Commodities' Merry Poppings

Editor's Note: This is a republishing of a column originally published on March 4, 2008.

The difference between good traders and bad traders is not how often they are right; it is how long they let their profits run and how quickly they exit their losses. What about market commentators? Speaking for myself, I cannot let it bother me when I am wrong, especially if unforeseen events blow my analysis out of the water. All I can do is admit it, correct it and keep on keepin' on.

What bothers me more than anything else is when I append, "But I hope I'm wrong" to a forecast and turn out to be right. Some people seem to take pleasure in watching a negative outlook come to fruition; I do not.

Consider an October 2001 column on how I thought commodity prices, high-yield bonds and emerging markets would rally over the following three years in response to lower interest rates. The high-yield rally is long behind us, the emerging-market rally never really paused and the commodity rally, which has had several stops and starts, is now moving like someone attached a rocket to a key body part. What is behind the latest surge?

A Market Of Commodities

First, let's return to a point made first in May 2004 and repeated several times since, that there is no such thing as "commodities" as an undifferentiated asset class.

We have a collection of unrelated markets, often with negative correlation of returns between them, whose only linkages are they are tangible and traded on an exchange. For this reason, let's use a set of 19 different cash markets (except for coffee, where a continuous front-month future will be used) instead of an index. Cash markets eliminate the distortions of contract rolls.

Second, let's ask the very simple questions whether the spectacular leaps seen in a number of physical commodity markets in recent weeks have been the result of three obvious causes from financial markets: higher expected inflation, a weaker dollar and lower short-term interest rates. In the case of the dollar, the same split away from an index approach will be taken, and we will use the Chinese yuan and the euro as the markers.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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