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* Volatility in many commods markets has halved over 3 years
* Banks' withdrawal from commodities sapped liquidity
* Volatility rebound may be exaggerated in thinner markets
* Graphic on volatility: http://link.reuters.com/ret82w
By Eric Onstad
LONDON, Sept 17 (Reuters) - Commodity traders curse it whileindustrial users of oil, metals and grains applaud it.
Several years of low volatility on commodity markets havehammered profits for speculators and constricted tradingopportunities, while providing stability for firms that buy suchgoods.
But both camps may get more than they bargained for when thecurrent period of extraordinarily narrow price movement ends,entering uncharted territory after a number of banks departedthe sector.
While prices have fluctuated more in some sectors such asoil in recent weeks, it's risky to predict how soon volatilityin commodities, which has halved in many markets over the pastthree years, will see a significant and lasting rebound.
The period of relative calm may press on since manycommodities have plentiful supplies and global interest ratesare still rock bottom.
But the sharp withdrawal of many banks from commoditytrading, sucking liquidity from markets, could send volatilitysoaring if unexpected catalysts emerge.
"Banks have been liquidity providers and market makers, andgiven the diminishing number of banks genuinely active in commodity markets, a move in volatility could be muchexaggerated," a commodity executive at a major bank said.
"When we do finally start moving, the impact in commoditiescould be much bigger than other financial markets. There isn'tgoing to be the natural supply of liquidity," said theexecutive, who declined to be identified.
Credit Suisse said last month it was winding downits commodities trading, joining the likes of Deutsche Bank, JPMorgan and Barclays, which areeither exiting or significantly downsizing their activities inthe sector.
BIG PLAYERS
While other financial markets have also seen decliningvolatility, the slide in commodities volatility has had a biggerimpact. Stock markets have been on a bull run, but commoditieshave been hit with sliding prices and withdrawals by investors,squeezing profit opportunities for funds and traders.
The slide in volatility has extended throughout commoditymarkets from gold to grain to Brent crude oil, where at themoney (ATM) 30-day implied volatility has slid to17.09 from 40.32 three years ago.
Gold is down by about 50 percent to 14.74 since 2011.
Implied volatility is how the market prices futurevolatility, while realised volatility is actual past volatility.
It's a big contrast to the situation several years ago whencommodity prices lurched higher, prompting regulators to imposenew rules on speculators, who were blamed for the volatility.
"Recent volatility in prices for basic commodities --agriculture and energy -- are very real reminders of the needfor common-sense rules in all the derivatives markets," GaryGensler, then chairman of the U.S. Commodity Futures TradingCommission (CFTC), said in 2011.
The CFTC declined to comment on the current decline involatility, as did Britain's Financial Conduct Authority and theEuropean Securities and Markets Authority.
"The withdrawal of banks from commodities has had a bigeffect on volatility," said Itay Simkin, chief executive ofcommodity hedge fund Krom River. "Historically those (bank) guysused to be big players in volatility."
Guy Wolf, global head of market analytics at broker MarexSpectron, said banks' withdrawal had not only cut liquidity butresulted in the winding up of trading books, which includedstructured products, embedded with a short vega profile.
Vega measures the sensitivity of an option price to changesin implied volatility.
"The market could probably have absorbed one major exit. Buthaving multiple exits at the same time with no natural new handswas a problem," Wolf said in a report.
While volatility is no longer falling sharply and in somecases rising slightly, many fund managers and speculators arecautious after being burnt in recent years.
Failing to make money through other strategies in lacklustrecommodity markets, some positioned themselves for a rebound involatility from levels that seemed extremely low, but lost moneywhen volatility sank further, industry sources said.
"Implied vol and realised vol for most metals are relativelysimilar, which seems to suggest we're approaching a fair value,albeit that fair value is at historical lows," the bankexecutive said.
"You've had many people over the past two to three yearssaying we're at the low so now's the time to buy, but that'sbeen proven wrong and they bled profits."
CUSHIONED FROM SHOCKS
Wolf said it was likely the volatility bear market hadended, but that did not mean a bull market had begun.
"How quickly volatility goes back up is a function of manythings, rate hikes being one," he said.
Some analysts and traders believe the flood of cheap moneyduring the global financial crisis has been a key factor indepressing volatility, while others point to healthy suppliescushioning commodity markets from reacting to shocks.
In the oil market, since 2011 every new geopolitical worryhas resulted in a lower peak, said Ole Hansen, senior commoditystrategist at Saxo Bank.
"We are seeing increased supplies coming from non-OPECsources, which is making the market less responsive to anygeopolitical events."
David Bicchetti, associate economic officer at the UnitedNations Conference on Trade and Development (UNCTAD), warnedthat the current low volatility may be deceptive.
He and UNCTAD colleagues have previously called forincreased transparency and stronger regulation to pop pricebubbles and prevent crashes.
"I do not think that low volatility means that the problemsare solved. It is maybe like the calm before the storm as ithappened in 2007-2008, where most people did not foresee anycrisis looming," he told Reuters. (Additional reporting by Claire Milhench; Editing by DaleHudson)
