Credit – another dimension of commodity trade

Amid mounting fears of debt crises in Europe (or more generally sovereign debt around the world) commodities are seen as safe haven. This consensus might be misconception as market participants could miss several points.

• First point is (but possibly lest important) the fact that “FEAR” is not an equilibrium concept
• Secondly demand and supply curves may not be independent the demand and supply is not guided my current prices but rather by future prices.
• My last but not least important point is that the futures markets heavily depend on credit market. As I mentioned earlier the supply and demand curves may not be independent (even in case of commodities) as financial intermediaries adjust actively their balance sheets to their VAR models (pro-cyclical). In other words greater demand for the assets tends to put upward pressure on its prices, and then there is a feedback effect in which stronger balance sheets feed greater demand for the asset which in turn raises the asset price and lead to bigger balance sheets ( for more detail analysis of this process please look on the one of the previous post or read Shin and Adrian paper ). This process if unchecked can lead asset prices up to the sky and then down to the hell. At climax of this process utilization of collateral is at full and the price is strongly dependent on further and faster credit inflow which amid rising LIBOR rates may be difficult.
  
  Chart above shows swap positioning for US copper futures (The Spreading: For the futures-only spreading measures the extent to which each non-commercial trader holds equal long and short futures positions. Non- commercial traders are not involved in an underlying cash business; thus, they are referred to as speculators). It clearly shows that copper prices are strongly affected by speculative activity and are heavily dependent on credit market. This I just one example but cross-correlation of metals is high and all commodity markets looks similar. As I wrote previous post I think we just get into unstable phase.