Commodities Are in a Vicious Cycle -- Don't Get Sucked In

Occasionally, an event comes along that rocks price stability in the commodity markets. During such times, market volatility and chaos enters a loop that can be difficult to get out of. While looking at a quote board, we should remind ourselves of two things: First, current pricing is always temporary. It never feels that way in real time, but markets rarely stay anywhere for long. Accordingly, overreacting to ebbs and flows is not only adding to the problem of volatility, but wreaking havoc on trading accounts. Second, current pricing does not have to make sense. Price discovery can only occur through the process of buyers and sellers bidding and offering contracts and prices they are willing to accept. During normal market conditions, traders can assess a proper price but during times of high volatility, fear and greed are driving the ship. Unfortunately, emotional trading -- and, therefore, price action -- often breed on itself until investors exhaust resources -- either money or the will to continue. We are seeing this play out in the oil and grain markets. For instance, wheat futures were locked limit up on Thursday, then locked limit down on Friday, before spending Monday and Tuesday flirting with limit up prices. Similarly, we have witnessed the oil market swing wildly within a $20.00 range in recent trading sessions. The reality is, if you take out the tragic scene unfolding in Ukraine, most commodities -- energies and grains -- would have likely started to make their way lower. Seasonality tends to favor oil and grain corrections in March as the markets regroup for the summer driving season and an uncertain planting and growing cycle. Further, the U.S. dollar is relatively high, which should have started putting downward pressure on commodities, but has yet to be factored in. A daily chart of wheat futures has seen a nearly parabolic jump, but the weekly chart seems to make a little more sense. Today's rally puts prices on the uptrend line resistance area with technical oscillators such as the relative strength index suggesting the rally is overheated. Of course, war-time markets cannot be expected to follow the rules so additional caution is warranted. Nevertheless, the chart pattern is inclined to encourage digestion from here. Chart Source: QST In crude oil, the insanity has become palpable. The spread between the front month and back month contracts has grown to unnatural levels. This tells me something isn't right with the rally. Further, aside from the obvious fundamental story regarding Russia and Ukraine, there is likely something going on behind the scenes with positions being unwound; for instance, in addition to the apparent short squeezing in outright contracts there seems to be a price squeeze in the spread market. This daily chart between the June and December 2022 futures contracts point toward an extremely painful spread being unwound by a large trader or fund which could be exacerbating the oil rally overall. A monthly oil chart depicts a rally that is approaching the top of a multi-decade trading channel. Perhaps we get a breakout and return to the $150 area, but that seems unlikely. Near today's highs, it felt impossible for crude oil to trade lower, and it was even more difficult to produce a bearish fundamental argument. In the past, those types of thoughts and mindsets have been the inflection point. Look at the peak oil top in 2008, the financial crisis low in March 2009, and the Covid crisis low in April 2020. I'm not comfortable suggesting a specific trade in this market. However, it probably makes sense to buy cheap puts in commodities across the board. The markets are behaving as if the worst-case scenario in Russia is imminent, and that isn't a guarantee. Remember, there is a substantial risk in trading options and futures. Past performance is not indicative of future results.

Commodities Are in a Vicious Cycle -- Don't Get Sucked In

As the worst is feared in Russia's invasion of Ukraine, widespread volatility in commodities is feeding on itself. Here are two rules to remember and my take on what we're seeing now.

Columnist Conversation

This Weekend on Real Money

This Could Get Messy

Latest AAP Podcast With Helene Meisler!

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.