Another View On Why Commodities Are Plunging

Blogged the other day: Conspiracy On How The Commodities Markets Were Rigged!

The GlobeAndMail carried the report on what Donald Coxe is saying, The real reason commodities are tumbling

• “This has done more damage to my personal wealth than anything in the last 20 years,” he said in an interview yesterday. But he has too much respect for how the U.S. authorities engineered the collapse in commodities – a move he said was necessary to shore up the global financial system – to be bitter.
  
  “My attitude is, goddamn it, they're good … it was brilliant.”
  
  To understand why commodities are plunging now – the S&P/TSX plummeted another 488 points yesterday – you have to go back to mid-July, when the U.S. Federal Reserve and Treasury first announced steps to support mortgage giants Fannie Mae and Freddie Mac.
  
  The move, which ultimately led to the Treasury taking control of Fannie and Freddie this week, touched off a chain-reaction of market events that culminated with the wrenching decline in commodities.
  
  According to Mr. Coxe, the Fed's ultimate goal was to trigger a rally in financial stocks, which would, in theory, help banks hammered by the credit crisis raise fresh capital and repair their balance sheets. To accomplish this, the decision to support Fannie and Freddie was deliberately announced on a Sunday, which had the effect of maximizing the reaction from thinly traded financial stocks on overseas markets.
  
  Because many hedge funds were using massive leverage to short financials and go long on commodities, when North American markets opened and banks initially rallied, the funds were forced to cover their short positions.
  
  At the same time, the U.S. dollar was rallying because the risk of holding Fannie and Freddie paper had diminished. The rising dollar, in turn, made commodities less attractive, giving funds that were already scrambling to cover their financial shorts another reason to dump oil, grains and other commodities.
  
  The losses were swift and dramatic. On the Friday before the July 11 announcement, crude oil closed at $145.18 a barrel. Over the following five days, it plunged 11 per cent. “Leverage was being unwound dramatically,” Mr. Coxe said on a conference call last week. “We had a true panic.”
  
  As oil and other commodities were tumbling, fears about the slowing global economy were mounting, giving resources another push downhill. This was also in keeping with the Fed's wishes, because lower commodity prices would help quell fears about inflation.
  
  Mr. Coxe has no proof that the Fed and Treasury acted in concert to boost financials and sink commodities. He is basing his assertions on conversations with hedge fund managers and on years of watching financial markets. “There's no doubt whatever in my mind” about what happened, he says.
  
  The future is less certain, however. Now that Freddie and Fannie have been nationalized, the credit crisis is still very much alive and financial stocks are looking as shaky as ever. As for commodities, once the current storm passes, Mr. Coxe is confident they will recover.

On today's Financialsense.com market wrap, market commentator, Michael Shedlock made a rebuttal on Coxe's claims on his editorial, Commodity Bulls Jump the Shark

• While it is true the Treasury is guilty of blatant manipulation when it comes to the bailout of Fannie Mae and Freddie Mac, the dollar did not rise nor did oil or commodities drop because of it.
  
  Let's take a look at charts of the US dollar and crude in the aforementioned five days around July 11 when crude started to plunge.
  

  
  
  
  
  The chart clearly shows that crude started to plunge long before the dollar rally. Right off the bat we can clearly see Coxe is off on his timeframe in regards to action on the US dollar.
  
  Furthermore, the odds of a Fannie Mae bailout causing crude to plunge immediately but the dollar to stay flat for two weeks then soar are virtually zero.
  
  Yes, Coxe is correct that Paulson wanted to ignite a rally in financials, but when it comes to Fannie Mae (FNM), Washington Mutual (WM), Freddie Mac (FRE), Lehman (LEH), and others, I believe one needs to take a look at actual results before making claims of brilliant execution.
  
  Here are the actual results: Fannie Mae and Freddie Mac are both trading under $1. Lehman is under $4. Washington Mutual touched $1.75. Do "brilliantly executed plans" as Coxe puts it, always succeed so spectacularly? If that's success, pray tell what constitutes failure?
  
  The plain fact of the matter is there were many fundamental reasons for the dollar to rally, and it did. Likewise there were fundamental reasons for Fannie and Freddie to become worthless, and they did, in spite of admittedly massive intervention (manipulation).

Shedlock then continues..

• People will see what they want to see, but the dollar rallied because there was every fundamental reason for it to rally. Was there jawboning by Paulson and Trichet? Of course there was.
  
  However, the market ignored Paulson's jawboning for forever and a day, while Trichet's statements were in regards to a weakening Europe that is now clearly deteriorating rapidly. The dollar was poised to soar on the story of a weakening global economy that was supposed to decouple from the US but failed to do so.
  
  Carry Trade Blows Sky High
  
  A massive unwinding of the carry trade is now fueling the dollar rally. Huge speculation by traders shorting the Yen and going long the Euro, the Pound, the Australian Dollar, and the New Zealand Dollar is being unwound.
  
  Similarly there was massive speculation by traders shorting the dollar and going long the Euro, the Pound, the Australian Dollar, and the New Zealand Dollar. That too is being unwound.
  
  Those sorry bets were made on the misguided belief that Europe, Asia, and especially China would decouple from the US. In other words, massive bets were made that the tail would wag the dog. Now we see how foolish those bets were, especially for the Johnny-Come-Latelies who plowed into the trade just as it was about to reverse.
  
  New Zealand, Australia, Germany, Ireland, Spain, and the UK are in or rapidly sliding towards recession. This is an enormous fundamental factor and very supportive of a strengthening US dollar.
  
  Inquiring minds may wish to read Carry Trade Rout Continues for more details.

Do read rest of Shedlock's artiucle here