Global Crisis/Innovation Blog

Commodity Price Collapse: Why Commodity Prices Are Becoming the New Las Vegas

By Shlomo Maital

 

 Silver: Definitely not a gold mine for investors  

 

On Thursday May 5, a startling decline occurred in the prices of commodities, fulfilling a short-term prophecy made by Goldman Sachs last month.  Goldman Sachs’ chief commodity trader closed out long positions in April, causing ridicule and laughter. Turns out he was right, showing the huge advantages of strong independent thinking.

      The price of oil plunged, with Brent crude losing $12 yesterday, or 10 per cent, to trade at around $109 a barrel.    Silver, just a few days ago trading at around $50, is now back down to $35, having suffered its steepest crash since the 1980s. (Since 29 April, silver has crashed 23.3 per cent).   London Mercantile Exchange tin is down 9.8 per cent, palladium has lost 10.4 per cent, gold lost 4.5 per cent and brent crude 9.1 per cent.  In the US last night, the price of a barrel of oil was back below $100.  

 What in the world is going on?  The explanation seems fairly straightforward.  US and global economies are slowing.  And commodity prices, which are always a play on excess liquidity (money) and future inflation, have suddenly done a U-turn, when that inflation seems unlikely to occur.  According to Pulitzer Prize winning columnist Dave Leonhardt (NYT):

     For the second straight year, the recovery seems to be at risk of stalling. The economy grew at an annual rate of only 1.8 percent last quarter — eerily similar to the 1.7 percent growth last spring, just when job growth started slowing down. Fully 80 percent of people say the economy is in fairly bad or very bad shape, according to a New York Times/CBS Poll last month. More people say it’s getting worse than getting better, the opposite of a few months ago.   …The typical financial crisis has caused unemployment to rise for almost five years, according to historical work by the economists Carmen Reinhart and Kenneth Rogoff.  We are well ahead of that timetable, thanks to aggressive action by the Fed, the Obama administration and, in its final months, the Bush administration. But our working assumption should be that this recovery will remain at risk for a long time.

    In the American and global economies, we are going to be riding a seesaw for years to come.  News will alternate between optimism (inflation) and pessimism (deflation), and commodity prices will become highly variable.  Ironically, this variability itself will attract new players, because potential profit (and loss) rises in direct proportion with variance.  In the Black-Scholes option pricing equation, the higher the variance of the asset price, the higher the option price.  Look for commodity prices to become the new Las Vegas.   

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