This commodity market commentary was emailed to clients on February 15th 2009
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With a recently passed stimulus bill carrying a price tag in the neighborhood of $800 billion and mortgage crisis reform looming, much of the uncertainty over the direction of the new administration has been eliminated. However, unlike what was suggested by the December rally, Wall Street doesn't seem to be satisfied with the progress. Nonetheless, President Obama believes that the recent passing of the economic stimulus plan is a "major milestone on our road to recovery."
The true outcome won't be known until much further down the road, but there are serious concerns to be had on both sides of the aisle regarding the viability of this bill...and stock investors are well aware of the shortcomings. Accordingly, equities don't seem poised to make significant upside progress until much later in the year.
February is the weak link in what are supposed to be the best six months for equities. In fact, it is the worst month for the NASDAQ in post election years with an average of -4.1%. Also, if the adage "as goes January so goes the year" holds water, continued turbulence and bearish trade could extend well into the second quarter (and beyond if market confidence deteriorates). Keep in mind that the University of Michigan's most recent release of its consumer confidence index fell from 61.2 to 56.2. Before investors will be willing to go long the market, they will have to be willing to "go long confidence".
In the previous newsletter we expressed concern over what seemed to be unrealistic expectations for the incoming President. Since then, we have seen the Euphoria and optimism over the new administration fizzle and an equity markets decline to major support levels.
In the past we have noted some potential for the S&P to see depths as far as 670, the NASDAQ below 1000 and the Dow 7,000. While anything is possible, we believe that the risk of such a move has subsided. We also noted a possible retest of the November lows as a result of a lack of confidence in any stimulus legislation, and still believe that this risk exists. Although it seems slightly less likely now than it did a month ago as seasonal tendencies should shift from negative to positive going into the beginning of March. With that said, there seems to be a small window of opportunity for the bears to push the indices below known support levels in late February. A break of 800 in the S&P should lead to support near 785 and 756 before reaching the 740 area as seen in November. The November lows in the Dow were near 7,400, while the NASDAQ could see prices as low as 1070. If the bulls are capable of deterring a break of support and the subsequent trigger of sell stops equities should trade to the upper end of the current market envelope, 876 in the S&P and 8,350 in the Dow and 1390 in the NASDAQ.
Treasury Futures
Our commentary regarding the Treasuries in last month's newsletter was highly dependent on the direction of equities. Therefore, we offered to very different scenarios and outlooks. As we now know, equities have essentially remained range bound and have allowed for many of the Treasury market fundamentals to overshadow panic trading that dominated the complex in late 2008. Consequently, we underestimated the downside potential in the 30-year bond and were completely inaccurate in our forecast of the 10-year note (which we thought would extend its rally before reversing).
The abundant supply of Treasuries in the marketplace has kept bond and note prices under severe pressure and it seems like this will continue to be the case in the near-term. However, an equity meltdown , if it materializes, will dramatically change the trading environment.
At the current juncture, T-bond prices have retraced approximately 50% of their rally that began in the fall of 2008. A continuation of the slide to the 61.8% Fibonacci level will mean that the March bond will trade lower to the 123 area. Coincidently this is also the area that marks two standard deviations from the mean. In other words, statistically the market should at least temporarily remain above 123. We like the idea of being bullish at such levels through the means of short put options, or an aggressive option spread. Likewise, note traders may find value in being bullish near 121 and preferably 120'15. Note traders may be better off trading long futures, and possibly puts or put spreads to insure their speculation as the margins and risk tend to be lower than that of the long bond.
Don't marry your fundamental position on bonds. Inflation, high supplies are real but markets don't go straight down. Also, Treasury re-pricing has been accounting for such fundamentals since late December and late February/early March is normally a positive time for fixed incomes.
Grain Futures
The grains are entering a tricky time of year for traders. The infamous spring rally and the influence of weather related events tend to have a positive increase on market volatility but can increase the unpredictability of the commodity markets.
Surprisingly, the grain complex was able to forge lows far before the equity markets (which are still struggling to do so). However, the timing of speculative long commodity plays ahead of any actual economic and demand recovery may have left the complex susceptible to another retest of the lows in certain contracts.
Grain traders seem to be disenchanted with the dollar/grain trade, leaving the direction of the U.S. dollar with little influence over the near-term direction of commodities. With that said, a large re-pricing in currencies could bring the trade back to life. We remain long-term dollar bullish and believe that if greenback fluctuations garner grain trader attention it will most likely be bearish for corn and wheat. Soybeans on the other hand seem to have stronger seasonal and fundamental aspects that could keep heavy selling at bay.
Corn Futures
We were right to suspect that the corn rally wouldn't last, but now find ourselves curious as to why the selling was so muted. Nonetheless, we remain somewhat bearish in corn as demand factors remain weak. In a recent USDA Supply/Demand report, export demand was revised to 1.75 billion bushels. This was a 50 million decline from the previous month and nearly 30% lower from the previous year. Additionally, many livestock operations are conducting business at a loss. Until that changes it seems unlikely that the demand for cattle feed will increase.
The ethanol story is dying as demand for the fuel has dropped dramatically along with the corn usage to create ethanol. In fact, it has been noted that several key players in the industry have filed for bankruptcy and many others are hanging on by a thread.
In last month's newsletters we predicted that that the $4.30ish highs would hold, and they have. Although we expected the weakness to be more pronounced than it turned out to be, we feel as though there is more to come as March comes and goes. Despite what looks to be a strong possibility of a brief technical bounce, corn prices will likely succumb to demand destruction and make their way lower.
I like buying the April $4.00 calls with the expectations of selling futures against it should the price of May corn trade near or above $4.00. Depending on market conditions, more specifically option premium and liquidity, it may be a good idea to sell an out-of-the-money call to cover some of the cost of the original purchased $4.00 call should the rally materialize. Naturally, if the move happens swiftly you may simply prefer to hold the position in hopes for more gains or sell it at a profit and step to the sidelines.
Soybean Futures Complex
Thanks to trying weather in South America, Chinese buying and inflationary concerns soybean prices have rallied nearly $3 from the December lows.
On February 10th the USDA announced that they had reduced the estimated ending stocks for 2008/2009 from 225 million bushels to 210. This figure is up slightly from the previous year. However, on a world scale the ending stocks are expected to decrease by 3 million tons. Much of this is due to the hot and dry weather in South America that will likely result in a 6% reduction in production from Brazil and Argentina. Adding pressure is the fact that farmers in this region of the world are holding on to supplies in protest over high export taxes.
On the demand side of the equation, most of the buying is coming from China. Nonetheless, demand has been revised higher and could keep a floor under pricing.
In our most recent newsletter, we predicted that the $10.60 high in beans would hold and the prices would retreat. This time around, we are a little less certain of the outlook given what seem to be conflicting fundamentals. However, in light of strong seasonal tendencies and the appearance of heavy support near $9.30 in the March soybean contract we are leaning higher overall. With that said, prudent bulls should be patient and wait for prices below $9.50 before entering the market.
Wheat Futures
Similar to the perfect storm that caused wheat prices to soar in recent years, a fundamental black cloud continues to linger over the wheat market. The most recent USDA estimates of the 2008/2009 ending stocks were reported to be unchanged at 655 billion bushels. This figure is a significant increase over the previous year's 306 million bushels. On a broader based scale, the government agency expects world ending stocks for the same year to increase from 120 to 150 million tons. Exports are expected to fall over 21% this year and are on pace to meet the projection. Additionally, the USDA has reported that a significant amount of the winter wheat crop is rated good to excellent.
Large speculative short positions leave the market open to short covering rallies; however, the overall direction should be pointing lower. In fact, we may see a quick rally in May wheat above $6 before the downtrend resumes. Ultimately, we feel as though fundamental, seasonal and technical pressure could lead to prices in the mid $4 range at some point this spring or early summer.
Energies and Metal Futures
Crude Oil Futures
Despite repeated efforts of OPEC to keep crude oil prices afloat, the market has experienced an astonishing multi-month plunge. Major production cuts announced on October 24th 2008 and again on December 17th 2008 have been shrugged off as demand destruction in light of the economic fallout has taken control of market pricing.
Current production capacity is finally at a healthy level after spending much of 2008 under tight conditions. However, even with crude oil prices at discounted levels political tension in oil rich nations remains high and things can turn around with little to no notice.
We are approaching what has historically been a strong time of the year in terms of crude oil demand and price. According to the Commodity Trading Almanac, crude oil has posted gains in the month of February 21 out of 25 years. My analysis suggests that most of the gains occur in the last half of the month Thus, we are looking for some type of significant low in the energy complex shortly. Also providing support to our bold prediction is the fact that the market has made such a precipitous drop and could be in store for a massive short squeeze. We are looking for the April contract to hold support at or near $40 per barrel and make their way higher to resistance near $45.20 and then again at $48.90. For most traders, the mini-crude oil contract is more than enough leverage. Unless you have a high tolerance for risk and a sizable trading account you may want to steer clear of the full sized contract.
We remind you of a comment made in last month's newsletter:
A good friend of ours, Chris Jarvis (you have likely seen him on CNBC), is a well-known and respected energy analyst. When we asked him his opinion on the direction of the energy markets from here, his answer was simple; "The energy markets are a great buy at these levels, but you have to be careful because these markets will rip your face off before proving you right."
Gold and Silver Futures
If you have been with us for a while, you may be aware of our opinion that gold shouldn't be viewed as a safe haven or an inflationary hedge. Our assumption stems from the idea that in today's society, gold really doesn't have much of an economic value. Unlike many of the other commodities, the demand for gold is highly arbitrary in that it isn't dependent on consumption but rather societies perception. Aside from Christmas and Valentine's Day , as well as some industrial uses, gold buyers are purely speculating on the value of the asset.
The premise of the gold speculation is somewhat wide spread, and can be argued from many fronts. For example, analysts commonly refer to gold as another currency. However, a quick look at the bid/ask spreads in the cash transaction markets tell us that this may not be a feasible assumption. Nonetheless, the price of gold fluctuates and is a liquidate and tradable commodity contract.
The collapse of economic activity has triggered a rally from levels below $700 in late October to prices in the $950 range. What is most notable about the move is the fact that it has come despite an inclining value in the greenback.
There are several fundamental "stories" igniting told buying such as possible rampant inflation, a failing UK banking system and even speculation of the U.S. Federal Reserve defaulting on debt. However, we believe that the move may have exhausted itself in the near term. While the possibility of a quick move to $975 to form a textbook blow off top exists, it seems that the risk in this market is to the downside.
Seasonal and technical analysis suggests that April gold could see a slide of a $100 or more in late February or early March. It is not uncommon for metals prices to experience a dramatic pummeling in this time frame. For those looking to play this move, you are likely best off trading the mini-futures contract. The margins are low, and they provide the ability to ride out any adverse moves that could occur before the reversal. Put options are pricy, but an aggressive spread such as a bear put with a naked leg are possible. If interested, contact us for specifics.
Silver traders should look for similar action. Although, our charts are telling us that silver could run as high as $15, but we become highly bearish at such levels.
Currency Futures
The U.S. currency has nearly flat-lined, but for many that is considered to be a success story given the dismal economics behind the greenback. We have been touting our bullish outlook on the dollar for several newsletters but our confidence in the rally has stalled with the market.
Luckily for the Dollar, fundamentals across the globe are challenged. However, the greenback may have a slight edge when it comes to capitalistic activity and the prospects of such leading to a recovery. In Germany, France and Italy, taxes consume 47%, 54%, and 49% of their nation's income. Already the odds are stacked against the private sector lifting these economies out of the trench.
The current price consolidation in the dollar index seems to be the calm before the storm. While we are still leaning higher, the risks of a near-term sell off before the rally resumes seems to have increased. A break of support at 86.00 will likely pave the way for a move to 84.80. However, our overall target on the upside is at 89.85.
Japanese Yen Futures
From a purely technical standpoint, the Yen appears to be setting up for a rally. However, our seasonal studies suggest that the exact opposite may happen. Japan is facing the same dire economic fundamentals that other developed nations are experiencing and like many European countries their citizens don't necessarily enjoy the fruits of their labor. The highest individual tax rate in Japan is 50% and corporations are taxed at 41%. On a positive note, the Japanese government spends only 37% of their national income. This is much more conservative than other leading economies.
A rebound to just above 111 is possible, but we are looking for a retreat that will bring the Yen below technical support at 108.50 and eventually below 106.
Soft Futures
Sugar Futures
Sugar prices have enjoyed consistent gains in recent weeks, but evidence suggests that a pullback may be looming. Last week's COT report indicated that speculators remain overly long the market. This leaves the market vulnerable to profit taking as well as fickle longs exiting positions that were incorrectly executed too late to benefit from the rally.
Coming into the month, we weren't expecting sugar to find the momentum on the upside that it eventually did. However, we also don't believe that it can last in the face of struggling energy prices and abundant supplies. The old resistance should become new support. Look for the May contract to sell-off to about 12.75. Sugar traders may look to play this with short futures, but we recommend taking advantage of cheap option premium to insure the position against adversity. Contact us if you are interested in a recommendation appropriate for your account size and risk tolerance.
Coffee Futures
After finding a peak of nearly $1.70 in early 2008, coffee futures have struggled to find footing in the face of world production surpluses and the overall recessionary theme that has plagued all commodity markets. With that said, as we have mentioned in the past, coffee tends to be a commodity that is better capable of weathering economic storms. Addicted coffee drinkers typically don't give up their vice they simply buy it at discount shops or brew it at home.
While may coffee may be poised for some type of temporary technical rally, the overall seasonal tendencies point to lower prices. It seems as though the market has potential to break trend-line support in search of prices closer to $1. On the way down, we should see support near $1.05 and again at $1.03.
Keep in mind that our expectations antagonistic to many fundamental projections.
Coffee is a high stakes market, the options are expensive and the futures margins are high. Before entering this market, make sure that you are able to tolerate the risk involved.
Meat Futures
Hog Futures
Slightly higher than anticipated supplies along with weak demand led hog prices consistently lower in the previous months. However, many analysts are anticipating a decline in supplies which could eventually be a catalyst for sustainable gains as 2009 progresses.
The USDA's Hogs and Pigs Report at the end of December suggested that hog supplies were down 2.2% when compared to the previous year. In fact, many analysts, and the USDA itself, believe that we could see the largest reduction in production in history. Additionally, it is expected that production of alternative meats will also decline.
One of the primary explanations for the expected lack of production is the fact that producers suffered large losses last November at the third worst magnitude in history. On an annual basis, it is estimated that the average loss per head was nearly $21. Accordingly, rancher capital is running thin and many may be searching for other careers.
In last month's newsletter, we expressed our overall bullish bias but noted that the "bottom" may not be in just yet. We were right to be a bit reluctant as the market suffered a considerable slide before reversing course. However, we were also anticipating a larger based rally than what eventually materialized. From here, we are beginning to doubt the market's ability to forge further gains beyond the next week or so. The April contract must hold support near 62.65 to avoid a sweeping sell off to 58.90 in short order. In the meantime, assuming that support holds in the coming days the rally could temporarily extend itself to 66.70.
Live Cattle Futures
Naturally, the health of the economy must return before the demand for beef will. This is because consumer preference for alternative(cheaper) food types remain high during recessions. However, as we mentioned in the previous newsletter, cattle fundamentals remain overall bullish due to diminishing supplies. The reduction of product on the market is the result of rancher adjustments to the "new" economy and suggest that meat prices could appreciate well before the economy fully recovers. On February 10th of this year, the USDA predicted that beef production would be down approximately 2% in 2009. Already, production is down 7.3% from a year ago.
Last month we were calling for a period of choppy to weaker prices followed by a sizeable rally, and that is more or less what has occurred. However, we aren't convinced that the current rally will have the momentum and seasonal price support necessary to break out to the upside. It seems as though April Cattle will struggle to make progress above 89 cents and will likely retrace to the low 80's before finding near term support. Beware of a sharp tendency for cattle prices to slide in mid-March.
DeCarley Trading
1-866-790-TRADE
**There is substantial risk of loss in trading futures and options. Past performance is not indicative of future results. The information and data in this report were obtained from sources considered reliable. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities. Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.
