Commodity volatility is falling

It looked as though there was going to be an increase in commodity volatility in 2013 with gains near the end of the  first quarter, yet here we are in the fourth quarter with a continued decline in volatility in commodity markets. This has been an ongoing trend for five years. Each of the major commodity sectors have also seen the same trend in volatility.

Energy markets have followed the same downtrend. We are at five year lows for energy volatility.

Agricultural markets have been subject to greater spikes in volatility yet have also shown a down-trend for five years.We are off the lows seen earlier in the year, but 2013 will have the lowest yearly volatility relative to the last five years.

Industrial metals have been subject to sharp spikes with the same long-term down trend in volatility.2013 will see the lowest levels in five years. There is the potential for spikes in volatility but the markets have matched the tapered volatility in global GDP.

Commodity sector performance differences

What is driving the poor performance in the commodity markets? A first pass is to break down the sector performance of the DJUBS commodity index. We have looked at the top three sectors: energy, agriculture, and industrial markets. Over the last five years, the energy markets have significantly underperformed ags and metals. This decline is related to the great natural gas decline and n oil market which has been rangebound. Every move up in oil prices has been met with greater supply. OPEC and other producers have done a good job of keeping prices with an tolerance that will allow for continued profits. The last three years have seen stronger energy markets relative to other sectors.

Ag markets have been buffeted with strong strong supply shocks. Grain markets have seen drought last year and then strong production this year. Industrial metals have fallen with the slowdown in China growth.

The "Big Divergence" between equities and commodities

There has been a significant divergence between commodity and equity markets. We have looked at the Ten year period for the MSCI world index, the S&P 500, and the DJUBS commodity index. The pre-crisis period showed that the markets moved in tandem with commodities moving ahead of the equity indices late in the cycle. The markets moved together during the decline and moved together through the initial recovery. The fourth quarter of 2011 showed the beginning of the divergence with 2012 and 2013 showing a continued move in opposite directions. The high correlation of the earlier periods have fallen part and commodities decided to march to its own drummer. 

The difference with the S&P 500 becomes very apparent on  a relative basis. These markets are not correlated and have different driving factors.

The real story has been the strong movement in emerging markets over the last ten years. The increase in prices is orders of magnitude higher. On a relative basis commodity prices look tame over the this period. we will not that the strong increase in EM equities is related to the strong demand for raw materials. 

The divergence between emerging markets and commodities relative to the S&P 500 was significant. Commodities matched the US stock market until the end of 2011.

The more recent performance shows that emerging markets and commodities are now more tightly bound together. This binding between emerging markets is not seen in world equity markets which have fallen relative to the S&P 500 but have still outperformed commodity markets.

The end of the financial crisis has caused commodity markets to move more closely with supply and demand for the individual markets within the commodity index. With slower global growth commodity markets are more subject to supply shocks which have been the hallmark for the current commodity environment. 

The impact of QE on asset prices

The FT had a very good graphic on the impact of QE on asset prices. Beautiful graphics should tell us something profound. What I see here is a QE policy that is having less impact on all asset prices. the markets are just not moved by the same way as the earlier QE programs. The only exception to the trend of lower reactions is with Japanese equities. This is a special case because most of the move is related to easing by the BOJ. 

This is not what the Fed was expecting when they started QE3. The talk of tapering has not addressed the simple fact that the current purchase program is not moving asset prices.