No Bull in the Cattle Market

Cattle stocks and beef production in the U.S. have been declining since 2002 and beginning stocks have dropped more than 5% in the last five years. This summer’s drought also led to massive slaughters as farmers couldn’t efficiently feed the animals to hold them back for a later date. The declining cattle stocks across North America will take time to rebuild. Our thoughts have been placed on the buy side of the cattle market as it tightened up and we expected the cattle market to rally sharply in 2012. However, there have been major changes within the global cattle industry that may have signaled an end to our domination of the cattle global cattle market.

It’s no secret that Australia, Brazil and Argentina have been building their cattle business over the last several years. Brazil is second in total production while Argentina and Australia lag behind Chinese and European Union production. Meanwhile, our own production has fallen behind China and places us fourth on the list. The kicker is the new number one on export list – India.

Indian beef production has soared and since very little of it consumed in India, their growth in the export market has been nothing short of astounding. India passed the United States in beef exports in 2011 and will pass Brazil and Argentina this year. India’s 2012 record exports of 2.16 million tons will account for nearly a quarter of global trade. This boom has been fueled by cheaper exports to Asia, the Middle East and North Africa. India’s quickly growing supply has picked up the global supply slack due to the North American drought of 2012. India’s ascension to world leader in cattle exports should cause us to pause for thought.

First of all, every westerner’s image of Indian cows relies on the cows’ place as a religious symbol. Most Indian states have laws against slaughtering cattle. Therefore, the numbers that we’re quoting are only from above the board, licensed processors. The underground meat trade is estimated to have shipped another 1.5 million cattle. This is an additional 4.5% increase on top of their 2012 record exports. If we include these numbers in their processed tonnage, their exports would surpass Brazil’s record production of 2.19 million tons in 2007.

Secondly, the computation of beef production must be taken into account when viewing India’s growth as a major exporter. The trick in the numbers is that water buffalo also count as beef production in all of the World Agriculture Board’s global numbers and India has no laws against the slaughter of water buffalo. Water buffalo production here in the U.S. would be treated the same way. They both fall under the category of, “bovine meat,” and they will combine to make India the top bovine meat exporter in the world in 2013.

Finally, we should all view the interaction between the Indian government, the economy, and the primary beliefs as a negotiation of economic compensation for the sacrifice of personal beliefs. India is a predominantly Hindu country. Hinduism teaches that the cow is a sacred gift that provides man with everything he needs. Milk, butter and other dairy products, of course, but also fertilizer and manure for fires. The cow recycles the earth and leaves it no worse than it found it. These are the principals that are up for sale. The story has been played out over and over in history throughout the world.

Trading the cattle market for the all time highs was the 2012 trade that never happened. Many are still looking for it based on the tight North American cattle supplies. Personally, I think greed will supplant morality and India’s production will provide enough of a cushion to keep prices relatively, in check. I will still look for cattle to trade past the 2012 highs of $137 however; I don’t believe we’ll approach the all time highs of $167 from 2007.

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.

Third Stage Growth in Agri-Business

The run up in food prices this year has, hopefully, shined a bright light on the oligopoly that controls the world’s grain markets. An oligopoly is a market that is controlled by a small number of producers, which allows them to collaborate and set prices for the market as a whole. OPEC is the most common textbook example. The U.S., Brazil, Argentina and Australia dominate the grain industry. There is grain production in every country but these four control the vast majority of the export market. That may be about to change and bring new, long-term investment possibilities with it.

When crude oil topped $145 per barrel in 2008 it was a painful, but simple adjustment to the world’s lifestyle. When the grain market soared to all time highs this summer, forcing food inflation on the world’s population, the adjustments weren’t so simple. The mechanization of the global grain production process places more and more of the world’s food production in the hands of fewer and fewer people.

The global grain stores are running at multi year lows, just as they were at the beginning of this U.S. growing season. This summer’s drought was the worst in 50 years here. The weather pattern also knocked 13% off of Australia’s wheat crop and they’re the world’s largest wheat exporter. This also led to a nearly 60% decline in their ending stocks over the last three years. The only thing keeping prices in check at the moment is South America’s increasing efficiency. Brazil’s soy production may surpass the U.S. this year and thanks to their long growing season, double crops of corn are becoming normal.

The global demand growth for coarse grain production has been fueled by the Pacific Rim’s meat production industry, rather than by population growth. China’s population growth is less than one percent per year, yet their hog market is growing by an average of 3.5% per year. The growth in their agricultural markets for both grains and meats has been astounding, as production of both have shifted from individual farmers on their own land to the mechanized version of agri-business that is the model of the industrial world. Their soybean imports, which are used for feed, have grown from 3 million metric tons in 1997 to approximately 56 million tons this year.

These wheels have been set in motion and will not be derailed by a collapse in the Eurozone or a surprise in our elections. The trends in population growth and the move towards global improvements in diet are really just beginning. The United Nations and the Food and Agriculture Organization (FAO) just reported that global wheat prices for 2012 were up 25%. They added further that source inputs have now caused the price of dairy to rise by 7% in just the last month.

The arguments over who gets their principal back on a Greek or Spanish Bond is far less important to Greeks and Italians than the ability to put food on the table. Food inflation, as a result of the commodity rallies of ’07 and ’12, was also a primary cause of the Arab Spring. It is far easier to control a population with a full belly than it is to placate a parent unable to stop the crying of a hungry child.

So, where’s the trade? The trade starts with slowing global growth and negative growth across Europe. Negative growth will increasingly put the pinch on Eastern European countries like Kazakhstan, Ukraine and Russia. This is the main breadbasket of Europe and North Africa. Bottom up analysis of these macro trends reveals very large growth potential in several African countries. The BRIC’s have received most of the attention over the last ten years and rightfully so. However, as more and more resources are pulled from African countries for global production, it becomes clear that these countries are also next on the open borders list to develop.

Therefore, using the pending global economic contraction as the setup, I’ll be using declines in the stock market to knock the valuations of agri-business stocks like ADM, Monsanto, Cargill, AgroSA, Bunge, Caterpillar, DeutzAG, down and for retail investors to get washed out. There are two important things to take away from this. First of all, I am not a stockbroker. These trades cannot be executed through me. I stand to gain nothing financially from anyone following this advice. Secondly, I believe that we will get an equity selloff similar to 2008 and I plan on being ready to put cash to work in companies that stand to profit the most from the commodity markets I know best in the coming decade.

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.

The Value of the U.S. Dollar

The Federal Reserve Board is printing money at an unprecedented rate. The ECB is following suit. The Bank of England and China are both cutting rates to spur their economies and global sovereign debt is piling up like manure behind the elephant pen. Clearly, our currency is being devalued by the day. Some would argue that there’s a race to devalue among the major global currencies as the G7 nations attempt to boost exports and spur their respective domestic economies. Tangible assets like gold and silver or soybeans and crude oil may be the only true stores of value left in an increasingly wayward world. We read this every day. The truth is far less dramatic. In an ugly world, the U.S. Dollar is the prettiest of the ugly sisters at the ball.

The U.S. Dollar Index is exactly where it was four years ago. This is interesting considering that the aggregate money supply in the U.S. as a result of the quantitative easing programs has nearly doubled since the housing market collapsed. Theoretically, doubling the supply of U.S. Dollars should mean that each new dollar is worth half as much. Take this one step further and it’s logical to assume that if each new dollar is worth half as much then it should take twice as many dollars to make the same purchases that were made in 2008 yet, the Consumer Price Index is only 4.5% higher than it was then. Finally, I would suggest that considering the growth of the money supply and its characteristic devaluation, we should see an influx of foreign direct investment picking up U.S. assets at bargain basement prices. While logical, this is also incorrect as the U.S. Department of Commerce shows that foreign direct investment only exceeded U.S. investment abroad in 6 out of the last 20 years with 2005 as the most recent.

What has happened through the artificial manipulation of interest rates in the world’s largest market is that the U.S. Dollar has begun attracting large amounts of money as U.S. and global investors park their cash while waiting for clarification on the world’s major financial and political issues. Real interest rates in the U.S. are negative at least 10 years out. The Euro Zone is no closer to resolution. China is in the midst of changing leadership in a softening economy. Finally, what was an assured re-election of President Obama is now a legitimate race.

The inflows to the U.S. Dollar are easily tracked through the commercial trader positions published weekly by the Commodity Futures Trading Commission. The U.S. Dollar Index contract has a face value of $100,000 dollars. Commercial traders have purchased more than 25,000 contracts in the last few weeks, now parking an additional $25 billion dollars. The build in this position can also be seen in their selling of the Euro, Japanese Yen and Canadian Dollars. The Dollar Index is made up of these currencies by 57%, 13% and 9%, respectively. Collectively, commercial selling in these markets adds another $5 billion to their long U.S. Dollar total. The magnitude of these moves makes commercial traders the most bullish they’ve been on the U.S. Dollar since August of last year which immediately led to a 7.5% rally in the U.S. Dollar in September.

The degree of bullishness by the commercial traders in the U.S. Dollar forces us to examine the markets most closely related to it in order to monitor the spillover effect a rally in the Dollar might create. The stock market has traded opposite the Dollar for all but four weeks in the last two years. The last time these markets traded in the same direction on a monthly basis is August of 2008. The current correlation values of – .29 weekly and -.43 monthly suggest that for every 1% higher the Dollar moves, the S&P500 should fall by .29% and .43%, respectively. Therefore, a bullish Dollar outlook must be coupled with a bearish equity market forecast.

Finally, we see the same type of relationship building in the Treasury markets. The U.S. Dollar is positively correlated to the U.S. Treasury market. This makes all the sense in the world considering foreign holdings of U.S. debt have increased over 5% through the first seven months of 2012 (Fed’s most recent data). The bulk of these foreign purchases of U.S. debt are repatriated immediately to eliminate currency exchange risk. This process of sterilization forces interest rates and the Dollar to trade in roughly the same direction. This relationship turned briefly negative between April and June of this year on a weekly basis while one has to go back to March of 2010 to find a negative correlation at the monthly level.

Obviously, the trade here is to buy the U.S. Dollar. The negative speculative sentiment coupled with the bullish and growing position of the commercial traders could fuel a forceful rally. Small speculators typically accumulate their largest positions and are the most wrong at the major turning points. A recent study in the Wall Street Journal discussing individual traders’ biggest mistakes puts it succinctly. Small traders’ biggest mistakes, accounting for 60% of the total responses are being too late to get in and too cautious to take the next trade. Once burnt from exiting the last trade too late, the small investor is too scared jump in the next trade which reinforces the negative feedback loop they typically end up stuck in. Take advantage of this analysis and at least, prepare yourself with an alternate game plan.

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 is Pushing the Stock Market?

We turned bearish on the stock market rally near the end of August, as a result, we’ve missed out on the last leg of the rally from 1400 to 1450 in the S&P 500. The August highs presented us with a fundamental picture that was becoming increasingly bearish and combined with the European unrest, stepping aside seemed like the appropriate action. The primary analysis simply stated that the forward returns didn’t justify the added risk necessary to capture them. The fundamental picture hasn’t changed and recent metrics suggest most of the big money is also seeking the safety of the sidelines.

Nothing has changed, fundamentally to cause me to change my mind. In fact, several measures of sentiment are becoming increasingly bearish. First of all, the general public continues to support this rally. The Market Vane bullish consensus, Investment Insiders consensus and Consensus, to which I’m a contributor, are all near or, at their highs for the year. Fortunately, it does appear that they’ve finally taken some money off of the table in the last week. In spite of this, they still hold a larger position now than they did at the beginning of the year.

Ideally, the markets would see a shift in open interest, which measures the total degree of involvement, from owning the stock market to selling stock index futures. The further the market rises, the more selling pressure small traders should put into the S&P 500 futures. This would allow them to lock in some gains while still holding their stock positions. Thus, not incurring any capital gains taxes or, missing any dividend payments. The holding pattern as it currently stands looks like it’s ready to leave the small investors holding the hot potato.

Deeper analysis from Barron’s shows that stock market insiders, those who are buying or, selling the stock of their employer has increased to its most bearish level since February of last year. Barron’s insider ratio now stands at 40 sellers to every buyer. This type of selling comes from individual employees and corporate officers understanding that their respective companies cannot continue their bull runs. Recent filings of insider transactions include sales of Allied Nevada Gold Corp., Tiffany & Co., General Mills, Capital One Financial Corp. and Franklin Resources. This type of broad based selling needs to be noted.

Barry Ritholtz published a chart this week detailing the relationships between the business cycle peak and the market peak. There were fourteen occurrences between 1929 and today. The common words of wisdom have always been, “The markets lead the economy by 6-12 months.” His research shows that the average is actually just less than four months. This means you may not have as much time to manage your finances as you thought. I’ll also throw a chart published by JP Morgan this week on market inflection points into the cycles mix. They looked at the ’97, ’02 and ’09 bottoms. All three bottoms saw the S&P 500 double from its lows followed immediately by a 50% decline. The current S&P 500 rally is 113% off the ’09 lows.

Finally, I’d like to translate the metrics we’ve used into real world trading by discussing the behavior of the commercial traders at this critical juncture. Despite the market’s rally, large traders and commercial traders are both pulling money out of the market. Money flow in the Dow Jones is negative for the month and commercial traders began exiting the market in earnest after the first week of September. In fact, commercial participation in the market is the lowest it’s been since August of 2011.

Their declining participation leads to declining market volume. Declining market volume leads to an end of the move. Home runs are hit by sticking with the trend. Clearly, the trend is up and I turned a home run into a ground rule double. Fortunately, the S&P 500 is setting up a chart pattern that may help us cross home plate. The weekly chart shows consolidation at the top accompanied by declining volume. Technically, that’s a setup for a pull back. The trade is to place a sell stop at last week’s low of 1424. This order becomes a sell order only if the market trades that low. Your profits continue to run unless the market trades down to 1424. This also allows a short entry prior to testing support at 1395.

Take heed of the fundamental and technical levels we are approaching in the S&P 500. Use it as a benchmark to compare your other holdings. Many people have been lulled into a false sense of confidence that the market always comes back. I’d like to remind you that the rallies back from the ’02 and ’09 lows were fueled by more and more economic stimulus. Whether you believe that more is on the way or, not wouldn’t you like to protect yourself from the next 50% decline?

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.