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COMMODITY FUTURES FORECAST
Prepared by Philip Gotthelf
The Agricultural Season Begins
(April 27, 2016) "Stay away in May?" Or, it is, "Go away until May?" We are moving through spring planting and grain markets just provided farmers with a hedging opportunity ahead of the summer. New crop November soybeans made a 10.23 ½ high last week and remain above 10.00 for the moment. New and extended troubles for Southern Hemisphere production is supporting prices just in time for U.S. farmers to lock in far better values than were available in March. In just over a month, November beans moved from an 8.68 low on 3/2 to more than $10.00/bu. That is 8.68% higher in about six weeks.
The question is whether projected South American production deficiencies are sufficient to justify the current strength when considering the enormous capacity of Northern Hemisphere farms. I avoided trading most of the grains last week because upside technical strength was too powerful and I was getting beaten up by interim volatility. Sometimes, "neutral" is the best position. I did venture into short July corn after being stopped out last week with a loss. As I write, we have a small profit, but we need to see a bust below 3.61 before a correction is technically confirmed.
I was tempted to sell new crop July wheat, too. Prices almost reached $5.20/bu which seemed overstated when considering this is predominantly a winter crop. My hesitation was due to the fact that the U.S. grain belt is heaped in low pressure and severe weather threats.
We see storms stretching from Texas all the way to the Great Lakes. Too much moisture could become a problem for this year's winter wheat… South American deficiencies in other grains create a sympathetic response. Moreover, if severe spring weather does negatively impact U.S. winter wheat, there will be sympathetic reflections in corn and soybeans.
Regardless of planting intention reports, my surveys suggest a hefty amount of seed is being sowed in corn and soybeans. With new crop beans at or near 10.00 and new crop corn still under 4.00, the price favors beans. Some farmers can still adjust acreage to some extent. If I were a farmer, I would certainly consider hedging a portion of my anticipated production while prices remain above recent averages.
December corn provides a technical foundation for an argument that the current "real price" is $3.90/bu. Consider the reference line since last spring. Discounting carrying charge dissipation, we saw a seasonal rally during July '15 that abruptly ended as growing conditions remained favorable. Through the year, 3.90 remained the consolidation region, offering support until the end of December 2015. Thereafter, 3.90 provided resistance until this month's rally.
Although the July 2015 rally collapsed, the secular downtrend did not "officially" begin until the October 2015 high. Notice how the consecutive peaks declined; i.e. lower lows that define a downtrend. The problem for most traders has been interim volatility. The October high of 4.20 saw a drop to test 3.90; a 7% swing. The market rallied from 3.90 to 4.04; a 3.5% swing. Look at the position of the 20-day and 40-day moving averages. We see how there was just enough distance to participate in the breakouts and busts, but it was a rough ride.
This has become the nature of commodities where well funded interests like hedge funds move in and out of positions using technical signals. The power of the money acts as an accelerator in either direction, increasing volatility. The more participation there is from the technical perspective, the more noise we see generated in a self-fulfilling way. It is the placement of positions that actually generates the trends.
I cover this pattern in my first book, TechnoFundamental Analysis (Probus) when reviewing trends in the live cattle market. The "step-wise" chart formation is common as we have seen in commodities like crude oil. That book was published in 1995. Since then, commodity volatility has enormously expanded and the amount of speculation has increased in kind. The principles outlined in my book remain consistent even as markets are structurally altered by participation.
This is an important consideration when evaluating old rules within the new market context. As I mentioned, there is a saying about trading in May. For grain, the springtime is the pivotal season when planting intentions turn into planting realities. Even with the major increase in commodity speculation, books and theories we rely upon are based upon conditions existing fifty or even 100 years ago. Go to Amazon and search for "wheat farming." What you will see are books from the 1960s or titles about home grown grains. There are books published as recently as 1998 about "Soybean Production in the Mid-south."
My point is that agriculture has made enormous strides toward higher yields, drought resistance, and overall quality. This is relatively mundane in the eyes of Harry the Trader. I have had discussions with commodity hedge fund traders who have never been on a farm, yet they trade grains and meats as though they are experts in all aspects of agricultural production. On the other hand, I know farmers who are brilliant at their trade and exceptional businessmen. Back in the 1970s there was far more understanding about the fundamental nature of commodities than I see today. In many respects it is frightening.
You may wonder why I would be concerned. Simply put, ignorance is not bliss when it comes to wielding huge sums of money in commodity markets. We saw how Goldman Sachs got caught manipulating aluminum prices with a scheme to move inventories from warehouse to warehouse to keep product off the market. By the same logic, a small amount of speculative capital can move soybeans, corn, and wheat off the market with disastrous consequences.
My inclination is to sell soybeans and wheat as prices remain high from the recent spike. The problem is that I may be selling into a speculative trap. I do not believe we will have an eventual shortage based upon information from Argentina, Brazil, and Australia. We are in their harvests and I believe the final result will be more positive than the negatives reflected by the most recent action. Still, the hedge funds are sharing a bullish bias that can disrupt fundamental logic… at least in the near term.
International Soft Commodities
I shorted July coffee and cocoa as they were rallying in an attempt to pick a top. This is always a risky proposition. We managed to hang onto cocoa, but were stopped out of coffee before today's 4¼¢ drop. I suspect the decline is related to unwinding May positions before expiration. I suppose I should have expected this price action when examining the daily chart. I still feel coffee is overpriced. To be fair, the Dollar Index has dropped to suggest a Dollar basis adjustment.
I am hoping July cocoa meets 3220 resistance and it holds. That would indicate a correction to at least the gap above 3040. I'll take that. As with coffee, I believe cocoa is too expensive relative to fundamentals. It will take another week before knowing if my assessment was correct.
I am curious about sugar because the food versus fuel dynamic remains in play. Sugar-based alcohol is expensive even with crude oil above $40/bbl. Biofuels are in limbo pending a final outcome in traditional fossil fuels. The tipping price is above $60/bbl. All the soft commodities have experienced impressive rallies that appear to extend beyond fundamental reasoning.
Stocks and Commodities
The Wall Street Journal has been peppered with articles about company performances from banks to Apple to ABC Alphabet (Google). The news is not particularly encouraging. Not only have we seen the disappearance of manufacturing jobs, now we are witnessing downsizing in service industries and a potential "maturity bubble" among high tech establishments like Apple and Google.
From an historical perspective, maturing of industries and sectors is nothing new or unusual. There have been saturations in everything from railroads to airlines to Dot.Com and IT OEMs. In the 1980s we saw growth companies like Digital Equipment Corporation (DEC), Wang, Data General (DG), InterData, and H-P. By the 1990s, saturation disrupted the mini and micro computer market. Only personal computers and main frames remained standing. DEC was acquired in 1998 and DG ceased in 1999. Names like Kodak are sure to fade into oblivion. The beloved Blackberry "business mobile phone" has been substantially displaced by Samsung and iPhone… not to mention LG, Motorola Droid, and a few dozen more.
Tablets are ubiquitous and increasingly undifferentiated as are other personal computing devices. Just as we saw a computer consolidation in the 1980s and a Dot.Com bubble in the 1990s, we are staring at another major technological consolidation that is indicated by the first hiccup in Apple in more than a decade. Quietly, the complexion of giants like IBM has been morphing into proprietary software as the competition in hardware becomes overly intense and risky. News coverage is superficial at best.
Through all the potential discouragement, the DOW Jones Industrials have managed to recover from the first quarter swoon. But, this does not mean we are out of the woods. It could very well be a "dead cat bounce" (apologies to feline lovers). Equity market bulls call attention to piles of "cash on the sidelines." Longer viewing bulls point out that all presidential candidates want to bring corporate cash hoards back into the U.S. through policy modifications. This cash will allegedly grow the economy and support equity appreciation. For sure, these perspectives have merit. The problem is that cash cannot solve dislocation.
If there is a stock market consolidation, commodities will not have the same level of speculative cash available. Although there is evidence stocks and commodities are negatively correlated, the charts tell a different story. When stocks crash commodities follow. Look at the plunge in commodities in 2008/09. My concern is that the commodity price decline will not be based upon fundamentals and "normalization." Rather, the decline will be a result of another liquidity crisis.
My bearish bias has been rooted in the fundamentals. As I read more about companies "missing expectations," I see the potential for a liquidity based secular trend that can carry from June through the year… past the presidential election. This cannot be viewed in a vacuum. To be sure, a weather crisis will impact grain prices that will influence food prices and change the dynamic. But, even in such a case, falling liquidity will temper or even counteract such fundamentals.
The S&P 500 and DOW are relaxing at former high levels. Given recent news and seasonal influences, I would be taking defensive action. We have all heard about the "summer doldrums." This is not a reference to wind currents off the eastern shores of South America. It is a condition frequently seen in stocks as summer approaches and people take their annual vacations. Trading activity winds down along with appreciation potential.
Don't be surprised to see the DOW dip to a 17500 test. It has had an excellent run and some profit-taking should be expected. A bust below this level points to 17100. In turn, commodities will run out of steam. You may want to "go away in May."
August 27, 2016
Commodity Futures Forecast
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