Are we close to another beginning of a commodity spike down the road?

The negative U.S. and global economic outlook is putting substantial pressure on commodities. Economic data continued to confirm the deterioration. The nonfarm payrolls number of 533K released by the Labor Department on Friday was substantially above market estimates in the 300K's. In addition, crude on Friday held up by closing at $41.74/bbl, above the $40/bbl level but off from the $54.4 mark last week. Natural gas had broken the $6/mmBtu level and ended the week at $5.735/mmBtu. However, trading volume has been light across the board, impeding a proper functioning of the price discovery process. In particular, crude and most other commodities are generally exhibiting super-contangos (ie, future prices way higher than near-term prices).

While one should not catch a falling knife, what about a contrarian take? These super-contangos could be caused by two major factors, among others: the lack of liquidity or appetite for trading that put near-term storable commodities below the cost of carry, and the notion that a downturn will substantially curb demand and, therefore, supply-side investment. This increases the probability of supply tightness further out the curve. This decline in investment could affect reservoir management especially in ways that reduce future output. Chesapeake Energy cut its capital budget and planed to build cash over the next two years. The Saudis also suggested that $75/bbl oil is the price for marginal producers. Regardless of whether this could be a signal for price targeting, the current price level disincentivizes producers with higher variable costs.

While it is possible that available storage has been taken, so the cost of carry cannot be arbitraged away, but there have not been reports on this. One contrary indicator is the large build in Crude stocks in Cushing, OK, (a location designated by NYMEX, the commodities exchange, for oil delivery, when futures (or one of many kinds of financial) contracts expire and the holder of a contract has to take delivery of the commodity) which is most probably deliveries against the November contract and perhaps some level of speculative filling ahead of the December contract or further out the curve.

Further, fiscal stimulus in the form of large scale infrastructure investments, which aim to create jobs, are typically energy-intensive, in contrast with modern growth engines in the service sector. As such, the demand erosion in one segment will likely be partially offset by growth in fiscally-stimulated sectors, along with a slowing of projected efficiency gains.

But then again, don't stand in front of a moving freight train. The contrarian play may not work at all in the near-term!