Goldman Fights the Fed

It’s been an interesting week in the interest rate sector. Three major developments have come into play. We’ve had the Federal Reserve Open Market Committee (FOMC) meeting; Goldman Sachs made a major recommendation and the gap between Commercial trader positions versus large trader positions have increased to the widest levels since the economic collapse of 2008.

The week started with my download of the Commitment of Trader data. Commercial traders have moved to a four-year high in their short position total while large traders appear to have taken the other side of this trade. Short positions in the interest rate sector profit when the price of the treasury issue declines. When treasury prices decline, yields rise. Commercial traders are taking the action necessary to profit from a move away from our historically low interest rates.

On Monday, Goldman Sachs came out with a sell recommendation in U.S. Treasuries. This clearly puts them in line with the opinion of the commercial trader. Francesco Garzarelli, Chief Interest Rate Strategist at Goldman argued that U.S. 10-year note yields would not be able to remain below 2% much longer. Goldman rarely comes out with outright trades in the futures market, which makes the plain language this strategy was laid out in all the more notable. Quoting Goldman’s trade, “Sell March 10 year futures contracts at 130.00 and risk them to 132.00 with a profit target of 126.00.” In English, they are selling 10-year treasuries about where they are now (130.00) and risking $2,000 per contract to make $4,000.

Part of the interest in Goldman’s recommendation is that it came out ahead of the FOMC meeting. The Fed left interest rates unchanged with the same target rate for Fed Funds of 0 to .25%. They generally believe that the U.S. labor market is improving and that inflation has moderated. Due to the early stages of our recovery and the expected European recession combined with slowdowns in India and China they plan to extend the exceptionally low rates through the late 2014. The final point to note is that going forward the Fed has instituted a new policy of a publicly stated inflation target. This is a first for the U.S. and puts them inline with other countries like England, Brazil, Canada, Australia and many others. This is also a publicly supported policy by the International Monetary Fund.

The current policy places the Federal Reserve Board at odds with the head trader at Goldman as well as the collective knowledge and resources of the traders representing the commercial trader category in the Commitment of Trader Reports. This is the interesting part of the story. One of the primary axioms of trading is, “Don’t fight the Fed.” Successful trading is all about money management and taking ego out of the equation. No one has more resources than the Fed and taking the other side of their trade can only be viewed as an ego fueled proposition.

I believe that any market shocks will send rates lower and prices higher. Eurozone crisis, Greek default, Middle East tensions and collapsing stock market would each, individually send yields lower on a flight to safety. We are on the precipice of these things happening in combinations. Therefore, I will be siding with the Fed and expecting rates to, not only remain low, but also plan on any surprise moves accelerating the markets’ move that direction as well.

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.

Fossil Fuel Fracking

The three-way balancing act between the environment, job growth and energy self sufficiency are all going to play out in earnest here in Ohio during the coming elections. The primary reason for the growing interest in our State is the fossil fuel production capabilities of the shale fields throughout Ohio, with a special emphasis on the Utica shale deposits east of Columbus. The process of fracking, which drills down on average, 4,000 feet in Ohio and just as far horizontally, pumps the well full of chemically treated, “slick water” to crack the shale deposits, displace the gas and force it to the surface. This has dramatically lowered the cost of production and is ushering in significant economic prosperity.

There are always unintended consequences when theoretical models face real world application in high volume. There were more than 400 fracking wells drilled in Ohio in 2010. The Bakken shale reserves in North Dakota employ more than 6,000 wells to produce twice as much natural gas while also producing enough oil to place them at number 10 on the OPEC production list ahead of Ecuador. The production of natural gas and oil through the fracking process is not limited to the United States. Qatar, Russia and Iran contain about 70% of the overseas, undeveloped supply. This is why environmentalists are sounding such an alarm. Here in the U.S., fracking, while regulated by the EPA, is blamed for everything from contaminated drinking water to the recent earthquake, measuring 4.0 on the Richter scale outside of Youngstown. In fact, the EPA just approved a 100% green replacement for the biocide, “slick water” industry standard. How many Russian state subsidized fossil fuel producers do you think are lining up to purchase SteriFrac to protect the environment?

The economic prosperity that fossil fuel production is bringing to our area cannot be ignored. Ohio is making waves on the international energy production scene due to the volume and quality of its reserves. France’s largest oil company, Total SA, just purchased the rights to drill 619,000 acres of the Utica Shale Field for a total of $2.32 billion dollars. This shale field is expected to produce not only natural gas but also enough crude oil to put Ohio in the top five U.S. producers. The production boom is expected to bring more than 200,000 jobs to Ohio by 2015 and provide an annual income of more than $12 billion to Ohioans. These numbers can be extrapolated to include the Bakken fields as well as the Eagle Ford field in Texas, which is expected to drill more than 3,000 wells in 2012 alone.

The last issue to address is energy independence. The most promising estimate comes from London’s Daily Telegraph, citing British Petroleum research, stating that the U.S. could become entirely energy independent by 2030. More realistic research points to the U.S. Energy Information Administration, which recently stated that we pay $4 in natural gas for the equivalent energy as $25 worth of oil. This is up from less than a 4 to 1 ratio just 18 months ago. The price gap between domestic and overseas natural gas is nearly as wide. Most of Europe pays upwards of $16 per mmbtu (million metric British thermal units) compared to $4 per mmbtu here in the U.S. This price differential makes exporting liquefied natural gas (LNG) a growing business opportunity while the world catches up.

Comparing the cost of electricity to the cost of gasoline clearly explains the efficiency of natural gas. Forty percent of our electricity comes from natural gas. Massachusetts’s Institute of Technology published a paper this summer showing that the price of electricity has remained stable as gas prices have sky rocketed. Barring the extraction of shale gas, they expect the price of oil to increase five fold over the next 20 years. Meanwhile, allowing the use of shale oil would only see crude double in price while electricity will climb by a mere 5-10% in the same timeframe.

The issues we’ve addressed are merely the broadest points of a discussion that requires much further debate on all fronts. The simple facts are that we have a global production advantage that we haven’t seen in at least a generation. However, as a natural resource, we must respect the ground from which it flows and treat it accordingly. Finally, all fossil fuels have a finite supply. We must not allow cheap access to a new source to stall the development money and efforts flowing into renewable energy sources.

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.

Commercial Traders Bearish Ahead of Major Grain Reports

I currently write my article on Wednesday to meet the publication deadlines of various distributors. The primary disadvantage to this is that most of the important government reports come out on Thursday or Friday. Late week reports include the monthly Unemployment Report, 1st Friday of every month, Producer and Consumer Price Index releases on the 2nd Thursday and Friday of each month. Also included on this list are several agricultural reports, including this week’s major agricultural reports – World Agriculture Supply and Demand (WASD) as well as the USDA Crop Production and Grain Stock Reports.

The nature of our business is to try and forecast what the supply and demand numbers will be. Trading agricultural commodities seems almost quaint as the fundamental trends relate to the age old equations of supply and demand. Once the acreage has been planted or livestock has given birth or been sent to slaughter, the supply for the coming season has roughly been determined. Meanwhile demand for food both domestically and abroad can be measured based on population growth and the health of the global economy. Food is a fundamental necessity and therefore fairly inelastic in terms of substitute goods or budget concerns.

Daily price fluctuations, on the other hand, are much more volatile and the large trader movement ahead of this week’s reports should add considerable fuel to the fire. The January WASD Report has become closely watched as it finalizes the previous year’s production. This report has led to considerable volatility including limit moves in the corn market for each of the last five years in the trading session immediately following its release. The fact that the mix of limit up to limit down moves over this period is three to two shows just how wide the range estimates and expectations can vary compared to the report data.

This year should be no exception. Commercial traders in the grain complex have been heavy sellers over the last three weeks. They have shed nearly a third of their corn positions, totaling more than 60,000 contracts on the year-end rally and have sold nearly the same percentage across the soybean complex. In fact, the amount of net selling has triggered a sell signal based on a statistical algorithm across all soy products. This has been backed up by Steve Briese’s comments in his most recent Bullish Review, “A COT-Fisher sell signal has been triggered by commercial selling in bean oil. We caught the top in the bean complex quite cleanly last September, and the bean oil chart has developed the tell-tale bear market pattern over the past 4+ months (circled).”

Commercial traders have been very successful in predicting the long-term trends in the grain markets. This has a lot to do with their direct involvement in the industry. The producers and end users of grain products are intimately involved with their markets. The availability of the Commitment of Traders Reports allows us to peek into their actions and thus, provides us with an opportunity to look over the shoulders of some of the best analysts and traders in the world. Whether the initial reaction to the report is positive or, negative is fairly irrelevant. Either way, the big money is betting on lower prices across the grain markets through the first quarter of 2011.

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.

Precious Metals Ready to Soar

The turn of the calendar leads to reflections and predictions for the coming year. Economists and investment advisors typically use this as an opportunity for shock and awe to gain media attention and increase their capital base through the selling of fear and greed. Fortunately, there are some fairly impartial and anonymous surveys that take place within our industry and this year, there appears to be some merit as well as some action supporting the general thesis of higher precious metal prices through 2012.

We all know about the European Union fears and general deficit issues both domestically and abroad. We’ve written about it extensively and the general actions and conclusions suggest that much of the debt that has been taken on will be repaid with freshly minted currency and each currency unit printed will be worth slightly less than the preceding one. The global race to devalue domestic currencies to repay sovereign debt has renewed the purchases of precious metals as a store of monetary value.

A recent Bloomberg survey of 143 analysts forecasts an average gain of 27% in precious metals for 2012. The Professional Numismatists Guild (PNG) survey is far more bullish. Numismatists are coin collectors who trade the bulk metal as bullion. The average of their range of predictions forecasts a 2012 ending price of $48 per ounce for silver and $1,976 for gold.

Market internals heading into the New Year are also supportive of higher prices in the near term. The Commitment of Traders (COT) report shows some significant imbalances and actions being taken in both the gold and silver futures markets. The quantifiable actions of the reported positions and the adjustments they’ve made to start the year carry far more weight than the conjecture of the talking heads on TV. Commercial traders have set a new bull record in silver futures and central bank purchases of gold have soared.

Commercial trader purchases of silver futures totaled 32,950,000 ounces since mid-December. Meanwhile, the recently published report by the World Gold Council shows that the world’s central banks have been buying gold hand over fist. Their gold purchases totaled 148.4 metric tons, which equals 5.234 million ounces of gold. This is more than the combined annual production of the world’s top five gold mining companies. Total purchases of commercial traders and central banks equals a mind-boggling investment of $8.37 billion dollars worth of gold by central banks and just shy of $100 million worth of silver by commercial traders.

These purchases reflect diversification away from the U.S. Dollar and U.S. Treasuries and tie in directly with the shift towards precious metals in 2012 as a hard store of value. The political wild cards in play make it nearly impossible to trade such volatile markets on an annual time horizon. However, some statistical analysis backs up the projected near-term strength. Returning to the COT report, we can see that both large and small traders have taken the short side of both the gold and silver trades. The recent and decisive shift towards a bullish stance by the commercial hedgers has most likely, set the springs on a bear trap as projections point to higher gold and silver prices by approximately 5% by the end of January. This would certainly be enough to force small traders out of their positions and most large traders, as well. Their short covering may provide the lift to get these markets off the ground and out of the sideways channels they’ve been trading in since mid-September.

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.