Jan 15, 2005

A financial chart that caught my eye the other day (the VIX Index)... it's a chart I haven't looked closely at recently... but upon closer examination I noticed a few things... or more accurately, "didn't notice" a few things... and it's these things I "didn't notice" that made me look at the VIX Index chart a little closer.

The VIX Index is generally deemed as an indicator of potential market volatility... and one would assume, the VIX Index would show events or circumstances that could show noticeable potential volatility in the markets.

What I noticed the other day (or what I didn't notice) was that starting just after the month of March 2003, normal volatility diminishes very significantly from VIX Index compared to it's trading pattern just prior to March 2003... just look at the 5 year VIX Index chart...

Notice the trading pattern prior to March 2003,
and how it changes significantly post-March 2003.

As you can see from the chart above, the VIX Index is showing an almost "near perfect gentle decline" that starts just after March 2003, which has continued until today (Jan 14, 2005)... it's current level and recent trend seemingly indicates the market currently has very, very low volatility (or risk).

So what happened in March 2003 that would cause the VIX Index to start on a "near perfect gentle decline"?... nothing I could find... however, something significant did happen in March 2003, and that was the start of the Iraq War.

But hasn't anything else (besides the Iraq War) happened since March 2003 that would wake the VIX Index out of it's current "near perfect ever deeper multi-year slumber"?... or send it back into it's avg. trading ranges of the several years prior to March 2003?.

Curiously, I looked at several factors since March 2003 to see how they weighed on the VIX Index... and here's what I found (or "didn't find")...

During the month of Aug of 2004, 4 separate major Hurricanes slammed into Florida... I thought the 4 Hurricanes spanning the month Aug 2004 would have registered/weighed a little on the VIX Index... seeing how the 4 Florida Hurricanes were blamed significantly for increasing the price of Crude Oil due to the Oil Production disruptions in the Gulf of Mexico.

However, while Crude Oil Indexes show strong upward volatility (increasing by approx. 35% from just Aug 2004 to late Oct 2004 - a period of less than 90 days), during this same period, the VIX Index continued to dip even deeper into it's slumber-trading pattern, actually starting lower in Nov 2004 than it started in Aug 2004; see chart below...

90 days following the Florida Hurricanes, the Gulf of Mexico oil disrptuion,
and a steep spike in Crude Oil prices... the VIX Index continues it's trend lower.

When you look at a Crude Oil Index chart... using a 2 - 3 year chart of Lt. Sweet Crude... you see that Lt. Sweet Crude increased by over 100% between just the 1 year period of Oct 2003 and the end of Oct 2004; see chart below...

During this period of extreme crude oil price volatility (starting in approx. Oct 2003),
the VIX Index continued trending further lower; see chart below....

Well, how about the drop in value of the US dollar?... surely that would weigh (at least a little) on the VIX Index due to it's inflationary effect from the increasing costs of imported goods/products/materials into the US (due to the lower purchasing power of the US Dollar); see chart below....

Since approx. Oct 2002, the US Dollar has lost approx. 35%
of it's indexed purchasing power.

But suprise, suprise... the VIX Index even takes the weaker US Dollar in stride... with the VIX continuing it's slumbering-lower trading pattern post-March 2003, not even the inflationary effects (or diminished purchasing power) of the lower US Dollar woke the VIX Index from it's trending downward perfect slumber post-March 2003; (see chart below)...

Since March 2003, the US Dollar Index has lost approx. 20%
of it's purchasing power... yet the VIX Index continues it's quiet trend lower.

Well maybe, just maybe, a shortage of essential industrial metals (and their increased prices) might weigh on little on the VIX Index?.... wrong again!... the London Metal Exchange charts show a significant shortage of important industrial metals developing (along with inflationary pricing)... these supply/pricing pressures being further compounded by the rapid industrialization of both India and China...

1 Year LME Copper Warehouse Stocks level (see above chart)...
supply down approx. 89% in 1 year.

1 Year LME Aluminum Warehouse Stocks level (see above chart)...
supply down approx. 55% in 1 year.

5 Year LME Nickel Warehouse Stocks level (see above chart)...
supply down approx. 54% in 5 years.

(You'll notice that these supply charts show only the London Metal Exchange... this is because my chart source is only able to supply 30 and 60 day NYMEX supply charts, and unfortunately, the 30 - 60 day supply charts are to short to show clearly developing supply shortages.)

And as one would expect, decreasing supplies of industrial metals are also starting to increase their prices; (see charts below)...

5 Year Copper Prices (above chart).

5 Year Aluminum Prices (above chart).

5 Year Nickel Prices (above chart).

Even though you can see from the industrial metal charts above... that clearly show increasing supply constraints and pricing inflation... the VIX Index apparently just doesn't seem to find it very notable post-March 2003; see chart below...

So the $64k question is; has the VIX Index accurately accounted for Volatility & Risk post-March 2003?... the last time the VIX Index traded at these current low levels was back in the boring old days of 1996.

ADDITION: a few hours after putting this VIX Index commentary together, I thought it would be interesting to see what the price of Gold has done since exactly March 2003... because, when I first put this commentary together, I didn't use Gold as a comparison, because Gold isn't an essential item for the economy, unlike Crude Oil or important Industrial Metals... however, some would argue that Gold in itself is a Volatility Index... so I thought, might as well pull-up a Gold chart and compare it... and as you can see from the chart below... post-March 2003 Gold basically has an inverse relationship to the VIX Index...

Chart Source: www.kitco.com