Indexology^® Blog

All commodities in the S&P GSCI and the DJ-UBS CI crashed on June 20, 2013, losing 3.1% and 3.0%, respectively, after the Fed declared the U.S. economy was expanding strongly enough for the central bank to begin slowing the pace of its bond-buying stimulus later this year.  This is generally bad news for commodities since historically as the U.S dollar strengthens, goods priced in dollars become more expensive for other currencies. The historical negative relationship between the U.S. dollar and the S&P GSCI is shown below.

In addition to the generally inverse relationship between the U.S. dollar and commodities, there may be another overbearing consequence to the quantitative easing, reducing the incentive of the risk-specialists to fill the needs of commercial hedgers.  It is based on the systematic response to whether the monetary policy works or does not work. In other words, the “Risk On – Risk Off” behavior of this market may be dominating individual commodities fundamentals, like the unexpected inventory rise of crude oil.

Thursday was a day where it seemed the “Risk-Off” was overshadowing fundamentals. The S&P GSCI and DJ-UBS CI Gold, Silver, Coffee, and Nickel, fell 6.4%, 8.3%, 4.8% and  3.5%, respectively for the day, and each are now bear markets for 2013.  The S&P GSCI Gold, which recorded its biggest daily loss ever on April 15, 2013 of -9.3%, has not had two single day losses of this magnitude in the same year since 1980.

And waiting is exactly what the markets did for most of Wednesday, right up until the 2 p.m. press release from the Federal Open Market Committee (FOMC) meeting. Following the press release, markets sold off on confirmation that economic activity has been expanding at a moderate pace. As the release stated, “Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.”

The selloff in the S&P 500 resulted in an immediate 10 point drop, followed by a number of attempts to recover, finally ending the day down 22.88 at 1628.93. Bond prices also fell as the yield on the 10-year Treasury rose 8 basis points (bps) on the news. The previous day’s 2.18% close was quickly eclipsed as the 10-year note finished the day at 2.35%. The S&P/BGCantor 10-20 Year U.S. Treasury Bond Index gave up 1.20% and is now down 4.24% on the year. The importance of an index like the 10-20 year index, with 10.07 years of duration, is that it’s an indicator for mortgage rates, which are benchmarked to the 10-year Treasury.

The FOMC decided to keep the target range for the federal funds rate at 0%-0.25%, and to continue purchasing agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Fed’s previously stated plan was to continue the stimulus as long as the unemployment rate remained above 6.5%, with an inflation goal of 2%. Today’s press conference hinted that a 7% unemployment rate would be an acceptable level to start curtailing quantitative easing. Hints of a possible early start to tapering took its toll on the credit markets as well. The S&P U.S. Issued Investment Grade Corporate Bond Index was down 0.72% for the day, led by the Atmos Energy Corp. 4.15% January 2043 bond, whose daily total return was -0.03%. High-yield bonds did not sell off quite as much, as the shorter duration (4.97 years) index dropped by only -0.09% for the day as measured by the S&P U.S. Issued High Yield Corporate Bond Index.

The S&P/LSTA U.S. Leveraged Loan 100 Index was unchanged for the day and is down -0.26% month-to-date. When comparing the returns of both high yield bonds and senior loans, the performance of senior loans has better weathered the current volatility in interest rates.

JOIN US FOR OUR 7TH ANNUAL COMMODITIES SEMINAR!

Managing Commodities in Modern Times:
Hard-Won Lessons After 160 Years of Trial & Error

S&P Dow Jones Indices invites you to this half-day complimentary seminar which has become Europe’s annual meeting point for commodity aficionados for close to a decade.

Join us and other leading industry professionals for an afternoon of education and networking opportunities. 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?

Keynote Speaker: Hilary Till, Research Associate, EDHEC-Risk Institute, Principal, Premia Capital Management LLC., Co-Editor, Intelligent Commodity Investing

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 exposures in potentially uncertain times

In a release on June 19^th the S&P Dow Jones US Index Committee raised the market cap guidelines used when selecting companies for the S&P 500, S&P  Mid Cap 400 and S&P Small Cap 600. The new guidelines are:

• S&P 500: Over $4.6 billion, raised from $4 billion
• S&P Mid Cap 400: $1.2 to $5.1 billion, raised from $1 to $4.4 billion
• S&P SmallCap 600: $350 million to $1.6 Billion, raised from $300 million to $1.4 billion

The changes reflect the market’s movement since the bottom in March 2009 and especially in the last two years of gains.  The last increase was almost two and a half years ago in February, 2011.   Given the recent gains, what makes a company an S&P 500 Company is a somewhat bigger hurdle than it was two years ago.  The Index Committee monitors market developments as well as events affecting the indices. The guidelines help determine which index a company should be added to.  Market cap is not the only factor affecting the selection of companies for the S&P 500 and our other indices.  Other criteria include what sector the company is in, its liquidity and financial viability and that it must be a U.S. company.

The FOMC statement and Ben Bernanke’s press conference was not well received this afternoon.  Hopes for something that would smooth over the recent volatility with assurances that QE3 would last for many more months to come were dashed by comments during the press conference that most FOMC members could see bond buying tapering off this fall and ending by sometime in 2014. Despite those remarks, the Fed expects rates to remain low into 2015.

Behind all this is a factor bigger than even the Fed — the economy.  If the economy continues to strengthen interest rates will rise and if the economy reverses and turns down, rates will drop. Given the Fed’s 2015 forecast of 2.9% to 3.6% GDP growth, inflation of 1.7% to 2% on Core PCE and unemployment of 5.8 to 6.2%, interest rates will be slightly higher in 2015 but not out of sight. Look for the ten year treasury to be 3.5% to 4.5% in 2015.  The rest of the Fed’s economic projections slightly lowered the outlook for the rest of 2013 and made 2014 look a bit better.

In the short run traders can’t fight the Fed, but in the long run the Fed can’t fight the economy.