIL (Oil) are designed to support the firm's banking customers, rather than allowing them to participate directly in the commodity markets through a commodity broker of their choice. In particular, the banking sector created unlimited, long only index funds that customers assumed would behave as the commodity for which they were built. Not only do most of these funds fail to track their core partners closely, but they also block the client from the two major benefits of stock-trading futures. First, commodity futures use a margin. This allows a market participant to invest part of the nominal value of the contract while using its excess money as a working currency. Second, ETFs do not allow short positions, which effectively eliminates 50% of profit opportunities. The end result is that banks put a margin on the stock market while extending excess reserves to customers. Finally, the bank accepts the other side of the customer's transactions, creating the bank's short position when the market falls and customers exit the market.
I apologize for the long-lasting and fundamental nature of the discovery, but there must be some background to discuss the current state of the markets. Going back to the six charts we published, you can see a general cross-section of the economy as a whole. We published crude oil, honey, soybeans, corn, gold, and 10-year cash notes, all of which were traded sideways to lower and do so with overall stability and no chop. These are the charts the news refers to when it comes to "declining commodity volatility". In addition, their declining prices have diminished the profit potential of warehouses purchased or built by large banks. All and all, the markets are relatively tidy and deflationary trading has ruined many of the major business models of the big banks.
Our business is trading in goods. It began more than 150 years ago when the first Waldock came from Herfordshire, England as pig farmers. Our trading philosophy has always been an attempt to establish the true value of something using whatever tools were available to us at that time. My grandfather used to travel the country east of the Mississippi with a briefcase full of money and a giant gun (at least he was a giant as a kid) and make every purchase in person. My father used tape and hotlines to set prices in different regions of the country. I now use merchant engagement reports with a neural network to determine not only the size of the merchants' actions, but also their desire to act at certain price levels.
This brings us to the recent sales of commodity prices and the exit of commodity markets by many of the world's largest banks. Referring back to the charts, the merchant's momentum is the lower bar chart. Red is negative and blue is positive. Clearly, a major market sell-off puts these markets in the area of value of trade debt hedges. The typical model is to continue to buy long hedges as raw material input costs decrease in order to increase the profitability of future finished goods production. Looking at the charts, we are told that refiners stock up on crude oil under $ 98 a barrel, soybeans and corn under $ 12 and $ 4.50 a bushel respectively, and honey below $ 3.15 a pound and finally gold below $ 1300 an ounce. The fall in prices, coupled with the corresponding decline in volatility in many sectors – cereals, basic materials, precious metals and energy, paints a very solid picture of the reach markets for the foreseeable future.
These types of markets with limited reach, ebb and flows, which are increasingly lacking in index and speculative trading, respond extremely well to the negative feedback model that traders usually use. This means that the farther from equilibrium the market falls, the more the trade hedge (long or short) will add to its position as they make appropriate production assessments of their firm in the future at new market price levels. This is clearly evident from the charts as short-term market movements continue to push the market in one direction; you can see how the trading position is growing in an almost equal and definitely opposite direction. This is also called "average reverse trading". Markets are being sold, and declines are being bought based on the expectation that the market will return to the last levels to provide us with profits.
The fall in prices and the volatility of commodity markets had to happen simply because the legislation of easy money forced the market to find a door to use for excess returns. This door has become an opportunity for swap, storage and distribution in the commodity sector. In many ways, the common business of the last ten years is very similar to a long trading trend. Those who were in the beginning obviously had the greatest ability to make money, while those who remained late were competing for profits at the expense of declining margins and increasing regulation, not to mention higher interest rates on the horizon. I am proud of the value style of trading that we have developed over the years and grateful for a background that has always taught me that the market is always right.