“In recent years, the wild swings and volatility of the markets has become greatly magnified, due to the actions of high frequency traders (HFT), who specialize in day trading, – the buying and selling huge blocks of equities, often moving in sync with whatever direction the wind might be blowing on any given day. Two-thirds of the trading volume on the New York Stock Exchange and Nasdaq is now handled by computer programs, that doesn’t require any human input. While equity markets are still the favorite den of speculation for HFT traders, many of these “black box” traders are now setting up shop in the commodities markets.”

If traders in the commodities markets were to check into a Psyche ward, the files would no doubt read “Bi-Polar” or Schizophrenic.” This is so, because commodity traders have a habit of fixating on a set of data one day, and then quickly forgetting about the data the very next day, and re-focusing on something else. Market sentiment often turns on a dime, and without notice. This shifting of sentiment in commodity futures is nothing new, of course. That’s why for decades, dabbling in commodities was considered too risky for most investors, since sentiment, by definition, is unpredictable and impossible to measure.
 
Bipolar disorder, describes a set of behaviors that causes people to have big swings between severe high and low moods, and switching from feelings of being overly happy and joyful to feelings of sadness and depression. Because of the highs and the lows — the condition is referred to as “bipolar” disorder. In between episodes of mood swings, there are moments of so-called normalcy. Schizophrenia on the other hand is characterized by delusions, hallucinations, and incoherence, and is classified as a “thought” disorder while Bipolar Disorder is a “mood” disorder. In either case, these traits help to explain some of the reasons behind erratic price movements on a daily basis that vexes many retail traders.
 
In 2011, commodity traders started out with a positive frame of mind. The Federal Reserve’s money printing operation, dubbed “QE-2,” was running at full steam and flooding the world with cheap dollars. However, markets do not travel in straight lines. There are always zig zags along the way. There were numerous minefields that commodity traders had to navigate through, before reaching the finish line for 2011. There was the loss of Libya’s oil output, an earthquake and tsunami in Japan, the Silver bubble, the collapse of the Greek bond market, the Bank of England’s QE-2 scheme, the ECB’s 11th hour rescue of the Euro-zone’s banking system, and finally, signs that China’s factory sector was sagging under the weight of Beijing’s monetary tightening campaign and clampdown on real estate.
 
In recent years, the wild swings and volatility of the markets has become greatly magnified, due to the actions of high frequency traders (HFT), who specialize in day trading, – the buying and selling huge blocks of equities, often moving in sync with whatever direction the wind might be blowing on any given day. Two-thirds of the trading volume on the New York Stock Exchange and Nasdaq is now handled by computer programs, that doesn’t require any human input. While equity markets are still the favorite den of speculation for HFT traders, many of these “black box” traders are now setting up shop in the commodities markets.

At the peak of the commodities boom in April 2011, about $412-billion was stashed away in managed commodity funds, buoyed by the Fed’s radical QE-1 and QE-2 money printing schemes. The Fed’s experiment with QE was a huge success, that is to say, the Fed was able to conjure-up the illusion an economic recovery by simply printing vast quantities of paper currency that was covertly channeled into the stock market through its agents on Wall Street. Furthermore, the Fed proved that it could prevent the specter of deflation, by cheapening the value of the US-dollar in relation to other currencies. For eight straight months, the Dow Jones Commodity index zig-zagged its way higher, as the Fed fulfilled its pledge to inject $600-billion of freshly printed US$’s into the coffers of the Wall Street Oligarchs.
 
When the Fed first telegraphed its QE-2 scheme in August 2010, the high octane MZM money supply was languishing at a -2.3% annualized rate. By the time the Fed finished QE on June 30th, 2011, – MZM was expanding briskly at a +9.9% clip. Some traders reckoned the Fed was aiming to artificially inflate the value of the US-stock market, others figured the Fed was trying to spur Beijing into appreciating the value of the Chinese yuan at a faster rate against the US-dollar. Whatever the Fed’s motives for QE-2, rioters soon began taking to the streets in Algeria, Jordan, Libya, Morocco, and Yemen, ostensibly aimed at toppling repressive governments, – but also expressing extreme anxiety and anger over skyrocketing food prices, that was fueled by hallucinogenic effect of QE on traders in London and New York.
 
Commodities are priced in US-dollars, and with the Fed flooding the world with dollars, traders piled into markets. Copper climbed to a record $10,000 /ton in London, North Sea Brent rose to $125 /barrel, Corn futures in Chicago hit $7.50 /bushel, Silver futures soared to $49.50 /oz, and rubber jumped to all-time peaks in Shanghai and Tokyo. Coffee, cotton, and sugar also soared to all-time highs. Tyson Foods’ (TSN.N) chief operating officer predicted a “new norm” for corn prices at $7 a bushel that was pushing up costs for cattle, chicken and hog feeders. Corn prices had nearly doubled since the middle of 2010, and Tyson said it expected to spend $500-million more on grain in its fiscal 2011, a +13% increase over the roughly $4-billion the company spent on grain in 2010. Regardless, the Fed’s policy remained unchanged; – aiming to inflate the value of the stock market with unlimited injections of liquidity and locking short-term interest rates at near zero-percent, which in turn, fanned wild-eyed speculation.
 
While the Fed wasn’t scheduled to turn-off QE-2 until the end of June 2011, some commodity traders decided to jump off the QE-2 bandwagon a few months early. They figured that the bullish trade had become too crowded, and that the timing was ripe for a nasty shakeout. On April 12th, Goldman Sachs shocked the markets, by urging its clients to dump positions in crude oil, copper, cotton and platinum. On May 3rd, Societe Generale joined Goldman Sachs in warning of tougher times for commodities prices. “The conclusion of the second round of quantitative easing, (QE-2), will deprive commodities of a key ingredient of their winning streak,” the French bank said. “This suggests that the commodities bull-run support by QE-2 may run out of steam in the third quarter if the global economy shows any signs of weakening. The end of QE-2 on June 30th could well herald the end of the commodities bull market. If emerging market economies slow and abundant liquidity dries up after QE-2, deflation fears may be back on the agenda in the second half of 2011,” SocGen warned.

Two-days later, on May 5th, commodity markets were rocked by a nearly unprecedented onslaught of panic selling as modest early profit-taking snowballed into one of the worst days on record. In a slide reminiscent of the steep sell-off in the wake of the 2008 financial crisis, Brent crude oil dived a record $12 /barrel, and natural gas dropped over -7%. Tin was the biggest loser among industrial metals, shedding -7% to $28,500 /ton at one point. Chicago Corn fell -3% to $7.05 /bushel and soybeans fell -2.3% to $13.19 / bushel. Ironically, the May 5th plunge in commodities happened around the 1-year anniversary of the May 6th 2010 “Flash Crash,” on Wall Street, when the Dow Industrials plunged -1,000-points.
 
Silver was the catalyst for the slide, tumbling by nearly $5 /oz, its biggest one-day dive since 1980. Prior to May 1st, the white metal was zooming higher in a speculative frenzy, touching an all-time high of $49.50 /ounce from around $18 /oz in late August 2010 when the Fed first telegraphed QE-2. Now however, Silver was on course for its steepest fall in almost 30-years, losing -27% in a single week to $35.287 on May 6th. Silver led the rout, undermined by the Chicago Mercantile Exchange’s decisions to increase margins for new speculative positions by +245% in the prior weeks and months. After the May 2010 commodity plunge, fund managers were still divided over what direction prices were headed next.
 
The tug-of war in the commodity markets tipped in favor of the Bears in August, just as SocGen had predicted. While the Fed’s QE-2 scheme was generally credited for fueling the speculative run-up in commodities, led by the Silver market, working against the bullish tide was the People’s Bank of China (PBoC). While the Fed was launching QE-2 in Nov ‘10, the PBoC was draining 1-trillion yuan of liquidity from the Shanghai money market, by lifting bank reserve requirement ratios (RRR) 150-basis points to 19-perent. The PBoC was using calibrated hikes in banks’ reserve requirement ratios (RRR) as its main tool to tackle the commodity price bubbles inflated by the Fed. The PBoC moved away from using open market operations, a mechanism it has relied on for years, to soak-up excess money. By June 2011, the PBoC had resolutely lifted RRR’s to a record 21.5%, with each half-point increase draining 350-billion yuan out of the Shanghai money markets.

Two-days later, on May 5th, commodity markets were rocked by a nearly unprecedented onslaught of panic selling as modest early profit-taking snowballed into one of the worst days on record. In a slide reminiscent of the steep sell-off in the wake of the 2008 financial crisis, Brent crude oil dived a record $12 /barrel, and natural gas dropped over -7%. Tin was the biggest loser among industrial metals, shedding -7% to $28,500 /ton at one point. Chicago Corn fell -3% to $7.05 /bushel and soybeans fell -2.3% to $13.19 / bushel. Ironically, the May 5th plunge in commodities happened around the 1-year anniversary of the May 6th 2010 “Flash Crash,” on Wall Street, when the Dow Industrials plunged -1,000-points.
 
Silver was the catalyst for the slide, tumbling by nearly $5 /oz, its biggest one-day dive since 1980. Prior to May 1st, the white metal was zooming higher in a speculative frenzy, touching an all-time high of $49.50 /ounce from around $18 /oz in late August 2010 when the Fed first telegraphed QE-2. Now however, Silver was on course for its steepest fall in almost 30-years, losing -27% in a single week to $35.287 on May 6th. Silver led the rout, undermined by the Chicago Mercantile Exchange’s decisions to increase margins for new speculative positions by +245% in the prior weeks and months. After the May 2010 commodity plunge, fund managers were still divided over what direction prices were headed next.
 
The tug-of war in the commodity markets tipped in favor of the Bears in August, just as SocGen had predicted. While the Fed’s QE-2 scheme was generally credited for fueling the speculative run-up in commodities, led by the Silver market, working against the bullish tide was the People’s Bank of China (PBoC). While the Fed was launching QE-2 in Nov ‘10, the PBoC was draining 1-trillion yuan of liquidity from the Shanghai money market, by lifting bank reserve requirement ratios (RRR) 150-basis points to 19-perent. The PBoC was using calibrated hikes in banks’ reserve requirement ratios (RRR) as its main tool to tackle the commodity price bubbles inflated by the Fed. The PBoC moved away from using open market operations, a mechanism it has relied on for years, to soak-up excess money. By June 2011, the PBoC had resolutely lifted RRR’s to a record 21.5%, with each half-point increase draining 350-billion yuan out of the Shanghai money markets.

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