Tuesday, March 18, 2008

Commodity Prices Take a Big Hit

Commodities experienced a big sell-off yesterday.

Most commodities fell Monday, as investors sold oil, coffee and grains to cover deepening losses in stocks and bonds. But gold ended slightly higher, as safe-haven buying kept it above the key $1,000 level.

The Reuters-Jefferies CRB Index, which tracks 19 commodity futures, fell about 5%, its sharpest single-day slide in almost 40 years.

The sell-off in energy, base metals and crops coincided with margin calls on global financial markets and a dire need for cash in almost every financial industry as the fall of Wall Street's Bear Stearns shook the global economy.

Crude oil futures took their hardest tumble in almost two weeks, sliding more than 6%. Copper, one the most economically sensitive raw materials, was down 5%.

Coffee and cocoa lost as much 10% during their worst moments in Monday's trading.

Other key crops like wheat, corn and soybeans also slumped, many hitting limit-down for the session.

Most of these markets had rallied for months now due to a weak U.S. dollar. The currency fell again Monday, plumbing new lows against other major currencies. But commodities prices fell anyway.

The WSJ noted:

"People liquidate positions because they need money for other things," said Mark Waggoner, president of Excel Futures. "Sometimes they just bail out of everything."

Silver and copper prices fell, while gold, the traditional safe haven in tough times, shed most of its big early gains in the broader liquidation trend. Still, Comex gold for March delivery gained $3.20 per troy ounce, or 0.3%, to end at $1,001.40.

In grains, soybeans, corn and wheat all tumbled by the maximum amounts allowed by exchange rules. Sugar and coffee both fell more than 10%.

"You're seeing massive risk aversion," said Leonard Kaplan, president of Prospector Asset Management. "Everybody is getting out of everything, in every commodity."

The energy complex was particularly hard-hit, including a 6.9% drop in reformulated-gasoline blendstock, or RBOB, futures. This is the biggest drop for the front-month contract in its Nymex trading history.

"Today was such carnage ... sometimes I thought it was just throwing the baby out with the bath water," said Kevin Mallon at Prebon Energy, who called the decline in RBOB "overdone."

In other words, the reason for the sell-off was technical (the need to raise cash because of margin calls) as opposed to fundamental (a drop in demand). Here's a chart of the CRB index which shows the degree of selling:

One day does not a trend make. In other words, it's the long-term trend that matters. But yesterday's sell-off was very large. Some traders may want to continue taking profits -- especially after a long rally like we've experienced. On the flip side, the dollar is still dropping hard. And with the Fed expected to make a big rate cut today that trend should continue. A dropping dollar adds further upside price pressure to anything priced in dollars which is every commodity out there.