The best time for a sailor to set her rigging, stock her suppliers or plot her course is when seas are calm and the wind gentle. When the wind is roaring, and the swell is heavy they need to focus on seamanship and they need everything in order. The same is true of commodity risk management. When hedge funds are pouring into a market and speculating up prices, and emerging market demand is roaring, and floods in Chile are cutting into global stockpiles a buyer needs to focus on his hedging. He needs the right frameworks, policies, systems, and tools in place to support him. He does not need to be ‘re-rigging’ his sails as the market turns against him.
If we think of commodity markets as being like seas – i.e. they can be calm with steady, low prices and low volatility. Or rough with high or climbing prices or both and high volatility – then we are currently in the calmest global commodity markets in the past decade.
The 2013-2016 rebalancing of the Chinese economy from export manufacturing towards internal services, weak GDP growth in Europe and America, and strong supply across the commodity complex suppressed commodity prices from 2010 to 2015. As prices levels fell so did speculator and day trader profits which in turn lowered market volatility. Prices have picked-up from early 2016 lows for most commodities, but market volatility remains calm. Below shows the last 7 years of market activity in commodities using the Thomson Reuters and Bloomberg commodity indices.
Today’s commodity market environment puts hedgers and risk managers in a paradoxical situation. On the one hand low volatility means there is little pressure on them to act. Their month-to-month positions are not swinging wildly. On the other hand, without pressure from rapidly changing commodity markets, procurement and treasury teams can become complacent. There is very often little done with these rare opportunities to shore up a company’s defences against commodity risk and build up capacity to hedge and monitor markets. The best time to strategize and reassess policies and processes to deal with commodity risk is when there is little commodity risk. Much like our sailor will check her lines and patch up her boat when the sea is calm, the best time to prepare for commodity risk is when markets and calm.
At Flow&Ebb we often find our clients look for our help when markets are rising and are volatile which adds a layer of extra complexity to preparing them to deal with commodity risk.
Commodity market professionals will understand that these suppressed prices and calm markets will not last. We cannot say for certain when we will see market volatility return. Energy and industrial metals markets have already started to climb upwards which is pulling back in day-traders and other speculators which boosts volatility. Some small markets like Platinum are already accelerating ahead of the complex as rebounding economic growth in Europe, North America and the emerging markets drives up demand and erodes stockpiles. Agricultural markets remain suppressed from high supply overhangs, but we are seeing signs of the bumper harvests of the 2010’s ending.
The commodity supercycle theory states that commodity markets go through 15-20 year boom and bust cycles. In 2015 many commentators suggested we were at the end of a supercycle and a new one was beginning. If this is true then we’ll start to see a steady, but perhaps not rapid, increase in commodity market prices throughout 2018. As we approach the end of the year its likely that we will see higher prices and higher market volatility. Although we cannot say for certain if this will happen, what we can say for certain is that 2018 is prime-time to brush off your commodity risk policies, reassess them, and explore new processes and systems for dealing with commodity risk. Trust us – you want to do this before the market is too unpredictable, too chaotic and too tricky to deal with.