Historic Pricing Opportunity in Gold and Platinum

The next time someone asks you if you’d rather have an ounce of gold or, an ounce of platinum you might want to think about your answer. Platinum’s relative value to gold has plummeted over the last two months. In fact platinum is currently $140 less per ounce than gold. This is the lowest value I could come up with using the entire history of the platinum and gold futures markets.

There have basically been three periods when platinum traded at a discount to gold. All three of these periods were characterized by fearful economies. The first period from ’80–’83 saw platinum bottom at $131 less than gold. We also had a total of 6 quarters of negative GDP growth during this period. The second period was ’91-’93. We only had two quarters of negative GDP during this period. We are currently in our third period of platinum’s discount to gold and we’ve had four consecutive quarters of negative GDP finally ending in the second quarter of ’09.

The three periods of platinum’s discount have averaged more than 15 months in duration. The historical sell off in this market fits right in with the volatility we are growing used to. Therefore, we must focus on the underlying dynamics to predict the next range of volatility.

All three of these periods have been defined by recession, declining consumer confidence and household deleveraging. Perhaps the clearest measure of this is through the Federal Reserve Board’s Household Debt Service Ratio data. This measures how much debt American’s carry relative to their disposable income.

Declining sentiment can be measured by the amount of debt we carry relative to our expectations for economic growth.Debt is the first thing that is shed as the economy sours and we may be nearing the bottom of this debt shedding cycle. Prior to the personal debt explosion of the 2000’s, American’s debt to disposable income tended to trade in a range of 10.5% to 12%. While this may seem like a tight range, consider the effects of your own personal debt varying by nearly 15% and you’ll get an idea of what that range feels like to the average American consumer. The debt boom peaked in Q3 of 2007 at nearly 14% of disposable household income. Currently, we have pulled back to just over 11%. This puts us near our historical trough levels. However, it is important to remember that trends tend to overshoot on the downside just as much as they do on the upside. Therefore, I would expect to set a new record trough in terms of household deleveraging some time in 2013.

This is one of the rare opportunities to watch a truly macro economic trade made in the commodity markets. The industrial demand for platinum is fueled by the government’s mandated shift to ultra low emission vehicles (ULEV’s) as well as the global growth of the auto industry, which is heavily based on platinum use in catalytic convertors. Furthermore, the speculative nature of the gold market’s rally will eventually fall of its own weight when some degree of certainty manifests itself in the global markets.

The average ratio of gold to platinum is more than 1.5 times. This ratio is obviously negative at the moment as we are currently at an historical low. I expect resolution of the European banking crisis and a resumption of normal business operations to quickly snap this market back to a normal pricing structure. Once this happens, the market should continue to build a base as individual populations work their own debt issues out. Finally, I expect to look back in time and be grateful to have seen this once every 10 years opportunity well in advance of the market’s turn.

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.

Decoupling the Stock Market from the Economy

Many economists are suggesting that the climax of the Euro Zone drama is quickly approaching with the October 23rd Euro Summit coming this Sunday. Regardless of the opinions one might hold on this matter and regardless of the political rhetoric or public protests, business is still taking place and the markets are still trading. This has left individual investors overly concerned with the next news event and fund managers only lightly invested. Clues are surfacing that suggest the stock markets may be preparing for a period of strength by decoupling from the economic conditions and world politics.

The economic downturn of the last three years has taught domestically based companies to do two things. First, they’ve had to operate more efficiently. They’ve done this by cutting less productive workers and keeping their best. The prolonged downturn in the job market has allowed companies to cherry pick the very best and brightest employees. These employees eager to prove their worth have sought to establish new, profitable markets and production efficiencies. The philosophical argument of the productivity of the American worker has shifted to the back burner as corporations have culled their work forces.

The result of this ongoing effort to recreate the American workforce and decouple individual companies from the broader economic dismay has created a slimmed down, flexible and actionable corporate system from the top down. The survival instincts of the American entrepreneur have not been lost on large-scale commercial traders who have been actively buying stock index futures in the face of European uncertainty.

We noticed the effect of this shortly after the S&P downgrade of the U.S. in early August. The stock market sold off 20% as the cumulative effect of a souring economy, European debt woes and the S&P downgrade all became a reality. Counter intuitively to the world coming to an end, commercial traders immediately doubled their bets that the stock market would recover in the following week. Conspiracy theorists suggested that the massive buying in stock index futures was the result of Ben Bernanke’s black ops, “Plunge Protection Team.” The stock market did make a new low for this period of consolidation on October 4th. Once again, commercial traders stepped in to buy the market.

Over the last week the relationship between the U.S. Dollar, the Bond market and the stock market has formed a very bullish scenario. There are two primary keys to this. First of all, sentiment between individual investors and commercial traders is diametrically opposed. Individual investors have shifted to net short the stock market and long the U.S. Dollar. This fearful position would profit if the Euro unravels, the stock market falls and global cash seeks the safety of the U.S. Dollar.

Secondly, mutual funds managers have been holding more cash than normal as their management style has been reduced to mitigating unexpected losses due to Euro fears rather than deploying cash into good companies. This has placed them in catch up mode, as they’ll be forced to put cash to work if the market rises in an effort to match their returns to their benchmark indexes.

Fund managers’ fears may become reality as we’ve seen commercial traders come in to buy the stock index futures once again, this time above the 1185 consolidation level in the S&P 500. When we throw in speculative short positions, which have now surpassed their ’07 highs, we can see that both sides of the trade have taken on major positions. Technically, we can see that we have already traded above the August rebound highs and we are also approaching a very strong seasonal period for the stock market.

While I leave room for a news event driven panic ridden sell off I expect it to be short lived, as there really isn’t much selling power left in the market. This obviously means that I am siding with the collective knowledge of the commercial traders who have far better access to the inner workings of global banking meetings, the ECB and the Federal Reserve Board.  This could very well lead to the S&P 500 futures testing the July levels around 1300 in spite of a deteriorating economy.

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.

Who Gets the Risk Free Trade?

Effective trading in the markets has historically taken one of two routes. The first route understands the macroeconomic landscape that allows producers of copper in Argentina to sell it to China as they develop massive infrastructure projects. The second route has been through providing market liquidity. This has involved acting as an intermediary in the production to final use chain. Grain elevators are a good example of this. Both of these endeavors entail risk on the traders’ behalf. Over the last twenty years, a third type of trading has taken center stage – the institutional guarantee.

The institutional guarantee is risk free and it is sold to the voting public under the auspices of governmental transparency. The public has the right to know what the next stimulus program, jobs program, interest rate policy, trade sanctions, etc. are going to include as well as when and how they’re going to be implemented. It is our right as voting citizens to be included in the decision making process.

There are two realities that emerge from this process. The illusory feeling of inclusion is really the maximum benefit the general public can receive from this information. The tangible effects of these programs have little effect on any of us, individually. We may get a stimulus check or at some point be able to refinance our home but the push for full disclosure has very little tactile impact on our lives.

The second reality is that institutions with massive capital can leverage governmental and Federal Reserve policy into an artificial backstop. Transparency is actually causing more problems than it solves. Institutions who have teams of lawyers and accountants to dissect the latest minutes from Capitol Hill or Ben Bernanke’s latest testimony before Congress filter through it with magnifying glasses to find exactly what loophole there is to exploit.

The exploitations of these loopholes combined with the expected accountability of the government to back up their policies have been creating economic bubble after economic bubble. There is no incentive for legitimate market strategy or need for allocating a portion of a portfolio to speculative markets when a guaranteed return can be had through leaning on economic policy.

This has always been part of the way business has been done. Historically, it was limited to a few people or firms with the right board members or being part of the right social circle. The deals had potential for huge gains. Think of westward expansion and the railway industry or the creation of entire neighborhoods of public housing. These deals were independent, local and a small part of the overall capital pool. The information age has diminished the profit margin on these deals if for no other reason than to keep public uproar to a minimum.

The institutional guarantee trader has simply swapped out declining profit margins for increased leverage. This has funneled more and more capital from all over into smaller pockets of profitability therefore, metamorphosing smaller non-related pockets of exploitation into something global and systemic. This is how we ended up with the current global banking crisis.

There will always be people who are better informed or who make better decisions, that’s the way it’s supposed to be. Using analytical skills to make a dollar is the American way. My suggestion is that our own thirst for information may be hindering the effectiveness of policy decisions. When Paul Volcker put the clamps on inflation his intentions were clear but the Fed’s implementation of that strategy was announced in the papers after actions were taken. This protocol eliminated the free ride opportunity in the financial markets. The same can be said for the handling of the savings and loan crisis when more than 700 banks were allowed to fail. America was made a great country by pioneers and visionaries willing to step out and put their money where their mouths were. No one should be too big to fail and no one should be given a free ride even if it is framed as, “keeping American’s in the loop.”

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 is a Value at $6 Per Bushel

December corn futures, this year’s crop, have sold off more than 25% in the last month due to three primary concerns. First of all, the market was significantly overbought by speculators. These included near record net long positions held by Commodity Index Traders, managed futures programs and small speculators. Commercial sellers established their maximum short position at the market’s high above $7.50 per bushel in June and have since held fast against the other market participants. The commercial trader commitment to their short position suggested that farmers growing corn this year collectively felt like this was the best possible price they could receive for this year’s crop.

Secondly, September’s weather was perfect for finishing the crop. This has caused expectations of yields to be better than the USDA’s abysmal August forecast. The season’s weather, which was so damaging early on, has presented the crop with a chance to catch up. This was the tide that slowly turned the market negative. Once the market started heading south, speculative long liquidation fueled the fire.

Traders who had bought into the bull run in grains this summer began heading towards the exits. The final straw was the materialization of European troubles and the withdrawal of capital from all risk related asset classes. The run to U.S. Dollar safety in turn made our grains more expensive on the open market while facing declining global demand as the expectations for a slowing economy increased.

The corn market’s sell off has brought the fundamental laws of supply, demand and profitability back into the equation. Corn at $6 per bushel is much more attractive on the open market. Corn at $6 per bushel also brings back profitability to hog, cattle and ethanol producers. Remember that 40% of this year’s corn crop has been mandated to ethanol production and China is intent on developing a self-sustaining hog industry by 2013.

I expect corn to rebound smartly from these levels based on the demand side of the equation. This should be seen in large commercial purchases through this week’s Commitment of Traders Report. However, the short-term wild card in this equation is the next USDA Crop Production Report on October 12th. This is an update of the same report that that fueled our rally this summer. The industry whisper is that yields could be higher than expected. However, I’m pretty sure local farmers may argue with the USDA on that one.

A Crop Production Report surprise to the downside would be short lived. Unfortunately, initiating new positions heading into a report is always a risky proposition. November corn options expire on October 21st. This is more than a week after the crop report. The market should have sorted itself out by then. Currently, the October corn $6 put option is priced at about $1,000. This is equal to a $.20 move per bushel of corn. Buying this option as well as December corn futures on a one to one ratio will provide traders with downside protection into the report while not limiting their upside profit potential. The market could very well run back to a $7 per bushel equilibrium price. This would equal a $5,000 profit in the futures for a realized net profit of $4,000 and maximum risk of $1,000 via the purchase of the option.

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.