This futures trading commentary was emailed to DeCarley Trading brokerage clients on November 16th, 2009
Thank you for choosing DeCarley Trading. We are proud to offer the DeCarley Perspective as an informational guide to our clients and hope that you walk away from the newsletter with a better understanding of market fundamentals, as well as technical and seasonal factors.
The DeCarley Perspective is intended to give you a broad based view of the financial and commodity markets and provoke you to explore various market approaches.**Past performance is not indicative of future results.
Another round of positive earnings is behind us and investors have managed to maintain a "glass half full" mentality when it comes to the recovery. Moderate improvements in data are being given more credence than the continuous struggles in the job market and the fact that government stimulus (printed money) has been the driving force behind fundamentals. However, traders that have made decisions solely on economic reality likely haven't fared well throughout 2009. I think that it is fair to say that the markets were under-pricing stock values in March and have now over-priced the pace of the recovery. Reality, could be somewhere in-between but as a trader it is important to avoid over analyzing the fundamentals. Instead, we prefer to keep them in mind and focus on the chart and seasaonal patterns.
In last month's newsletter we pointed out the market's tendency to dip in late October to create buying opportunities going into November. This year, like many, the pattern worked out well. Going forward, November has been the best month for the S&P since 1950 and among the best in the Dow and NASDAQ. It also happens to be the beginning of the "Best Six Months".
The bulls normally "give thanks" by buying stocks. The week before Thanksgiving has seen the Dow up 13 of the last 15 and the day before Thanksgiving has only experienced 11 losses in 56 years.
It is hard to be a bear in November given the market tendencies during this time of year but that doesn't mean that there won't be breaks in the rally. In the Stock Index Report, we had announced our original upside target as 1103 and that has since been reached. Going forward, we feel as though the underlying momentum is pointing toward a move that could eventually see the 1150 area in the S&P futures at some point in December. In the meantime, look for support near 1070 and maybe even as low as 1050. The same rally could bring the NASDAQ to the mid-1800's before running out of steam. However, should these prices be seen they are believed to be great opportunities to be a bear.
Treasuries
Constant banter from the Fed suggesting that the overnight target rate will remain low for a considerable amount of time has created a market that is allergic to fundamentals. In recent weeks, there have been several events and surrounding market moves that could have brought Treasury bulls to their knees...at least temporarily. However, significant selling pressure has failed to materialize and the bears are slowly covering positions in disappointment.
The slowly grind lower in the dollar as well as recent strength in equities could have meant doom and gloom for Treasuries. Additionally, signs of inflation haven't made it into the government's data but rallying commodities suggest otherwise.
Due to the aforementioned events, we feel as though a buy on dips approach to Treasuries will be ideal in the coming weeks. Inflation is coming, but it probably won't be a factor in 2009; we suspect that bonds and notes will be firm into the year-end.
In the previous DeCarley Perspective we were looking for a dip to the mid-to-low 118 range in the December 30-year bond futures and the mid-116's in the note. We also noted that we thought such a pullback might be a good place to begin playing the "long side" of this market using either options, futures or both depending each client's risk tolerance or personal strategy. As it turns out, the long bond slightly exceeded our original downside target but we are maintaining an overall bullish outlook from here.
Look for a possible move to 120 in the December bond in the near-term with an intermediate target of 123 if all goes as planned. If we are wrong, the mid-117's should be supportive; if broken the next significant technical barrier will be 116'03.
The 10-year note chart isn't as favorable to the bulls. In fact, the market is facing nearly immediate technical resistance and could struggle to keep the usual pace with bonds. First resistance in the note lies in the mid-119's then again at 120.
Don't forget, Treasuries can rally with stocks but in such circumstances the price incline in interest rate products is often at a slower pace.
Grains
With the harvest nearly behind us, grain traders are focused on the health of the economy and the U.S. Dollar index. At times, commodities seem to be moving in lockstep with the S&P and at others, traders appear to be focusing on the negative correlation with the greenback. The recent run in grain prices came at the hand of a weaker dollar combined with nearly disastrous harvest delays and what looks to be sizable fund buying.
It seems as though given the time of year, the near-term fate of agricultural commodities will be determined by fluctuations in the U.S. dollar and speculation on the economic recovery. Each of these factors could prevent the grain rally from extending itself in the coming weeks.
Wet harvest weather and what is said to be aggressive fund buying has managed to push corn prices higher than most had expected during what is normally a relatively quiet time of year. The corn harvest is still ongoing due to delays and this leaves many to wonder about the quality of the product that will eventually be yielded.
Although supply issues are keeping corn prices elevated, the demand side of the equation is suffering; Corn sales are behind the average pace. However, ethanol production is ramping up again and despite the inefficiencies in producing corn based bio fuels speculators may see this as a reason to be long.
In the last newsletter, we expected December corn to hold resistance near $3.80 but mentioned that there was some risk of a move to the $4.00 area and would be bearish at this price. The wet harvest was just what the market needed to send prices to our second resistance area and as the chart predicted, a large pullback ensued.
This time around, we will focus on March corn. In their sharp decent earlier this year, the open outcry version of the futures contract left several gaps above the market. In general, a market has a tendency to fill gaps but we doubt that it will be something that is possible right away without a collapse in the Dollar. Instead, we feel as though the March contract will find comfort in its current trading range and traders might have better luck starting to become bullish near $3.75ish but we see the possibility of $3.40 on a dollar short covering rally. The seasonal lows are in but if you want to be bullish in this market, patience might be the key to success.
Soybean Complex
Beginning in mid-October, we had entered what is normally a seasonally favorable time of year for the grains. However, according to the Commodity Trader's Almanac traders should exit any bullish soybean trades on or about November 9th.
Soybeans have enjoyed strong Chinese demand and this has managed to keep bean prices trading at a perceived "premium" to corn. However, on November 10th, the USDA increased its estimate of 2009-2010 ending stocks from 230 to 270 million bushels. This is approximately 60% higher than the previous year and puts the ending stock to use ratio at 8%; far more comfortable than what has been seen in recent years. That said, like corn, the soybean harvest is running behind schedule and there are concerns over quality of the crop.
In our opinion, the market has likely already priced in the potential for significant damage and the odds favor sideways to lower trade from here. The March soybean future looks comfortable trading between $10.25 and $9.55; however, with a lack of surprise fundamental news it seems as though the path of least resistance will be lower. A break of $9.55 could mean a push below $9.00 and maybe even as low as $8.40. We like selling rallies but if you want to be a bull, look for large dips.
Wheat
Wheat prices tested, but couldn't hold above, the 125-day moving average. This suggests that despite the large short covering rally, the trend is still bearish. In fact, seasonal tendencies imply that wheat normally peaks in mid-to-late November and should be overall weak through the middle of May.
Wheat might seem cheap relative to prices seen in 2007/2008 but historically speaking $5.00 wheat is a bit pricy and there is certainly room for prices to deflate. On November 10th, the USDA increased its estimates for the 2009/2010 ending stocks to 885 million bushels, the highest levels in 9 years. Additionally, the USDA expects wheat exports to be down 14% for the 2009/2010 season.
March Wheat should find resistance near $5.59 then again at $5.80 at which time we are inclined to recommend bearish strategies. A move lower to $4.21 isn't out of the question over the next several weeks.
Energies and Metals
Crude Oil
Last month crude oil made an impressive and, arguably unfounded, run into the mid-to-high $80's. The move seemed to be the result of happenings in other markets as opposed to supply and demand fundamentals for "black gold". Accordingly, prices above $70 per barrel seem expensive in a jobless recovery. Although it is true that crude oil is somewhat elastic when it comes to demand, many have been forced to alter their consumption habits suggesting that demand won't be as much of an issue in the near-term.
Last week OPEC released its expectations for world demand in 2001 and 2010, which were 84.3 million barrels per day and 85.1 million barrels per day respectively; their projections weren't too far away from that of the Department of Energy. At such levels, demand isn't outpacing immediate supply as it was in the 2007 "bubble".
From a seasonal standpoint, crude oil tends to be weak through the first week of December. Additionally, should the U.S. dollar show some stability crude oil prices will likely struggle to hold recent gains.
The equity market is the wild-card, we are looking for stocks to see additional gains and in the past this has been supportive for the energy markets. However, at some point the positive correlation will have to fade and now seems to be as good of a time as any. After all, lower crude oil will bolster the economic recovery but prices above $80 will start to pinch the wallets of consumers. Therefore, crude and stocks can't travel in the same direction indefinitely.
The January crude futures are moderately oversold and seem to be headed higher in the near-term. We are looking for resistance just under $80 and again near $82 but doubt that the market will be able to sustain such lofty pricing without a greenback plunge.
Gold and Silver
Gold futures are "running" on the premise that inflation is just around the corner and the U.S. dollar will never regain its posture. Adding fuel to the fire was a purchase made by the Reserve Bank of India of 200 tons of gold for $6.7 billion. This is a sizable stance considering that in August the World Gold Council claimed that central banks bought 14 tons of gold in the second quarter of 2009 and this was the first net central bank purchase in some time.
The moves in gold aren't based on industrial or consumer demand but instead a perceived value of safety from inflation. Of course, if you look strictly at the numbers there are strong arguments against the effectiveness of gold in fending price pressures but none of that seems to matter once the "gold bugs" get started.
In our opinion, the gold bus is getting too full and at some point, it will have to unload. By nature, markets don't go straight up or straight down in the long run, and those that do in the short-term will eventually pay the price. However, with prices literally "off of the charts" it is nearly impossible to gauge at what price the buying mania will have to take a break.
Last month we pointed out the gold euphoria and interpreted it as an indication that a counter trend move was in the making. After all, once all of the buyers are in there won't be anyone left to keep prices moving higher. We called for a pullback to $1,020 but thought that under $1,000 was a possibility. We now know that $1028 was all that the bulls would allow before another round of buying took over.
This time around, we can't help but feel as though a counter trend move is looming. The most recent $100 rally has had little digestion and a mere 50% retracement would mean $1076 and we think that a retest of $1028 isn't out of the question. However, seasonals are still pointing higher so a much larger reversal might not be possible until the first quarter of next year.
Currencies
The fundamentals backing the U.S. dollar are weak, but competitive relative to the other major currencies. The currency markets have replaced the Japanese Yen with the U.S. dollar as its victim in carry trades. Essentially, investors are borrowing dollars (selling) and investing them overseas in order to benefit from the interest rate differential. Also similar to the predicament of the Yen a few years ago, the dollar has suffered a relentless grind lower.
As desperate as the situation seems for the greenback, there is some solace knowing that there is no easy money to be made in the financial markets. At some point, investors will have to unwind the position leaving the dollar poised for a massive short covering rally similar to that experienced by the Yen when its carry trades were squared.
The U.S. government hasn't realized that actions speak louder than words. They continue to speak of a strong dollar policy but behave in the opposite manner. Accordingly, the market is comfortable diverting funds away from the dollar but even the slightest inclination that they will begin "putting their policy where their mouths are" could send the markets reeling.
In the meantime, there is considerable support in the mid-74's and for now we believe that this will hold. That said, there appears to be some risk of a market flush triggered by sell stops and irrational trade that could put the dollar index as low as the mid-71's. We lean higher from current levels but should the 71 handle trade we would become largely bullish. If things turn around, the first upside target will be 77.35 then again at 80.40. If you want to be bullish the dollar, we suggest that you use conservative strategies until prices see the low 70's. The trend is lower and picking exact bottoms can be difficult.
Not surprisingly, a reversal in the dollar would mean topping action in the Euro. Given the most current Euro zone GDP figures suggesting growth at a mere .2% and expectations for .7% in 2010 and 1.5% in 2011, it isn't unrealistic to expect the Euro to relinquish some of its power.
From a charting perspective, the rally looks to have some potential to reach the mid 151's and maybe a bit higher but the party should be ending shortly. That said, an unexpected but possible decline in the greenback to the 71 area could mean the Euro will retest its highs near 1.60. If the Euro fails near the mid 151's, look for a pullback to 1.47 for starters with 1.45 being a real possibility.
Softs
Sugar
Many analysts are expecting another surge in sugar prices and seasonal tendencies, as well as strong fundamentals, suggest that they might be right. It was the USDA that announced much earlier this year that world stocks for 2009/2010 would be the lowest seen in 16 years; from there this market has provided little mercy to the bears in its way. Weather problems in Brazil lead to the highest sugar prices since 1981 and continued turmoil in India over sugar pricing has managed to keep prices afloat. Subsequently, the futures markets have become comfortable with sugar trading in a defined range between 21 and 25 cents.
Sugar prices can be explosive at times, so playing the short side of this market might be dangerous even if the technical signals are there. For instance, in 1980 the November sugar contract (which isn't really traded much) rallied to 45.00 cents and in the 1970's the nearby futures posted an all-time high near 60.00 cents. There are some that feel as though the inflationary pressures, combined with ethanol factors, and tight supplies could be the perfect storm that recreates such a move.
Accordingly, although we wouldn't bet the farm on such a move, buying on dips and avoiding shorts might be a good idea in the near-term. Also, buying out of the money lottery tickets such as the March 34 cent calls might be worthwhile. Normally buying calls with a market near 30-year highs seems irrational but in this case the minimal risk might be justifiable.
In the March contract, we expect that the mid-21 area will hold but a slide to 21 cents is possible and such levels could be great buying opportunities.
Coffee
Coffee has been violently range-bound (yes, that is an oxymoron) for much of 2009. Tight supplies in producing countries, and expectations of declining stocks in consuming countries, have provided underlying support. Due to the lack of trend and treacherous trade, open interest has seen its lowest levels in over three years in recent months. With the holidays approaching, this might not change any time soon.
We don't have a strong opinion in coffee either way and will leave this one up to you. However, look for support near 128 and again under 120.
Meats
Hogs
Hogs have managed to post a solid recovery from the August lows but the rally might be coming to an end. In previous newsletters, we had mentioned that the cost of hog production for most ranchers had exceeded the market price leaving them in a compromising situation. With the recovery in prices, it is likely that those that had been "sandbagging" will rush to bring their pigs to slaughter. This combined with lingering (an unfounded) demand concerns over the swine flu might work with seasonal weakness to force prices lower.
Hogs failed to follow their seasonal down-trend in October as we had expected but this time around the charts seem to support the premise of lower prices. The February futures are considerably off the highs and might see a bounce in the coming week but the overall slide could eventually reach the mid-50's in the February contract. Look for initial support in the mid-59's.
Cattle
Live cattle futures rallied in the first three weeks of October only to fall flat going into November. However, small speculators seem to have overloaded themselves on short positions. The COT numbers suggest that the most fickle traders, non-reportables, have been the primary driving force for lower prices. This suggest that despite what seems to be a retest of the October lows the best play in this market could be on the long side of the market. We grow bullish February futures near 84 cents but don't be fooled if the market flushes sell stops to bring prices even lower. If you like it at 84, you will like it more a bit cheaper!
DeCarley Trading
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**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.
