Commodities' Merry Poppings

Let's set up a small comparison across three time periods. The color-coding scheme will remain uniform throughout.

1. July 19-Oct. 17, 2007 (green). This is the period between the July global bull-market high and China's acquiescence to a more rapid revaluation of the yuan. As I noted in January, a stronger yuan is a powerful fundamental in our financial markets
2. Oct. 18, 2007-Jan. 30, 2008 (blue). This is the period extending to the most recent cut in the target federal funds rate. All charts are sorted on this period
3. Jan. 31-Feb. 29, 2008 (red). This period encompasses the latest commodity surge

Average Daily Returns For Commodities Over Selected Periods

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Source: Bloomberg

The only commodities whose returns declined between Period 2 and Period 3 are corn and gold, both of which are still in identifiable bull markets. Did the financial markets trigger the commodity price increases?

The Yuan

A stronger yuan buffers commodity price increases for Chinese importers, so we might expect this to be a powerful factor, especially for those industrial materials of which China imports vast quantities. Period 3 correlations of returns for the commodities against the yuan fell only for silver, platinum, and both hard and soft red winter wheat.

Comparative Correlation: Commodities Vs. Chinese Yuan

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Source: Bloomberg

The euro, which gets so much of the attention when people talk about the dollar, has been less of a factor. Its Period 3 correlations of returns against the commodities rose for aluminum, zinc, cocoa, copper, lead, nickel, coffee and natural gas. Interestingly, Period 3 correlations declined vs. those for Period 2 for those two "headline" commodities, gold and crude oil, whose movements often are attributed to changes in the euro.

Comparative Correlation: Commodities Vs. Euro

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Source: Bloomberg

Repo Rates

The short-term interest-rate markets have been distorted by the flight to quality, risk aversion and the credit crunch affecting LIBOR at the end of 2007, but we can use the repo rate as a relatively clean measure of short-term interest-rate trends. The repo rate is secured by collateral, lies just over the T-bill rate on the risk curve and is the most appropriate rate for commodity futures. If we convert the repo rate into a 90-day instrument price and correlate those returns against commodity returns, can we blame monetary largesse for what we see in the markets?

As a rule, no. Period 3 correlations, plotted inversely to account for the price-yield relationship, jumped for palladium, platinum, crude oil and sugar, but that is it. As much as many of us would like to blame irresponsible monetary policy for commodity inflation, the connection is not a strong one.

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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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