From Tulips to Bitcoins

Introduction

“The price of a commodity will never go to zero . . . you’re not buying a piece of paper that says you own an intangible piece of company that can go bankrupt.”

—Jim Rogers

Commodities came into vogue with the beginning of the new millennium, as investing in crude oil, gold, silver, copper, wheat, corn, or sugar was introduced and marketed massively as an “investment theme” and a “new” asset class by banks and other financial intermediaries. The first investable commodity indices—the S&P Goldman Sachs Commodity Index and the Dow Jones AIG Commodity Index—were developed in the early 1990s, but after the turn of the millennium, every major investment bank offered its own commodity index and index concept. This development opened up a new and attractive asset class for institutional investors and wealthy individuals. We witness today the same development in the cryptocurrency world, making an exotic new asset class investable for the public.

At least temporarily, the collapse of Lehman Brothers and the worsening financial crisis caused a break in the skyrocketing prices. Crude oil crashed from its high at 150 USD/barrel during the summer of 2008 to below 40 USD in the spring of 2009. In the course of the year, prices recovered again, to above 80 USD. Industrial metals also benefited from the economic recovery. In the aftermath of the financial crisis, and amid worries about rising public debt as well as the stability of the financial system, the interest of investors in gold rose substantially. In 2009, with the European debt crisis looming, gold surpassed the level of 1,000 USD for the first time, but it climbed as high as 1,900 USD per troy ounce in 2011.

The Commodity Market and Cryptocurrencies—Some Basics

A commodity is any raw or primary economic good that is standardized. Organized commodity trading in the United States dates back almost 200 years, but commodity trading has a much longer history. It goes back several thousand years to ancient Sumerians, Greeks, and Romans, for example. In comparison to commodity trading, the history of the stock market—where you exchange pieces of ownership in companies—is much younger. In 1602 the Dutch East India Company officially became the world’s first publicly traded company on the Amsterdam Stock Exchange in Europe. In the United States, the first major stock exchange was the New York Stock Exchange, created in 1792 on Wall Street in New York City.

Commodities can be categorized into energy, metals, agriculture, livestock, and meat. You can also differentiate between hard commodities like metals and oil, which are mined, and soft commodities that are grown, like wheat, corn, cotton, or sugar.

By far the most important commodity sector is crude oil and its products like gasoline, heating oil, jet fuel, or diesel. With the world consuming more than 100 million barrels of crude oil every day, that comes to a market value in excess of 6 billion USD per day, or 2.2 trillion USD per year! About three-quarters of crude oil goes into the transportation sector, fueling cars, trucks, planes, and ships.

Metal markets are usually divided into base and precious metals. By tonnage, iron ore is the biggest metal market, with more than 2.2 million tons of iron ore mined globally. Nearly two-thirds of global exports go to China; that’s around 1 billion metric tons! At 70 USD per ton, the market value of iron ore, on the other hand, is rather small. The biggest metal market, in value of US dollars, is gold. Around 3,500 tons are mined per year, an equivalent of 140 billion USD. The total aboveground stocks of gold are estimated at around 190,000 tons; that makes gold a physical market of nearly 8 trillion USD. In value terms, copper, aluminum, and zinc are next, whereas other precious metal markets—silver, platinum, or palladium—are rather small.

In agriculture and livestock, the biggest markets are grains like wheat and corn as well as oil seeds like soybeans, and sugar.

Bitcoins were released as the first cryptocurrency in January 2009. Since then, more than 4,000 alternative coins (“altcoins”) have been invented. The website coinmarketcap.com tracks prices of about 2,000 of them on a daily basis. After massive price corrections in 2018, the total market capitalization of all cryptocurrencies dropped below 200 billion USD. Bitcoins remain the dominant cryptocurrency, with a market capitalization of almost 70 billion USD and a market share of 40 percent. The next five most traded cryptos are ripple, ethereum, stellar, bitcoin cash, and litecoin. Together these five cryptos amount to a market capitalization of 30 billion USD, less than half of bitcoins.

Organized commodity trading by itself has a longer history than equity markets, a fact often overlooked in the focus on the dramatic price swings over the past decades. For example, the Chicago Board of Trade (CBOT) was founded in 1848 to provide a platform for trading agricultural products such as wheat and corn. But trade and the speculation in commodities is much older than that. Around 4000 BCE, Sumerians used clay tokens to fix a future time, date, and number of animals, such as goats, to be delivered, which resembles modern commodity future contracts. Peasants in ancient Greece sold future deliveries of their olives, and records from ancient Rome show that wheat was bought and sold on the basis of future delivery. Roman traders hedged the prices of North African grains to protect themselves against unexpected price increases.

The history of commodity and crypto trading is colorful and instructive, and my aim with this book is to bring to life the most important episodes from the past up to the present. Some of these are spectacular boom-and-bust stories; others are examples of successful trading. All are worth paying attention to.

The first six chapters cover major events from the 17th to the 19th century. The Dutch tulip mania of the 1600s is considered one of the first documented market crashes in history and is still a topic of university lectures. In the 18th century, rice market fortunes were earned and lost in Japan, and in the process candlestick charts—which are used today in the financial industry—were invented. In the 1800s, J. D. Rockefeller’s strategies and the rise of Standard Oil marked the beginning of the oil age. At nearly the same time in the midwestern United States, two men were trying to accumulate a fortune by manipulating wheat markets, while in California the Gold Rush broke out, with momentous consequences.

The episodes of commodity trading in the 20th century read like a “Who’s Who” of business history: Aristotle Onassis, Warren Buffett, Bill Gates, and George Soros are just some of the major players. Meanwhile, crude oil was playing an increasingly important role.

The 1970s saw a real boom in commodity markets. After a shortfall in its wheat harvest, the Soviet Union went shopping for US agricultural goods, reinforcing an already positive price trend in wheat, corn, and soybeans. It’s no overstatement to say that the rapid rise of crude oil prices during two oil crises in 1973 and 1979 changed the existing world order; the 1990 Gulf War was, in part, an attempt to reverse the clock. During this period the price of oil doubled. Among the collateral damage, the German conglomerate Metallgesellschaft was driven to the brink of insolvency by its crude oil-trading activities.

The emerging commodity boom of the new millennium attracted additional speculators and led to other boom-and-bust episodes. The collapse of Amaranth Advisors, which accumulated a loss of 6 billion USD within a few weeks by betting on natural gas, hit news headlines worldwide.

Weather often has played a role. The flooding of New Orleans by Hurricane Katrina led to a price spike in zinc in London, as the majority of zinc warehouses licensed by the London Metal Exchange became inaccessible. An active Atlantic hurricane season in 2006 not only caused oil prices to rise due to damage in the Gulf of Mexico but also pushed the price of orange juice concentrate to new heights.

A “millennium drought” threatened Australia, resulting in record high wheat prices worldwide. A few years later, a drought in India drove the price of sugar to levels that had not been observed for 30 years. Shortly before that, Cyclone Nargis in Asia caused a human catastrophe. Rice had to be rationed, and the rising prices led to unrest in several countries.

As a new decade began, the trendy themes of commodity markets shifted first to rare earths like neodymium and dysprosium, then to “energy metals” like lithium and cobalt, which are essential for energy storage and the electrification of transportation in the future. Since 2009 blockchain and bitcoins have caught the attention of traders. With tradeable bitcoin futures introduced at COMEX in 2017, the cryptocurrency has now become a commodity. With prices starting the year below 1,000 USD, bitcoins rose to 20,000 USD in 2017; then the cryptocurrency crashed by 80 percent in the first weeks of 2018. In the history of the biggest financial bubbles of mankind, tulip mania was pushed to second place after 400 years at the top.

The chapters in this book are framed by the biggest and the second biggest financial bubbles in financial history: tulips and bitcoins. In between are the stories of 40 major commodity market events over four centuries. These episodes were accompanied by extreme price fluctuations and individual outcomes, and they demonstrate that each market can be subject to a boom-and-bust cycle due to a change in supply, demand, or other external factors. This holds true for South African–dominated platinum production, sudden frost in coffee or orange harvests, unrest in Côte d’Ivoire that affected the price of cocoa, strikes by Chilean mine workers that pushed copper prices up, and the fluctuation of bitcoin and other cryptocurrency prices because of financial woes.