Destroying the recovery ex-ante ?
A funny thing happened this week with a remarkable change of tactics inside the FOMC, the rate decision organ of the Federal Reserve. Whilst almost every one was anticipating some form of new (h)opium to please the bulls, the minutes of the March meeting showed exactly the opposite. Some might argue that these minutes from the FED desperately try to achieve a virtuous confidence circle on the economy by stating "no need for stimulus". I think there's something else going on, ie commodity trading annex correlations, and the fact that the QE efforts undermine the recovery by its side effects on this particular asset class.
This week, may be some missing pieces of this puzzle have been provided by a study published on voxu : http://www.voxeu.org/index.php?q=node/7841
It goes a little bit deeper into the recent rise of "financialisation" of commodity market, more specifically, into the high correlation between equity indices and commodities since the Lehman fall. Most of all, it focuses on the rise of high frequency trading on various commodity markets. And the numbers are impressive indeed as shown by the following chart :
Simultaneously, the authors also discover a persistent significant correlation between commodity prices and stock market returns since 2007, most significant on oil but also on other more soft commodities :
And then we come of course to the following question : does this matter ? I am afraid very much so because commodity movements have been brutal with considerable volatility. But at the end of the day, this price volatility determines the price of what you and I are served upon our daily plate. And what others in the world can no longer afford to consume for that matter as well (Arab spring rings a bell ?). According to my opinion, the authors rightfully conclude :
In our view, this finding adds to the growing empirical evidence supporting the idea that the financialisation of commodity markets has an impact on the price determination process. Indeed, the recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. I n fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed. Moreover, given the large selection of commodities we analyse, we would expect to have different behaviours due to their seasonality, fundamentals, and specific physical market dynamics. Yet, we do not observe these differences at any frequency. In addition, the fact that these correlations at high frequencies started during the 2008 financial shock provides additional support for the idea that there are financial-based factors behind this structural change. Therefore, the very existence of cross-market correlations at high frequencies favours the presence of automated trading strategies operated by robots on multiple assets. Our analysis suggests that commodity markets are more and more prone to events in global financial markets and more likely to deviate from their fundamentals. This result is important for at least two reasons. First, it questions the diversification strategy and portfolio allocation in commodities pursued by financial investors. Second, it shows that, as commodity markets become financialised, they are more prone to external destabilising effects. In addition, their tendency to deviate from their fundamentals exposes them to sudden and sharp corrections.
And it matters of course for other reasons : commodity inflation is bad for purchasing power, bad for corporate profit margins and hence the recovery. So after all it might not be such a bad idea to stop the artificial support of the stock market by QE ad infinitum : A red rag on commodity bulls and algo trading is not what the world economy is looking for right now.