This commodity trading newsletter was emaield to clients of DeCarley Trading brokerage services on May 31, 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.
There is a large question mark looming over the stock indices. If you have been with us, or following our newsletter The Stock Index Report for long, you have probably noticed that I can endlessly ramble on about stock index futures. Additionally, more often than not I am vocal as to my opinion in regards to the overall direction of trade. However, we find ourselves nearly speechless in regards to the current environment.
Consumer confidence is on the rise, the Chinese economy looks poised to cushion the global recession and some analysts suspect that the stimulus package may begin to have a positive impact. However, we wonder if all of the immediate good news is out and has already been "celebrated" in the marketplace. A slow-paced recovery may not be enough to avoid a potential sub 800 move in the S&P in the coming months.
The major stock indices spent the entire month of May trading in a relatively tight price range. The June S&P peaked in early May at 929.50 traded as low as 875.25 a little over a week later but has failed to pick a direction since.
The eerily quiet trade seems to be the pre-cursor to another explosion in volatility. After all, the market's fear index, the CBOE's VIX volatility index, is threatening to dip below 30 after being valued near 90 in late 2008. I certainly don't expect the same type of volatility to resurface but I do think that the market's complacency will need to be tested. This normally comes in the form of a sharply declining equity market.
As a reminder... May marks the beginning of the "worst 6 months of the year". You have likely heard the mantra, "sell in May and go away"...A $10,000 investment compounded to $531,444 for November through April in the previous 58 years compared to $1021 for May through October. Additionally, according to the Stock Traders' Almanac, June ends the "Best Eight Months" of the NASDAQ which begins in November. A $10,000 investment in these eight months beginning in 1971 is said to have gained $315,278 as opposed to a loss of $2,938 in the other four months.
While we think that it will ultimately be a rough summer for stocks, we encourage bears to be conservative in their speculation. We have been suggesting a rally to the 940/950 area in the June S&P for several weeks now and still see it as a possibility on a last gasp rally. Don't forget that markets have a way of luring in the late-comers before making a move. That said, should we see the mid-900's we will become highly bearish. A combination of short calls and long puts will likely be great candidates should this unfold. Stay tuned to the Stock Index Report for details.
Treasuries
Rumors of a downgrade of the U.S. government from its AAA rating, diminishing confidence in the U.S. dollar, the subsequent potential for less foreign investment in U.S securities and an unprecedented amount of debt issuance nearly brought the Treasury bulls (and ourselves) to their knees. A large wave of Treasury liquidation brought bonds and notes considerably below our original expectations, but it now seems as though buyers have been lured back to the markets by relatively attractive yields.
Despite being historically low, yields on government treasuries are at their highest point since November. The benchmark 10-year note is hovering around 3.5% while the 30-year bond ended Friday near 4.30%. Several years ago, these yields wouldn't have been considered to be worth the hassle but in today's "return of capital" as opposed to a "return on capital" mindset, it seems like a great place to park cash.
Insiders that we have been in contact with seem to think that the 3.75% area on the 10-year note is enough to trigger a considerable amount of portfolio adjustments into U.S. backed Treasuries and out of riskier asset classes such as equities. Confirming this assumption, a recent interview of Pimco's Bill Gross, revealed that the bond investment giant is beginning to see opportunities in the Treasury front.
The U.S. dollar has been under pressure as of late which has raised concerns over the stability of the currency and better yet the viability of foreign investments in domestic securities such as Treasuries. Keep in mind that the Chinese government and other foreign entities are holding a large portion of U.S. debt; if they begin to fear that losses on their currency holdings will outpace that of any investment interest, they may begin looking for alternatives. At a time in which the Fed is financing expenditures at a never before seen pace, this could be devastating to the interest rate markets and the economic recovery plan. Fortunately, we see potential in the U.S. dollar and believe that the bond market's worst fears will dissipate in time.
Accordingly, we feel that a reversal in the dollar, combined with short covering and yield hunting, could result in a sizable rally in bonds and notes. After all, market sentiment has become overwhelmingly bearish and this typically signals that most of the sellers are already in.
While we can't rule out a retest of the lows, or even slightly new lows, it seems as though the path of least resistance in bonds and notes will be higher in the coming several weeks. Supporting our assumption; seasonal tendencies are pointing toward a mid-June low, the Fed may pick up the pace of their seemingly light handed Treasury buying, and if our prediction of lower equity prices in mid to late summer holds true, Treasuries may benefit.
This has been a relatively volatile market, we like playing the 5-year notes or options in the 30-year in order to mitigate market swings, it may also be wise to protect any long note positions with long puts. See the Bond Bulletin for specific trade recommendations. Newsletter followers were advised to get long the market at a price equivalent to about 115'05 in the September contract and currently have open recommendations for a lopsided short option strangle that is biased to the upside.
Grains
As goes the equity markets, goes the commodity markets. Agricultural products such as corn and soybeans have greatly benefited from stock market optimism in hopes that it will eventually lead to a global recovery and increased demand for grain products.
Also aiding the commodity rally is a weak U.S. dollar, which has recently forged new 2009 lows. As the domestic currency gets cheaper, our goods and services get more expensive. Therefore, even in the absence of stable supply/demand fluctuations it is possible for grain prices to see dramatic moves based on action in the currency markets. It is our belief that the most recent corn and soybean rally has been primarily dollar related and that a turn in the greenback could erase a good portion of the recent gains. Based on the information available to us at this point in time, we speculate that the U.S. dollar may be nearing an intermediate-term low. Likewise, while the grains may have some room to move on the upside in an immediate time frame the longer-term prospects are for considerably lower prices.
Our expectation for a grain reversal in the coming week or weeks is also consistent with our belief that the equity markets, following a potential run up, will suffer from selling pressure as the summer progresses.
Corn
Last week the USDA announced that the 2008/2009 corn exports remained down approximately 33% from the previous year. Yet, corn prices have remained stable. This is not entirely unexpected given that markets typically price in news before it is officially announced and considering that we are in a time of year in which there is a great deal of weather risk to pending crops.The grain markets tend to build in a considerable amount of risk premium into pricing to compensate for the "off chance" that there will be a weather related catastrophe that damages crops and reduces the yield. Clearly, even in the absence of demand lower supplies will keep a floor under pricing.
However, more often than not the elevated price turns out to be unnecessary. Most crop years are without major drought or flooding and once this is established, the market quickly deflates the risk premium that was built into pricing. As a result, the seasonal tendency for corn futures is to experience a swift slide going into mid-June.
These seasonal tendencies, combined with our assumption of a higher dollar and lower equities (yes we realize that we are boldly going against the grain), suggests that aside from a moderate continuation of the currently rally, and barring any unforeseen weather disaster, corn prices should trade consistently lower heading into July.
In last month's newsletter we noted that we liked being bearish above the $4.30 area. We have since re-adjusted our bearish level to $4.42 with the possibility of a spike high to $4.57 but prefer the short side from such levels. If we are wrong about the U.S. dollar and equities, corn could see prices above $5. Therefore, bears should be cautious.
Soybean Complex
Soybeans continue to carry a relatively strong fundamental picture. The May supply/demand reports suggest that 2008/2009 exports are expected to be raised to a record 1.24 billion bushels but the ending stocks are on the tight side.
However, rumor has it that much of the buying has been at the hands of funds. If you recall, it was fund buying that brought beans to prices in excess of $16 before pulling the plug and forcing them well under the $10 mark. While funds, more specifically fund managers, may have a lot of money backing them, they may or may not be capable of making rational decisions. Nonetheless, they can have a profound impact on pricing as we have witnessed in the most recent few years of grain trade. That said, just because the "big boys" are doing it doesn't mean that it is gospel. Higher prices may eventually be in the cards for soybeans, but we have a sneaking suspicion that the near-term highs may be looming.
Similar to corn, soybean prices tend to display weakness throughout the summer months. In fact, according to the Commodity Trader's Almanac, the seasonal peak is June 1sth and a bearish bias should be held until October 6th. According to the authors, selling futures and them buying them back at the previously mentioned dates would have yielded a profit about 70% of the time with a cumulative total of about $54,213. On a side note, there was no reference to the draw downs experienced in losing years or before the profits occurred.
We see considerable resistance near $12.17 and wouldn't be surprised to see a last ditch effort by the bulls to extend the gains to the mid-$12's but feel as though this market should be finding a top soon in conjunction with a dollar low and equity market reversal. Keep in mind that chatter suggests that farmers are looking to hold their old crop supplies in hopes for prices in excess of $12.50. Therefore, if we do see such prices, a quick price revaluation could be underway as farmers unload their soybean inventories.
Energies and Metals
Crude Oil
March through September are said to be the best months of the year to be long crude oil. However, June tends to see more price consolidation than gains. It seems as though fundamentals seem to support this assumption. Recent gains in crude oil look to be highly speculative and related to optimism of a global recovery leaking out of the equity markets; perhaps the market has gotten a bit ahead of itself. After all, crude oil has rallied on what seems to be tepid demand and ample supplies.
We can't help but feeling bearish on crude once the July futures reach the high $60's but we do respect the possibility of a move to the low $70's. Once again, our speculations are based on our opinion of the dollar and equities as well as technical and seasonal analysis of this particular market. That said, despite crude's recent ties to stocks and currencies, it also has its own set of issues to deal with. Political tension in the middle east remains high and creates the potential for large rallies in the blink of an eye. Keep in mind that about 20% of the world's oil travels through the Strait of Hormuz, and Iran could potentially interfere.
Gold and Silver
In early 2009, gold and the U.S. dollar were trading in lockstep as the historically negatively correlated relationship fizzled. To the dismay of many spread traders, each market managed to see price appreciation in January and February as traders flocked to what they believed to be "quality" assets. However, the dollar/ metals inverse trade is back and seems to be pushing extremes.
Again, early 2009 gains in gold and silver were attributed to safe haven buying in the face of economic turmoil. As the investment community has become more comfortable with the slow but relatively stable growth prospects of the U.S. economy, they have shifted their interest in metals away from a flight to quality and toward an inflationary hedge. Nonetheless, the metals bias has remained bullish and that may be extended in the near-term. Conversely, looking beyond the next week or two it seems as though gold will also be a candidate for the bears.
In last month's newsletter we noted our doubt that the metals could "make significant price gains in the absence of another bout of economic panic"; and as it turns out we were off the mark. In our defense, we did mention that inflation was a wild card. Once technical resistance areas were broken, the dollar plummeted and interest rates soared...the metals rally was ignited. This month, we are calling for moderately higher prices in gold and silver but a reversal seems imminent.
Keep in mind that we believe that a contrarian view can be helpful in speculation. On May 20, 2009 the World Gold Council announced that the world gold demand was up nearly 40% in the first quarter of 2009. Much of this demand was directly related to the purchase of bullion by panicked investors. If a majority of the buying has already taken place, it may be difficult for dramatically new highs to be made immediately.
Look for near-term resistance just under $1,000 in gold but we do think that there is potential for a run to $1,020 as stop orders near the $1,010 highs are elected. Picking a top in the metals can be dangerous, bears should be conservative in their approach and allow for a considerable amount of error. Thus, mini contracts and/or option spreads may be the optimal choice for many retail traders.
Currencies
The U.S. dollar is still suffering at the hands of the Fed. The market's original concern was with the Fed's pledge to purchase its' own securities (AKA print money and encourage inflation) but is now feeling the impact of a possible downgrade of the AAA credit rating held by the U.S. government. We don't expect this downgrade to take place...at least not for now, but all the market needs to price it in is the possibility.
We suspect that oversold conditions in the dollar combined with a renewed interest in flight to quality will eventually lead the way to a recover. In the meantime, the June dollar index could see levels slightly below 79.00 at which point we like the idea of constructing a bullish strategy. However, picking a bottom is a dangerous activity and any bullish trades should be either limited risk or hedged. For instance, futures buyers may look to buy puts, sell calls or both as a means of taking some of the bite out of being early (or wrong). A low risk way to play this market would be to buy deep out-of-the-money call options...they are lottery tickets, but sometimes these types of positions can pay off nicely. We like the July 84's for about $250 or the September 88's for about $350 (these prices incorporate the bid/ask spread, they settled for less on Friday).
Euro
Despite weak fundamentals, the Euro has been favored over the dollar as investors attempt to hedge inflation risk in the U.S. We are looking for the market's infatuation with inflation will diminish and flight to quality sentiment will return. It may not be today or tomorrow but in the next week or two, we see the possibility of a sharp currency reversal.
Keep in mind that as tensions over North Korea's nuke tests heat up, so may the Dollar. Should this scenario come into play, the Euro may suffer.
British Pound
Softs
Sugar
Sugar fundamentals remain supportive; on May 21st the USDA predicted that 2009/2010 will end with the lowest world stocks to use ratio in 16 years. The market rallied on the news, but the gains were modest as the market had already priced in such an outlook. World sugar production is expected to be 159.9 tons, up from 148.7 in the previous year but demand is expected to outpace production. Sugar has quietly benefited from increased demand thanks to fuel alternatives such as ethanol. In the meantime, Czarnikow, a large private sugar firm claims that sugar at 10 cents per pound is well below production costs. Sentiment such as this should at least keep a floor under pricing.
The technical aspect of the market leaves little room for discussion given the sideways price action. Therefore, we prefer to look at the seasonal tendencies which suggest that a continuation of the rally could materialize in late June. Look for prices under to 14 cents to become bullish.
Coffee
Some fundamental analysts seem to believe that coffee prices, although technically overbought, have the fundamentals to back the recent rally. Columbian production is expected to slip by 1.3 billion bags forcing the exports to fall over half of a million bags. Likewise, the Brazilian government had stated that it expects that coffee production for the 2009/2010 season to be just 39.1 million bags as opposed to 46 million last year.
Nonetheless, we cannot ignore the potentially large seasonal slide that is looming. Coffee futures tend to rally in the spring in anticipation of a South American freeze, but confirmation of proper growing conditions and crop yields tend to deflate the risk premium carried in prices.
In last month's newsletter, we underestimated the strength of the bulls. We felt as though a move to 126 would result in dried up buying and an eventual reversal lead by seasonals. This month, we acknowledge the potential for coffee to reach prices slightly in excess of $1.40 but feel as though such levels should act as a price ceiling.
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.
Meats
Hogs
Unfounded swine flu panic has wreaked havoc on lean hog prices since April 27th when it became an international health emergency...or at least it was considered to be. The subsequent drop in prices has yet to fully recover despite the fact that even improperly cooked pork does not spread the illness.
As we had expected in the previous newsletter, some rationality has returned to the marketplace but it is clear that there is still a lot of uncertainty in pricing. We has been looking for the futures market to fill the gap left from the swine flu announcement, but the most recent rally fell short. We still believe that this gap is a target for the bulls and will be filled sooner rather than later.
Also, seasonal pressures and potentially lower grain prices (which will prevent speedy delivery of hogs to the market) should have a positive impact on hog prices. Look for the July contract to make its way toward 72.40.
Cattle
Live cattle futures have been painfully range bound for the entirety of 2009. Fundamentals have been challenged; beef production and inventory is down from last year's levels and higher grain prices have encouraged ranchers to bring their cattle to slaughter sooner in order to avoid high feed costs. However, with a potential reversal in on the horizon in grains and a technically supportive atmosphere in the cattle market, it seems as though August cattle should, at minimum, make its way back to the top of the range. In the right circumstances, we may even see a rally that could bring prices into the mid-to high 80's.
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.
