Bear Market Debt Ceiling Rally Should be Sold

Trading the stock markets has become, as much about guessing what the next news piece will be from the European Central Bank or the White House as it has market knowledge. News driven markets are notoriously tough to trade. This can be seen in lower trading volumes as market participants wait on the sidelines for things to sort themselves out and then rush in all at once when they think the market has given them an answer. Patience is the better part of valor. Successfully trading news event driven markets means having a sound strategy waiting to be put into action once the dust begins to clear. I think this is one of those times and this is the plan I’ll be implementing.

The debt ceiling and the Greek debt problems are hanging like a black cloud over the stock markets. Many believe that a resolution of these issues will lead to a reactionary stock market rally. I hope this is true because I’ll be selling stock index futures based on the assumption that a post debt ceiling resolution rally will be short lived and that the sell side of the market will be the proper side to trade from.

There are a few reasons for this. First of all, I believe that we have been in a secular bear market since the financial meltdown of ’08. Starting with that assumption, we have seen corporate profit margins soar since the market bottomed. However, most of this has been due to cost cutting of both labor and financing. As a result, corporate earnings are at their highest margin since their peak in ’06. This means that it is unrealistic to expect corporate profit margins to continue to rise.

Secondly, if we consider this a bear market rally, which I do, we have measurable statistics that say the stock market has NEVER rallied four straight years within the context of a secular bear market. We are in the third year of a rally, which already puts us into the 17% probability area. Furthermore, the average gain for consecutive up years in a bear market rally is 42%. The Dow is currently trading around 12,500. This is a cumulative gain of 43% from the ’09 close on a year over year basis. This puts us at the tail end of a bear market rally by historical measures.

Thirdly, we face structurally high unemployment here in the U.S. We need to average 115,000 new jobs every month just to maintain 9% unemployment. We averaged 78,000 per month throughout 2010. We are slightly ahead of pace in 2011 averaging 124,000. However, to lower the unemployment rate by 1%, we would need to average 240,000 per month for an entire year. The best decade ever for job growth was the technology driven 90’s when we averaged 181,000 per month for the decade.

Declining tax receipts based on lower corporate profits, lower employment numbers and disgruntled consumer sentiment combined with legislatively burdensome small business policies leaves little room for new hiring and small business growth. The last twelve months has seen the weakest small business growth in more than a decade.

Without another technological revolution or the mass renovation of our countries’ infrastructure, we will continue to fall behind developing nations.

These are the fundamental forces at work behind the constant news reports of who’s to blame for the last failed debt ceiling proposal and why I’ll be looking to sell the market. Therefore, when it is finally resolved, and I believe it will be. I expect the market to rally as a sigh of relief brings fresh money to the market like lambs to the wolf.

This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.

Wheat and Corn Spread at 25 Year Highs

There are prices we accept in life as absolutes. We accept
that gold is more expensive than silver or that a Mercedes is more than a
Chevrolet. Sometimes, things change. Remember when diesel fuel was cheaper than
gasoline? Not only is diesel more expensive, it has maintained its premium for
more than ten years now. Recently, another market relationship has been called
into question – the relationship between corn and wheat.

Historically, wheat futures trade at a premium to corn
futures. In fact, over the last 40 years, there are only about ten periods
where corn closed at a higher price than wheat. Going through 15,000 days worth
of data, I found that there were a total of 56 trading sessions that corn
closed at a higher price than wheat. This is .0037% of the time. Nineteen of
these closes have occurred this year and fifteen came in 1984. There have been
no instances of this for more than 25 years.

The typical eyeball range for the spread is around $1.50.
Wheat is normally worth about $1.50 more per bushel than corn. The widest this
spread has been is $7.15 in March of 2008. The recent peak was in August of
last year at $3.82. Conversely, when this spread has gone the other way, as it
is currently sitting, the widest we’ve seen it was corn trading $.40 cents over
wheat last month.

I went back through the USDA Acreage and Crop Production
reports from the periods when this spread went negative and found some
similarities between 1984 and 2011. The carry out stocks for the new crop years
were exceptionally tight in both cases. The carry out stocks at the end of the
1983 crop year were lower due to two factors. First of all, fewer acres were
planted in 1983 due to governmentally implemented acreage reduction programs
following record production in 1982. Secondly, crops in 1984 experienced severe
drought conditions, which led to the second smallest harvest in history. In
fact, the 1984 harvest ended up being 49% lower than 1983’s.

We started 2011 back at the same record low stocks to usage
ratio we were at 25 years ago. This year, the governmentally sponsored ethanol
production intends to take 40% of the 2011 crop off of the market and we have
had lousy planting weather on top of that. Combining governmentally driven
demand and lousy weather we begin to see the similarities between the 1984 and
2011 crop years.

The corn and wheat contracts for September delivery are still
trading back and forth of even money. The trading idea is to sell corn at a
higher price than we buy wheat. This strategy will profit as these two markets
return to a more normal trading relationship and wheat begins to rebuild its
premium over corn. This spread has recently traded as far as $.33 cents towards
corn over wheat at the end of June. The highest it has been is $.40.

Calculating the trade on a cash basis, we can determine our
trading parameters. Forty cents is equal to $2,000 per spread position in risk
to a trading account’s value. Conversely, a quick reversion to the spread’s
normal range of $1.00 to $1.50 in wheat over corn would equal a cash value of
$5,000 to $7,500 in trading account profits per spread position. However, as
with the diesel fuel to regular unleaded example, it’s possible that these
market relationships can shift from anomaly to a new normal. Therefore, risk
must always be the first consideration when deciding whether or not a trade is
suitable for your account.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

 

Shifting Sentiment in the Sugar Market

 

We’ve spoken repeatedly about the value of food commodities
throughout this year. However, the sugar market supply will most likely outpace
demand this year. The sugar market is quickly replenished with multiple
harvests per year. The quick growth cycle combined with more normal weather
patterns in the primary producing regions should see this year’s crop make up
for the last two years of deficit production.

The sugar market was 2010’s most volatile market on a
percentage basis. Using the stock market and gold as a comparison, gold would
have had to reach $3,300 per ounce to match sugar’s rally for the year and the
Dow Jones Industrial Average would have had to fall to 4172 to match sugar’s
decline. Given this type of volatility it’s easy to see why we look to the
commercial traders’ actions to establish a sense of value in the markets. These
are the traders who focus solely on their market and build their business plans
around their ability produce sugar or, turn it into a finished product.

Commercial sugar traders have been exceptionally good at picking
out the major turns in this market and thanks to the Commitment of TradersReports, their actions are easy to trace. Commercial traders were active buyers
as the market traded down to $.20 cents per pound in early May. Since then, the
market has rallied more than 50% to over $.30 cents per pound. Remember, we
said sugar is a volatile market. This move higher has been fueled by two
factors. First of all, the refining margins on raw sugar have been
exceptionally high. This brought in quite a bit of recent demand but will
subside as the spread between raw and refined sugar narrows due to increased
production. Secondly, there has been significant speculative money put to work
on the long side of the market with investment coming from small traders, funds
and managed money.

The rally in sugar may be running its course as the spread
between raw and refined sugar tightens and the commercial traders see this
market as more and more overvalued. Through analysis of the weekly COT reports,
we can see that ownership of long positions is shifting from commercial, value
based buying and into the hands of speculative buyers. Last week commercial
traders sold more than 14,000 contracts, which were almost directly bought by
managed money and swap dealers.

The shift to a speculative stance in this market could leave
it vulnerable to a sell off if the fundamentals hold steady. Production in
Brazil, Thailand, Russia, France and India all appear to be near all time
highs. Much of this is due to extra planting based on the high prices received
last year. A rising tide may float all ships but an overloaded one will still
be the first to sink.

 

This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.

Corn to Rally using Crude Oil as Analog

The corn futures market was facing unprecedented demand heading into this year’s planting season. The tightest supplies since 1937 and the governmentally mandated ethanol program’s consumption of 40% of this year’s crop put extra pressure on Mother Nature to produce a record crop. We all know that this spring broke the 100-year-old record for rainfall. When we combined this with cold temperatures, flooding along the Mississippi and a southwestern drought, it became obvious that corn acreage would suffer as farmers would be forced to wait for the fields to dry and planted more beans and less corn.

Last week, the USDA issued its acreage report and the markets fell out of bed. Corn acreage planted was reported up 5% from last year at 92.3 million acres. This is the largest planted area since 1944 and second only to 2007. The market sold off nearly 12% in the next two trading sessions as traders, farmers and end line users scratched corn their heads in wonder. Message boards were lit up as people wondered how there could possibly be an increase in acreage when the main question was, “How many acres have been lost due to flood damage and the wettest spring on record?”

The USDA’s accounting methods and history of revision has been brought to the forefront of this discussion. Is the USDA turning into the Federal Reserve System and constructing its data to fit its needs? The report did create a flush in the market and ease food and ethanol prices instantaneously. The flush also washed out most trading and hedge funds on the long side of the market.

The reported acreage versus the expected acreage was one of the biggest surprises on record. One industry analyst, Rich Feltes actually found these numbers to closely match his own forecasts while Carl Zulauf from Ohio State questioned the validity of the USDA’s estimates and points to next week’s USDA Supply and Demand Report for more accurate data. Finally, some of the largest Ohio farmers don’t see any way that the acreage reports can’t be revised sharply lower.

The real issue here is, how do we trade it. The analog I’d like to pass on is crude oil’s decline to $90 per barrel on the news of Saudi Arabia’s production increase combined with waning demand in the face of a recessionary Europe. Crude oil sold off hard on a news event down to what was previously a resistance level for that market – $90 per barrel. Corn sold off on a news event down to a level that was once also considered resistance – $5.50 to $6.00 per bushel. The dynamic in crude oil has changed so that what was once resistance – $90 per barrel, is now support. I believe the same is true in the corn market. I expect the market to bounce around here as traders square their positions but ultimately, I believe the acreage numbers will decline and the acreage that has been planted will not provide the 155 bushel per acre yield expected due to delayed planting.

Ultimately, the tight corn stocks coming into this year combined with the ethanol market and growing global demand will place added stress on this year’s crop, which I believe will be smaller than the most recent USDA predictions. Therefore, this sell off in the corn market should be bought in anticipation of higher prices at harvest.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.