Buy the Atypical Mad Cow News

Mad cow disease comes in two forms, typical and atypical. The typical version is the communicable disease that results from improper animal husbandry and feed issues. The communicable type leads to Creutzfeldt-Jakob disease in humans. The human cases here in the U.S. were sourced to the consumption of British and Saudi Arabian products in 2003. The ’03 outbreak also marked the start of declining herd sizes as well as country of origin labeling.

Atypical bovine spongiform encephalopathy is a random genetic mutation that does not spread from cow to cow. This is the type that was discovered at a transfer station in Hanford, California this week and provided the catalyst for this week’s buying opportunity in live cattle futures. Its detection was due to the increased controls, labeling and testing methods put into place after the 2003 Canadian scare.

The definition of atypical by the Department of Agriculture suggests that this is a random mutation that occurred genetically. The key here is the reaction to the news. Based on our history, the images we’ve seen on TV and the Oprah Winfrey special in 1996 the knee jerk reaction has been to stop beef imports, quarantine the population it came from and eat more chicken. The 2003 episode, which saw one reported case of Creutzfeldt-Jakob’s disease, brought the Canadian beef market to its knees. Canadian cattle prices fell by more than 85% and led to the mass liquidation of approximately 20% of their animals to reduce the herd size and prevent further damage to the industry.

However, the response to the headline news is not always indicative of the true story. Atypical forms of this disease confine the issue to the individual animal. Therefore, neither the herd’s nor the public’s health is actually affected. In fact, cases of mad cow have declined from over 37,000 in 1992 to less than 30 in 2011. The controls and husbandry practices have dramatically improved in a business that is dominated by…..India!

Yes, India has the largest cattle herd in the world. India has nearly twice the cattle we have here in the U.S. It’s funny what happens when you search for global cattle herds rather than global cattle slaughter. I assume Indian cattle live longer. Mad cow is passed to people through the consumption of infected meat. Therefore, Brazil leads the pack at 10.7 million head processed and the U.S. comes in third at 5.7 million.

There have been eight reported outbreaks or cases of mad cow since the information age took hold. The last typical outbreak in the U.S. occurred in 2006 and sent prices plunging by 11%.  The average decline for an outbreak of the typical variety is 6.4%. The last observation was atypical and presented itself last March. The story unfolded with a knee jerk sell off followed by a rally, as the truth became known. The net market movement for the event was a rally of nearly 4%.

The current scenario is playing out in the same fashion. The day the news was reported, the market closed limit down. The following morning’s headlines included a ban on U.S. beef by South Korea, our 4th largest importer. This also comes at a time when we are actively trying to negotiate with Japan to lift their import restrictions on U.S. beef. Japan was our number one importer prior to the 2003 mad cow episode. Headlines being what they are, we’ll watch the market for signs of a turnaround and look to buy live cattle on this news induced sell off.

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.

Utah Now Accepts Gold and Silver

One hundred and fifty years ago Congress passed the Legal
Tender Act, authorizing the use of paper notes to pay government bills. This
week, Utah Governor, Gary Herbert signed into law House Bill157 allowing gold
and silver to be used as currency in place of increasingly worthless paper
notes. Several states have proposed similar bills but Utah’s is the first to
pass. The bill provides for transactions based on the weight of the metals to
determine their value rather than face value. This allows the use of gold and
silver bullion to be used as payment rather than the limited scope of federally
minted precious metal coinage.

There are two distinctly separate issues at work here. The
first issue is the Governor’s expression of his constituents’ voices. There is genuine
concern that the easy money policies in place since September 11th
which includes TARP, Quantitative Easing 1,2 and 3?, Operation Twist and so
forth will seriously devalue the greenback’s worth. This is not tin foil hat,
alarmist conjecture. Our money supply has ballooned over the last 10 years.
Money supply as defined by M1, which is currency plus demand deposits like
checking and savings accounts has mushroomed from $1.25 trillion in April of
’02 to $2.22 trillion, currently. That’s an increase of 77%. Furthermore, the
Federal Reserve forecasts M1 to grow at a 17.4% rate over the next 12 months.
Theoretically, each new dollar printed is worth exponentially less than the one
that preceded it. The dollars you hold in your pocket should be worth 77% less
than the same dollars in your pocket 10 years ago. Clearly, there is a Dollar
devaluing argument to be made.

The second issue is the game changing effect this will have
on the physical gold and silver trade. This could truly be a watershed moment. For
example, let’s say you’ve been ahead of the game and began buying gold and
silver years ago. Good for you. Generally, this meant buying metal from a coin
dealer who charged you a premium above the spot market for your purchase and
then the government charged you sales tax on top of the merchant’s premium. The
end result is that you’ve been overpaying to get in the market. Think of it as
a front end loaded mutual fund.

Now that you’re ready to get out, you find yourself offered
below market prices on your physical holdings and due to your success, you’ll
be issued a capital gains form to pay Uncle Sam his share. The end result is
that being right the market meant you had to pay up a total of four times.

Utah House Bill 157 will now treat precious metal transactions
just like currency exchanges. In other words, if you ask for change for a $100,
you’ll get the entire $100 back. You’ll be able to cash in your precious metal
holdings for fair market prices or, simply use precious metals to make
purchases, payments or deposits. The law states that metals don’t have to be
accepted but, if they are, it will be by weight of the metal and the market
price for it.

Finally, the kicker, as I’ve read it, is Utah will offer a one-time
tax credit to offset capital gains on any metal that is being exchanged for
paper. The capital gains and tax reporting nature of getting out of your
holdings will work like a currency exchange. This eliminates the physical black
market or, shadow market of physical transactions. This will avoid multiple
calls while shopping transaction values and eliminate the tricky conversation
of tax reporting issues. Who’d have thought that seldom mentioned Utah would be
the pioneer of such forward thinking?

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.

U.S. Dollar Super Rally

Now that the sunshine of Easter has passed, it’s time for some doom and gloom. We live in a society that rushes towards the end game, whatever the end may be. People as individuals can employ critical thinking. People as a group tend to migrate as a herd. The behavioral side of economics has just begun to gain traction. We are going to look at a small slice of it through the examination of market cycles and why the recent sell off in the stock market may be a clue of bigger things to follow.

There are two storm clouds on the horizon the Euro crisis and the U.S. equity markets. These two episodes could combine to force global equity markets lower, sharply hike interest rates on sovereign debt and create a super rally in the U.S. Dollar.

The European debt crisis started with Ireland. They had been the model child for development within the European Union. Prior to the debt bubble collapsing, their unemployment rate was at an all time low of 4%. Home ownership had sky rocketed and they were quickly emerging as a force in the financial services sector. However, their banks and the Irish people had assumed the continuation of their upward trajectory was a given and based tomorrow’s payments on today’s earnings. When the crisis hit in November of 2010, they transferred privately owned bank debt to the people through government issuance of new debt at a higher interest rate to attract buyers. However, it was quickly realized their paper was simply junk and they were bailed out by the European Union and the International Monetary Fund as well as other independent sovereign nations.

Greece was in a similar situation and is now receiving bailout terms better than those that were offered to Ireland. This has led the Irish people to decide whether they intend to repay the ECB at all. Furthermore, the issue of Spain’s debt is now on the front burner. The interest rates Spain is paying on the open market to finance their debts are unsustainable. The Spanish debt is distributed among its citizens through over extended mortgages, much like our own. However, Spanish law does not allow easy outs to greedy individuals the way we do. Therefore, Spain will need a bailout and due to the size of its debt ($2.4 Trillion) will want better terms than Greece ($550 Billion). Finally, now that the bailout procedure is established, they’ll be able to push for similar treatment.

Ireland, November 2010. Greece, February 2012 (2nd bailout). Spain, ? 2012.

The cycle is shortening and speeding up as the players of the game learn the bailout rules. The simple rule is that it’s first come, first served. The race to the rescue funds has begun.

Abruptly changing gears to look at the U.S. equity market and starting with the tech bubble of the late 90’s we can see that investors were willing to pay for tomorrow’s earnings today. The herd then paid for next week’s earnings, next month’s, next quarter’s and so on until all valuations were skewed.

The 2007 rally saw a test of the 2000 highs. However, company earnings were far less than they were through the tech rally. Much of 07’s rally was based on easy monetary policy and cash out refinancing. Finally, out of the financial crisis of 2009 we have gotten most of our money back on WEAKER earnings still. A market flooded with Dollars fueled the ‘09 rally. The price to earnings ratio of the S&P 500 has been in a steady downward trend for the last 10 years. A fall in share price from these levels would be expected. A solid rally will see the P/E ratio increase with share price but the time is not yet. This is simply the third wave of weaker highs.

Finally, there is a real possibility that a declining stock market may coincide with the needs for further bailouts. Further sovereign bailouts will deeply erode investor confidence. This will force higher sovereign yields across the board as investors demand higher payment for holding risky paper assets (could sovereign yields outpace corporate yields?). The rise in yields will crack the 30-year bull market in bonds, further reducing investors’ willingness to buy. This leaves the U.S. Dollar as the only currency liquid enough to absorb a tidal wave of safe haven money looking for a home. Ending on a brighter note, this will make it far cheaper to vacation overseas with your family in 2013.

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.

Beans and Corn Battle for Acreage

Last week’s USDA Prospective Planting report made the production demands on U.S. farmers quite clear. The world said, “We need more!” This was most evident in the corn market. The major adjustment in the report was the disappearance of 514 million bushels of corn from the ending stocks. This has to be attributed to either a smaller ending 2011 crop or increased exports. The missing corn was not used as feed because the warmest winter in years allowed herds to graze far more than usual. The resulting inventories leave U.S. corn supply near 15 year lows. There is also considerable trade chatter that the USDA may not have revised their ending stocks low enough with some traders believing the true revision should be in the neighborhood of 900 million bushels.

The result of these numbers was instantly higher prices, especially for corn already in the bins. Our statistical model showed that corn should sell off in the days heading into the report and rally afterwards. The corn market sold off about 6.5% heading into the report and has rallied more than 10% since its release. There are three main factors in this market going forward. First of all, the planting intentions for corn are 95.9 million acres. This would be the largest planted acreage since 1937 and would lead to a record crop if all goes well. Second, as always, weather is a major concern. The warm spring will get the crops in early, but any weather shocks down the road lead us right back to extremely tight supplies. Finally, the risk of economic shock due to a Spanish or Italian implosion is very real. This would hurt Eurozone trade with China and China is our primary importer of corn and soybeans.

The soybean and corn markets are competing for acreage and that competition is scored by market prices. Farmers are trying to manage the coming year’s budget and must analyze their operations accordingly. The expected trend line yield for corn is approximately 160 bushels per acre and 43 bushels per acre for soybeans. The break-even cash prices for these crops are expected to be around $4.60 and $11.50 respectively. The current market prices of $6.50 and $14.25 gives corn a significantly higher expected rate of return and explains the large increase in expected acreage for the 2012 crop.

The price disparity will continue to grow until soybeans can trade high enough to justify more acreage. Unless some acres are shifted from corn to soybeans, we could see a huge swing in the corn to soybean spread due to the projected record 2012 corn crop. Soybeans typically bottom out at about 1.7 times the price of corn at the beginning of April and then rally through the end of July before selling off again into harvest. Given the large imbalance between the two crops, the current spread of beans at twice the price of corn could easily surpass 2010’s high of 3.34 and could very well test the all time high of 3.6 set in 1988.

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.