Indexology^® Blog

Please click here to register for our live-streaming of S&P Dow Jones Indices half-day complimentary seminar which has become Europe’s annual meeting point for commodity aficionados in less than a decade.

It is the perfect opportunity for all who can’t attend in-person to join us and other leading industry professionals for an afternoon of education and interactive sessions. Take a front row seat to walk away with valuable insights into current trends and issues under the umbrella of who’s complaining, who’s hedging, who’s speculating, who’s to blame and finally, where do I go?

Our speakers will examine:

– What causes spikes in commodity prices and how regulation is impacting commodity investment in modern market times.
– Perspectives on what the speculators are doing versus who are the hedgers, and why the lines might not be so clear.
– What incidental factors are tipping the market and the limitations for producers and consumers?
– What’s driving the world’s demand economy today and where it might be heading.
– The latest techniques in managing commodity index exposures in potentially uncertain times.

Within the last week, we’ve read about threats of another war in the Middle East, collapsing currencies across emerging markets, imminent rumblings of yet another Greek bailout.  As of this writing, there is one day left until the Fed’s much anticipated pronouncement on the “end” of QE.  Talk abounds of September being the worst month for stocks; October’s record is blackened with crashes.  And yet: yesterdays’ close of 14.16 for the most widely followed barometer of fear, the CBOE Volatility Index (VIX), is close to a third below its 10-year average. Has the VIX, the vaunted “fear gauge,” ceased to reflect true market anxiety? 

It’s worth pointing out that  VIX markets are not predicting an easy ride forever.  The VIX index represents a blended expectation of S&P 500^® Index volatility for the next 30 days; futures on the VIX Index extend the forecast to supply longer-term volatility expectations.  As shown above, these futures prices increase steeply to a level in line with VIX’s 10-year average.  Given that this 10 year interval includes both the “great moderation” of 2003-2008 as well as the subsequent five years since the bankruptcy of Lehman Brothers, the bigger picture for volatility seem neither particularly bullish or bearish.

In the past few years – characterized by alternating risk-on, risk-off dynamics – the VIX has been a remarkably effective proxy for optimism or fear across multiple international markets.  Five years on there is growing evidence that investors’ formerly incontinent risk appetite is becoming more discriminating.   A case in point is provided by comparing U.S. and emerging market equities: the current correlation (0.56) is above levels prevalent prior to the crisis, but well below the majority of readings since.   

One potential conclusion is that the U.S. equity market is more independent, so that volatility in EM equity is no longer of great concern.  Does the VIX still serve as a global systemic risk indicator?

But perhaps we are asking the wrong question.   An errant correlation can always be found somewhere, then shoehorned into justifying a new era of market dynamics.  Perhaps current low VIX levels are accurately reflecting a globalized and coordinated risk-on environment.  After all, it is not difficult to find reasons to be cheerful. The extent of ‘tapering’ has arguably been largely discounted; a surprising Fed announcement would be highly uncharacteristic. The world’s advanced economies are recording concerted positive growth; the likelihood of a fully-fledged combat operation by NATO allies in Syria is receding at considerable pace.  A Greek bailout, while politically awkward, is highly unlikely to shock a well-informed market.  Even the much-battered rupee is showing signs of stabilization.

Such arguments provide little reason to demote the VIX Index from its privileged position as the primary indicator of global greed and fear.  If the relative independence of EM and U.S. equities has indeed increased, it has done so because of a reduction in the perceived importance of systemic risk factors (in which case a “low” VIX is arguably justfied).  And if systematic global risk should increase, the unparalleled systemic importance of the U.S. equity market will mean that the VIX is uniquely positioned to reflect the evolving impact of such risks.

Commodity indices have seen tremendous success as investors look for asset diversification in their portfolio; simple exposure to the asset class; or even a hedge against inflation. Historically, the main commodity indices have been very much US centred and predominately denominated in USD. Why? The main reason is that these indices use exchange traded commodity futures to base their prices on and for many years, these have been listed in the US on US exchanges. Over recent years however, there has been a strong growth in volumes on non-US exchanges, and this has been particularly the case in agricultural derivatives. Europe for example has a physical wheat market which is over twice the size of that in the United States; however due to the lack of a reliable commodity futures contracts in Europe for many years, it was difficult to gain appropriate exposure. This has changed dramatically since the Common Agricultural Policy (CAP) stopped artificially supporting prices in grains in Europe in the early 2000’s. Since then, the Europeans grains futures markets were able to develop.

Nearly 10 years on and the European Wheat and Rapeseed contracts, operated by NYSE Liffe (NYSE Euronext group), have literally exploded and established themselves as global reference prices for European Wheat and Rapeseed.

S&P’s recently launched WCI was one of the first global commodity indices to understand this and has included these contracts, as well as our soft commodity contracts out of London, into their indices. With this index investors can now obtain easy exposure to these major trading flows in Wheat and Rapeseed.

S&P Dow Jones Indices is an independent third party provider of investable indices.  We do not sponsor, endorse, sell or promote any investment fund or other vehicle that is offered by third parties. The views and opinions of any third party contributor are his/her own and may not necessarily represent the views or opinions of S&P Dow Jones Indices or any of its affiliates.

Sorry, grains and meats, you are not one of the four main food groups.

Since this is the case, eating may have just become more expensive, especially for the high-end chocolate lover. Not me of course… but once again, as a commodity lady, when I consume goods (or goodies) and notice that prices are increasing or decreasing I think about the prices of the raw materials and how the indices are impacted.  I have noticed the price of chocolate increasing, so decided a deeper dive into the softs might be interesting.

So far in September, sugar, coffee and cocoa are hot. While the S&P GSCI Sugar and the S&P GSCI Coffee are up 5.1% and 3.2%, respectively, MTD through Sept 13, 2013, both are coming off of bear market draw-downs. From Jan 31, 2013- Aug 30, 2013 the S&P GSCI Coffee lost 26.5% and going back to its high in April 2011 the index lost 68.2%. The S&P GSCI Sugar lost 31.8% since July 31, 2012.

The story for the S&P GSCI Cocoa looks a bit different, and rather than a rebound from a bear market, it looks more like a bull.  From its low on June 27, 2013, the S&P GSCI Cocoa is up 20.1%.

There have been strong fundamentals supporting the price, both on the supply and demand sides.

Producers have cut capacity because when the cocoa beans are ground, roughly equal parts of cocoa butter and cocoa powder are produced, but consumers have demanded butter over powder, leaving producers with excess powder. The uneven demand profile can be blamed on greater high-end consumer demand, which requires more cocoa butter than powder.  Normally, as the cocoa butter-to-powder ratio increases, cocoa futures drop and the production evens out; however, this time is different since there are worries about a global bean shortage, especially from the Ivory Coast, one of the world’s top producers.

The FOMC, the Fed’s policy makers, meet Tuesday and Wednesday this week.  For investors the key agenda items are tapering and the future of QE3. Interest rate policy is almost forgotten as everyone prepares to scan the announcement expected at 2 PM Wednesday and then rush to either buy, or sell, bonds.  Market pundits seem roughly split with a slight tilt towards expecting some cut back in bond buying and QE3.

Paul Krugman, in today’s New York Times, argues for continuing QE3 at its current level. His concern is that starting to wind down QE3 would be seen as a signal that there is little room for additional job growth and that efforts  to create jobs and increase economic growth should be abandoned.  Krugman acknowledges that there is a lot of uncertainty about how strong the economy is and how much room there is for more QE3 – he wants to err on the side of encouraging growth.

As we have been reminded in the fifth anniversary of financial crisis reviews, the US economy recently came through the worst, and most confusing, period since the Great Depression of the 1930s.  Back then it was clear to Franklin Roosevelt and his economics team that there was a lot they didn’t know about the economy.  Their approach was to try a lot of things in the hope that something would work and that the rest wouldn’t do much damage.  Despite some 75 years of advances in economics, the Fed is still trying things to see what works.  QE3 is one thing the Fed tried. While no one knows for sure if it works, the economy is better off than a year or two ago and most agree that low interest rates and easy credit deserve some credit for the gains.   With interest rates up from last May, leaving QE3 fully in place a little longer would be reasonable.