Commodity markets are contending with a growing liquidity crisis

In runaway power and gas markets, rising prices are limiting the number of contracts traders can hold due to increased collateral requirements. In oil, macro investors have withdrawn their bets on commodities as a hedge against inflation after central banks started raising rates. Meanwhile, some traders have turned their backs on the London Metal Exchange after the meltdown in nickel trading earlier this year.

In the face of that attack, underlying prices have been fraught with risk. Whether it’s the disruption of trade flows from the war in Europe, China’s covid-zero policy, or the central bank’s responses to runaway inflation, the result has been a period of increasingly severe intraday swings.

“We are stuck in a low conviction environment with risks lurking in every corner of the globe,” said Ryan Fitzmaurice, principal trader of commodity indices at Marex North America. “It’s hard to get too excited until open interest and hot money are demonstrably up.”

In some markets, illiquidity was the talk of the summer.

Oil hedge fund manager Pierre Andurand complained that the crude futures market is broken, citing large intraday price swings with no apparent cause. Saudi Arabia’s Energy Minister Prince Abdulaziz bin Salman lamented the “extreme” volatility and lack of liquidity, saying it was a possible reason for OPEC+ to cut output.

cash shortage

In energy and gas, the problem is similar to the one that plagued the entire commodity space when war first broke out in March: the availability of cash. Equinor ASA estimated that energy margin calls could total $1.5 trillion earlier this month, sucking up much of the industry’s available finance as lobbyists push for ways to ease the cost of trading.

But in other markets, including oil, copper and agricultural products, the problem is diminishing risk appetite. Macro traders have turned their backs on commodities as central banks have embarked on one of the most aggressive interest rate hike cycles in decades.

“Money in absolute prices was made long before the war and at the height of the crisis,” said Greg Newman, chief executive of Onyx Capital Group, referring to the oil market. “What is happening now is more a function of uncertainty.”

ETF exits

The pullback appears in the value of commodity exchange-traded funds. September is set to be the fifth straight month of broad-based commodity outflows, after seven months of inflows. Nearly $4 billion has been withdrawn from that sector since May alone, according to a basket of 15 broad-based commodity ETFs.

Commodity traders have already had a successful year. The world’s largest banks are on track to earn $18 billion in 2022, surpassing the record sums they made in the financial crisis. Trading houses including the Gunvor Group, Vitol Group and Trafigura Group have seen their profits soar, while oil majors BP Plc and Shell Plc have also made record gains.

For individual traders, the stellar performance leaves little incentive to take aggressive positions heading into the end of what has already been a very lucrative twelve months. That spells bad news for the brokers who are the intermediaries in such transactions, as volumes decline.

“This situation can be fatal for some listed futures,” said James Whistler, CEO of Vanir Global Markets Pte. function”.

(By Alex Longley and Yongchang Chin, with the help of Mark Burton)

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