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Apparently Its All Over For Commodities

Commodities form an important part of my trading universe, in fact as a I par back my universe of instruments they form a more and more integral part of what I do. This pivotal role occurs for a few reasons ranging from ease of trading, price discovery and familiarity. The first trade I ever did was on a gold stock and the interest has stuck with me for decades.  You would therefore expect that I take an interest in the market so I had more than a passing interest when this article dropped into my news feed. There are a few points I want to dissect. However before doing that it has been my experience that there are two interesting phases in the life of any market. The first is when people start to tell me this time its different. Etched indelibly into my brain are the words of Irving Fisher who could be considered one of the worlds first celebrity economists who days before the 1929 crash uttered the immortal phrase stocks have reached a permanently high plateau. The second phase is that when someone tells you that a given instrument is stuffed beyond repair and will never go up again. Neither sentiment is reflective of either the cyclic nature of markets nor the psychology of traders.

Point 1 – Firms leaving the business.

This is an interesting point because it points to the number of prop firms leaving the business. However the number of retail investors exposed to commodities via ETF’s has grown dramatically so there has been a shift in the markets demographic away from wholesale to retail. The five largest commodity ETF’s managed almost $6 billion in assets.

Point 2 – Low Volatility

This point highlights one of my enormous bug bears it is the confusion between volatility and trend – the two are not the same and one doe not rely upon the other. I thought I would take a further look at this and just have a look at the distribution of volatility within the gold market. The first thing I did was simply look at the average 15 day volatility for a given number of years ranging from 15 years to the YTD and the results are shown below.


Depending upon the look back period you can make a point that there has been a drop off over time in volatility . However volatility is relative concept and the current volatility in the gold market is sitting at 11.8% which is just below the average volatility for the YTD. Yet price has trended from around $1,000 to $1,350 and then back down to around $1,000. Looking at short term volatility tells us nothing about the trend. When looking at volatility I thought I might be missing something so I broke the look back period into five year blocks to get a sense of how it might have changed over time and the results are below.


When volatility is broken into blocks you can see that over time volatility has increased and then tapered off a little. The so called halcyon days of two decades ago that every longs for actually had markedly lower volatility than recent times.

I should also point out that volatility in the crude oil market regularly spikes to beyond 60% so i am not sure where this missing volatility has ended up. Again it is probably the perennial confusion between trend and volatility.

Point 3 – Correlation

This point always interests me because people very rarely make it clear whether they are talking about price correlation or returns correlation. Most people when they talk about correlation talk about price without meaning to. The correct measure in such situations is the correlation between the returns across asset classes. True diversification is generated when you generate uncorrelated returns. Te first chart below looks at the daily performance correlation for gold, S&P 500 and crude oil.


There is what appears to be an emerging positive correlation between gold and the S&P 500 and this surprised me a bit and I was suspicious that it was an artefact in the data so I generated a new series of data that looked back to the beginning of the century because my suspicion was that what I was seeing was actually the stagnation in gold and the rise of the US market post the GFC.


Looking at the data over much longer term gives a clearer picture of what is actually happening. As US markets collapsed gold recovered and as US markets recovered gold suffered so to my eye the emerging correlation is somewhat of an artefact in the data. Much is implied in the article about how good commodities trading was in the past but it needs to be remembered that gold took 31 years to surpass its 1980 highs. That’s a long time between drinks if you are a long only trader as many commodities firms were. Commodities are the magic swing through mutli hundred dollar range tools that people think they are.

Point 4 – Leverage

An irrelevant point if you know what you are doing. Leverage has been a function of commodities markets from day one and is the staple of FX markets and they dont seem to have any problem coping.

Point 5- Liquidity –

I am not certain what the point is here since volume in the majority of commodity markets has increased dramatically over the past decade.

Point 6- Regulation

This is an old catch cry – if you dont know what you are doing blame the regulator. In some ways this is the same as football coaches who blame the umpire for their team being rubbish.

Point 7 – Its downright difficult

There is a particular sentence here I want to highlight –

For one, their idiosyncratic characteristics can make price forecasting practically impossible.

Price forecasting for all instruments is impossible. For those who need a quick refresher on how stupid this sort of thing is I give you Jon Boormans wonderful, regularly update guru predictions chart.


Any attempt to predict price in any instrument is an exercise in delusional stupidity of the highest order.

The upshot of all of this is that the majority of things written about markets that have any sort of predictive narrative about the trajectory of a given market or markets is largely irrelevant and that includes this piece. The simple fact of all markets is that they are cyclical in both tone and the level of investor involvement. If I can defer momentarily to a local example. If you were to look at a comparison between housing and equities as an investment choice you would say that equities are dead. Yet funds continue to invest in them and prices continue to go up and down and some prices go up a lot.  The same is true for commodities and I doubt it will ever stop being true.



Sovereign Wealth

I do hold a more than passing fascination with the idea of Sovereign Wealth Funds – I find the idea of a nation being a custodian of the wealth of the nation to be intriguing. I am also interested ( read fucken appalled) in how badly managed our resources are. For example in 2021 it is estimated that Australia and Qatar will ship roughly the same quantity of liquefied natural gas (about 100 billion cubic metres) For which Qatar will receive $26.6B in royalties whilst we will collect $800M. A staggering disparity – you could say that our incompetence has cost us $25.8B. Alternatively you could say our government has given away this amount of money to someone else for whatever reason. The rationale for governments doing this is up to others to decide.

When thinking about such funds I wanted to see what the latest league table looked like and Google was very helpful and I assembled the following table. I extend it to the 15 largest funds to include our domestic fund.

SW Raw

As you would expect the rising might of China sees it in first place whilst we sit at 13. I decided to re rank this table according to population to get a measure of efficiency and to actually see how much benefit per citizen the funds generate.



China slips from number one to number 13 – so much money but also so many people. Adjusting for population size only moves us up three places. The absolute superstar of such funds is Norway who have an enviable record of managing their North Sea oil and gas revenues. We can only dream of what the size of our fund would have been if the countries resources has been properly managed

A Few Charts To Chat About

Every quarter JP Morgan Chase put out what they call a Guide to the Markets. The report itself is largely noise and is the sort of thing that research departments like to show to clients in an attempt to convince them that they are more than the sum of their convictions and misdemeanours. Generally I ignore this sort of thing but there are two charts within the report making the rounds and these deserve comment and the third is one that doesn’t get much attention but which is perhaps the most useful chart in the report.

The first chart I want to look at is the one titled S&P 500 at Inflection Points –


To be honest I have never known what they mean by the term inflection point. Inflection simply means a change in the form of a word although I do think they might be trying to be a little bit clever and use the meaning that is derived from differential calculus which is the point at which a curve changes from being convex to concave and vice versa. So the implication for the average punter seeing this is that the S&P 500 is at a point of instability or change when in fact all you are seeing is a series of straight lines drawn with the benefit of hindsight. I have been receiving these reports for some time and the terminal point of the final line has been creeping up as the market has moved up. Whatever predictive value they think is has is eroded by this simple fact of self correction. The other point that concerns me about this sort of thing is the small call out box in the middle of the chart which offers a series of metrics which are designed to offer a comparison between the present day and two points of previous reversal. Again the implication is to convey the notion that the market is at some sort of tipping point.

One of the things that amazes me most about trading is that the longer I do it the more I admit that I dont know. For a very long time I have been convinced that I have no idea where the price of instrument is going. I certainly know a lot about market dynamics, the history of markets (which is something everyone should study) and about my own reactions to events. But I have sod all idea about where the market is going. Granted I can create a narrative in my own head to justify my own positions but at the end of the day I simply make a bet on the direction of an instrument and I am consciously aware of my own behavioural short comings. Charts such as the one above try to convey a form of pseudo scientific form of prediction that does little more than seek to appeal to the various biases of the reader. Readers viewing this sort of thing will anchor on the two highlighted points and use them as a reference for their decision making when they are probably little more than a Ludic fallacy.


This second chart only tells us one thing – an index go up over time. But even that is not as obvious as it seems. Firstly, the S&P 500 is a relatively new index it certainly was not around in the early 1900’s. So what you are seeing is an artefact, something that is not real. Secondly, the chart doesn’t show the real changes in the index when adjusted for inflation. Accepting that the index did not exist for the majority of the period under investigation and using as much historical data as I could find I have adjusted the index below for inflation. You will also note that even though I have adopted the same log scaling the scaling of the data is different – this is what happens when you are plotting a made up version of the index.


As you can see the almost linear climb of the last few decades is not as pronounced when the data is adjusted. Whilst I dont want to overstate the impact of adjusting the data it is important to understand that the reality of investing over the very long term as opposed to the rosy picture presented by simple price data.

The final chart is actually what I would consider to be the only useful chart in the entire report because it documents the extreme rebound that equity markets are capable of.


As you can see despite some deep falls within the year the index has in the majority of cases managed to finish positive for the year.  However, it doesn’t man that the index has an ever upward trajectory – it can still go nowhere for periods of time which is what catches the buy and hold brigade. They misinterpret this chart as indicating that markets always get better and markets or more correctly indices do climb over time of their upward bias but that doesn’t mean your stock or collection of stocks will follow. The usefulness in this final chart is that it reminds us that markets change and they change over a variety of periods – change offers us the potential for involvement and therefore profit.

The Great Idiot Tax Continues

It is at this time of the year when superannuation funds crow about how good they have done and of their inestimable benefit to mankind in general and this year was no exception.  So as is my now annual tradition I thought I would have a look at how good they have done and compare that to the real world where delusions about how good you think you are dont exist. From the article I linked to I took this table which looks at the average return of a a growth fund since 1993.


Source – Superannuation returns above 10% for the June Year

This piece acts as a good starting point for comparison with the market. For this I used the All Ordinaries Total Return index which used to be known as the Accumulation Index. It includes not only the price movement of the index but also folds back in the dividends of the index components so it is a good benchmark for simply passively holding an index fund or ETF.


When the chart of the average return of a growth fund is first viewed it does create an overall favourable impression – there are only three negative years and returns seem overall to be quite robust. It is only when you compare this active management with a passive benchmark that you realise how poor local managers actually do when compared to the index. Remember these are people who are paid to beat the index and as we will see they are paid staggering sums of money. Looking at annual percentage returns is quite crude and does lack a bit of fidelity, you dont actually know what the true performance differential is so I looked at the value of $1 invested into an average growth fund and into the index and got the following.


The market leaves the industry for dead – the market investment would now be worth $9.87 versus the industries $5.91 and for this privileged investors have been ripped off handsomely. The chart below looks at what my guess of the annual fee intake of superannuation funds is. For this I have assumed an average fee of 1.5% to cover not only management fees but also advisor commissions.


So to produce a theoretical return of slightly better than half what the market produced  in the period above the superannuation industry has collected probably close to $310B in fees. So to once again steal from Winston Churchill – never in the field of human endevour has so much been paid to so few for so little.

The Reality of Statistics

I snipped this table from Business Insider – it shows the likelihood of various sorts of maladies befalling the average American. Apart from the appalling statistic for gun violence my guess is that it is roughly transferable to Australia.


It highlights the profound disconnect between true risk as expressed as a number that is harsh and immutable and our perception of risk. Granted our perception of risk is amped up by Politicians who wish to distract us and news outlet who simply want to shock us. As an example here is a surprise poll you can spring on people at parties. Get them to name the most deadly animal in Australia – this is a particularly fun exercise to play with foreigners who believe that everything that walks, crawls, flies or swims in this country is out to kill them. The answer to the question is surprisingly horses between 2000 and 2010 there were 77 horse related deaths, in a distant second behind horses were cows with 33 deaths for the same period. Ask yourself the question when was the last time you heard a public service announcement warning you to be vigilant about horses – my guess is never.

The point here is our perception of risk is not the reality of risk and this is true in trading. In trading we bring a veritable cornucopia of vague ideas about risk to the table. Yet in reality none of them are real. For example I know traders who will not invest because of the coming crash – I might add this crash has apparently been coming for about a decade. Granted they might be right one day but nobody ever got rich by waiting for that one day to appear. And this is the point of the lesson, accept risk and play or dont accept risk and dont play.

Investor Sentiment….Who Cares….

This is a chart of investor sentiment as produced by the American Association of Individual Investors. Each week the association polls its members with the question where do you feel the stockmarket will be in the next six months. The results are tallied to give a percentage bullish, bearish or undecided. These sorts of metrics are given great status in certain parts of the investing community and I have to admit when I first entered this business back when we all rode dinosaurs and wrote on slates I spent many and evening looking at sentiment indicators trying to work out exactly what they actually did, if anything.


A simple maxim when looking at  survey data is to look at the population that is generating the results you are looking at. In this instance individual investors are being asked their perception of the market over a given time period. It is important to note that investors are being ask to rate what is effectively and emotional response to the market – do they feel bullish, bearish or disinterested. They are not being asked a quantitative question. A quantitative question would something simple such as how tall are you? A sentiment or emotional question would be how tall do you feel? Such questions can be considered context questions and are such are dependant upon circumstance. For example I stand about 1.93 metres tall and yesterday I attended a 10 year birthday party so my perception of my height is that I am  giant. However, if I was playing in the NBA where the average height is over 2 metres then I would be less cocky about my height. To put it into the context of this survey around 10 year olds I am bullish about my height, around NBA players not so much. My height has not changed, what has changed is the context of my height. The same is true for these investors when polled, there is no context given to the circumstances that generated their response. For example if you have just come off a winning trade then you are apt to be bullish about the future. If you have just come off a losing trade then your confidence would be shaken and you might be more circumspect about the future.

However, there is a further point to be considered and that is the somewhat blunt one of who cares what average investors think about anything? The narrative fallacies of individuals is of no concern to any other market participants. But more importantly it is of absolutely no concern to the market. There is no way to communicate either the perceptions of individuals or the results of their collective perceptions to the market and given that average investors are consistently wrong in their perceptions it doesn’t seem to matter what they think.

This does raise the question of what about the polling of professional investors  and professionals are often surveyed about their perceptions of the market and people attempt to divine something from this sentiment. However, this approach also runs into problems. Consider the table below which was drawn from the Investor Intelligence Database. The table operates on a simple maxim. When fund managers are bullish they move out of cash and into stocks. When they are bearish they do the reverse. This cash/asset ratio was measured and then compared to the Dow to see whether the move was prescient in any way. Unfortunately, it wasn’t. The professionals managed to be correct in their interpretation of sentiment on only 7 out of 33 occurrences. You would have been better off tossing a dart.

Mutual Fund Record

At the heart of much of this surveying is an attempt to generate some sort of predictive modelling about markets. I note that the current fad is to look at social media tools such as Twitter to see if they tell us anything about the underlying emotional intensity of the market. Whilst I sympathise with the need for the average investor to try and predict where the market is going for the time being trading remains a reactive profession that is best served by simply looking at price, making a bet and managing the trade. Despite what many would have you believe it is not rock science.

What Crisis?

In somewhat of a similar vein to the post on scary charts I came across this piece yesterday –

For the past 40-50 yrs, those years ended with “7?” always spell trouble.
1977? – International Currency Crisis
1987?- Oct 19 Black Monday Crash
1997?- Asia Financial Crisis
2007?- US sub-prime Crisis
2017? – ?

There is a certain silliness on this sort of financial numerology and I understand that certain cultures place a lot of stock in such thing. But then my ancestors used to paint themselves blue and hit each other with bits of bone, something that we have grown out of. However, as with most so called patterns I was intrigued as to what the data actually said, so I generated a list of major financial shocks going back nearly a century. I did this because going back 40 to 50 years is cherry picking as is leaving out most of the events that occurred during that time. I found the following –


As you can see there is no pattern nor are there any magic numbers or dates. This one can go in the same bin as the trope that October is the worst months for the stockmarket.



General Advice Warning

The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.