Finding a Bottom in the Corn Market

The 2013 United States’ corn crop started off with predictions of being the largest ever. This was primarily due to the USDA acreage report issued on June 28th that showed 97.4 million acres planted for corn. This was the highest acreage allotted to corn since 1936 and also marked the fifth consecutive year of acreage gains for corn. This caused December corn futures (this year’s crop) to fall 9% in the next few trading sessions. Even though the market is now trading even lower than it was then, I think there are signs pointing to a bottom in this market. End line users should take advantage of the lowest prices we’ve seen in over a year.

Record planted acreage along with trend line yields would produce the largest corn crop in history. However, the University of Illinois pointed out as recently as last week that the USDA’s planting intentions report of June 28th won’t materialize the way the market initially reacted. The Fighting Illini pointed towards the prevented plantings number to support their argument that corn acreage may be more than 8 million acres less than originally forecasted. This is primarily due to the lateness of this year’s plantings. Furthermore, they comment on the currently declining characteristics of the corn crop condition, which may impact yields if pollination doesn’t get the weather it needs.

We often talk about a market’s, “fear premium.” Fear premium is the market participants’ disproportional concern of the market moving one direction instead of the other. Fear premium in the grain markets is always on the high side. Call options, which make money when the market goes up are always more expensive than put options in the grain markets. The difference between the current market price and the price of a put and a call option equally distant from the current price is 0 in an unbiased market. However, call options currently have a built in fear premium of approximately 30%. Therefore, the markets’ participants are 30% more concerned about prices moving higher by $.50 per bushel than the market falling by another $.50 per bushel.

End line users of corn have been stocking up on futures contracts with abandon. This is another good way of determining the underlying value of a market. The Commodity Futures Trading Commission issues it Commitment of Traders Report every week. The report tracks the market’s largest traders and categorizes them according their type of trading. Primarily, we look at three groups of traders – speculators, index funds and finally, commercial traders. We focus on the commercial trader category. It is our belief that those who produce the good and those who sell the good have the best understanding of a market’s value. Farmers, as a collective, ought to know what a fair price is for the corn they’re growing just as cereal producers or, cattle feeders should know what a fair price to pay is. End line commercial traders have built up a record position on the market’s decline. Clearly, they are willing to lock in as much of their future input needs as they’re bank accounts and storage facilities will afford them.

End line users of corn understand that even if we do end up with record acreage and good yields, we’ll still barely budge the global ending stocks number. The world currently stands at about 70 day’s worth of grain supplies. This is not just corn but an index tracked by AgriMoney that includes rice and wheat. The point of the chart published by AgriMoney is that peak production relative consumption has shifted to a deficit trend over the last 20 years. It has dwindled from 130 day’s supply in the mid 1980’s to our current level of 70 days. All things considered, this year’s US harvest could add about four days to the world’s supplies. This is hardly a drop in the bucket.

There’s no question that corn prices have been declining since the June 28th USDA acreage report and the next major report isn’t due out until August 12th. This leaves the market with time to trade its way through pollination and the trend to continue lower. However, the record net short position in managed money cannot continue to profit from corn’s decline for much longer. The market can only trade so low relative to its fundamental value. Commercial traders clearly see this market entering their value area. We’ll side with them and be on the lookout for a reversal in prices. Most importantly, we’re approaching prices that leave no more room for bearish surprises, therefore, the path of least resistance will soon turn higher.

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.

Waning Demand in Orange Juice Futures

The orange juice market has rallied by more than 16% since June 25th and is now trading near $1.45 per pound. This marks nearly a complete recovery in prices from the sell off that was triggered by the late June, Department of Agriculture’s Cold Storage Report, which showed a 2% increase in inventories. Much of the rally that had led to the $1.55 high in May was due to speculative buying based on reports of, “citrus greening.” Citrus greening has been found in all of Florida’s main growing regions and leads to smaller oranges and less juice. However, Florida’s expected decline in production will be more than offset by other global issues, which will continue to pressure the market lower from these levels.

Global orange juice demand has been declining rapidly since the European economy began to collapse. The truth of the matter is that orange juice is a luxury good. Orange juice demand actually peaked way back in 1998 with global per capita consumption at 5.87 gallons per year. This amounted to a total supply of 1.8 million gallons or, 250 million boxes of raw oranges. The downward trend in demand has been tediously steady with 2008 providing the only uptick in demand over the last 15 years. Current consumption estimates stand at 3.85 gallons per capita or, less than 75 million boxes of total production.

The effect of the global decline in world orange juice consumption has taken its toll on the world’s largest exporter, Brazil. They are responsible for about 80% of the total world output. Their effort to gain market share from the U.S. over the last decade has led to a gross imbalance in the current marketplace. This has led to an about face in their agricultural strategy as the Brazilian government is expected to cull as much as 9% of total orange juice acres and redirect their efforts towards sugar cane which has a higher profit margin.

The macro trend of declining orange juice production is not lost within the commercial traders in the marketplace. Throughout the 1990’s and even into early 2000’s commercial traders were using the orange juice futures market to guarantee their supply. This means that commercial traders were generally net long and end line producers converting raw oranges into finished products were more concerned about high prices than they were about low prices. Therefore, spikes in commercial buying frequently led to long positions between 8,000 and 12,000 contracts. Most of these commercial buying splurges were followed by gains of more than 10% in the futures market, which shows that their actions have merit within the orange juice pricing structure.The last time commercial traders owned more than 12,000 contracts was in June of 2008. Keep in mind that this was the drought year and all agricultural commodities soared. Perhaps, the penultimate accumulation of more than 12,000 contracts is more instructive from June of 2004. This is when orange juice traded down to a multi year low of $.55 per pound. Currently, the commercial position is net long a mere 1,300 contracts. This tells me that end line producers have no fear of citrus greening affecting the overall marketplace. Furthermore, this tells me that they’re not worried about locking in future production at these prices.

The macro factors we’ve discussed lead us back to the current market rally, which I believe will act as a dead cat bounce. Therefore, we intend to sell the September orange juice futures contract upon the first sign of a reversal to head lower. The current rally appears to be overdone and we expect it to culminate in a momentum divergence that will cue our first entry. This short trade also coincides with the midsummer trough before fears of late summer hurricanes and early winter frosts cause orange juice futures to begin to bottom. As always, we will be protecting our position with stop loss orders placed just above whatever the high ends up being. After all, whether we’re right or wrong isn’t as important as capital preservation. Meanwhile, continually seeking out low risk, high reward trading opportunities will take care of capital appreciation.

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 Rise in Crude is Temporary

The price of crude oil has risen by more than 13% in the last two weeks. The price has been driven up by a perfect storm of temporary factors including seasonal, environmental and political issues. We believe these will subside and return us to a fundamentally over supplied market causing it to fall back below the magic $100 per barrel mark.

Crude oil futures traded under $93 per barrel as recently as June 24th. This is also the day that flooding concerns began creeping into the news from Alberta, Canada, the largest exporter to the U.S. The flooding eventually shut down pipelines from Enbridge and Penwest Exploration beginning on June 25th. Uncertainty regarding future supplies created support for the market. Prices stabilized between $94 and $96 per barrel.

Meanwhile, unrest in Egypt began to grow. It started with the mob beating death of four Egyptian Shiites outside of Cairo. Civil protests calling for the ouster of elected President Mohamed Morsi fell on deaf ears while his primary support came from the fundamentalist Muslim Brotherhood. Egyptian citizens had finally lost their patience with Morsi as basic problems of infrastructure improvement and unemployment began to take a back seat to what was becoming a country ruled by Islamic law rather than the secular democracy that was fought for during last year’s Arab Spring.

The natural disasters and political unrest also came as the market was heading into the first of crude oil’s twin peaks of seasonality. The first peak is Independence Day. The second comes around Labor Day. The combination of all of these factors has forced the crude oil market rapidly higher in the face of weak fundamental data.

Crude oil inventories are well above their five-year average. This spring actually saw the highest inventories in the last five years, nearly touching 400 million barrels in May. This is more than 14% above the five-year average and 3.5% above last year’s inventory. The market remains oversupplied with inventories currently around 382 million barrels, still well above the current five-year average of 337 million barrels. In fact, inventories would be even higher had we not drawn down 10 million barrels last week to meet the temporary decline in Canadian imports.

Crude oil futures are currently trading near $105 per barrel. The technical pattern that has been forming on the daily charts is called an, “inverted head and shoulders.” While many people have seen tops referred to as a head and shoulders pattern, fewer are familiar with its bullish relative. Technically, the pattern is measured the same way. However, instead of subtracting from the neckline to find a target down below, we simply add the distance from the right shoulder to the neckline to generate an estimated high price for the move. In this case, the estimated target is around $106.50 in the September crude oil futures contract.

The situation in Egypt is the only wild card still in play. Mohamed Morsi has been ousted as President. The Egyptian military now appears to be running the country. Calls are already being made to host a new Presidential election along with proper monitoring of the voting process. The United States has remained curiously aloof through the recent unrest. President Obama appears unsure of which horse to back and is leaving our options open. Technically, not categorizing the uprising as a “military coup” allows us to potentially back the next ruling party, regardless of the outcome. This is far more palatable than stoking the unrest of a civilian uprising within the Middle East.

Trading the crude oil futures market during a period of Middle Eastern unrest is not for the faint of heart. While we expect the market to top out shortly, there is no telling exactly when the next news announcement may cause the top to be completed. This means we don’t know exactly what the risk may be to our account values. Therefore, a more conservative approach would be to use an option spread that allows us quantify our risk while accepting that our rewards will be limited. The first rule of trading is, “always know the risk.” We will continue to look for reversal chart patterns that would suggest the market is heading back towards its 90-day average price of $95 per barrel.

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.

Measuring the Metal Markets

The recent selloff in the metal markets has broken the sideways trading range they’ve been in for more than a year. We’ll begin by briefly recapping their recent history back to the 2011 high water marks. Copper was the first market to peak. An expanding Chinese economy and a low interest rate environment drove this market.  This led to large end line consumers purchasing forward contracts to meet future demand. Finally, copper peaked at $4.65 per pound in February of 2011. The silver market peaked in April of 2011 at nearly $50 per ounce. This was by far the most speculative of the metals markets and we’ll get into the ramifications of a speculative rally, shortly. Platinum made its high in August of 2011 at $1,918 per ounce. Gold was the slowest to peak finally reaching $1,923 per ounce in September of 2011.

The recent declines have come amid a backdrop of rising interest rates. The language coming from the Federal Reserve Board suggests that they are looking to tighten money supply and withdraw some of the excess cash that has been pumped into the system beginning in September 2001.

The recent lows mark very important Fibonacci points. The Fibonacci sequence originated in 13th century Italy by Leonardo Pisano, nicknamed Fibonacci. The mathematician found the pattern of 0+1 = 1, 1+1 = 2, 2+1 = 3, 5+3 = 8, 8+5 = 13, etc. This pattern is found throughout nature to include flower seeds, shells, pineapple segments, etc. Their adaptation to trading financial markets came through the use of wave analysis and the energy released in the action and reaction of those waves.

The trading adaptation converts the Fibonacci sequence into ratios. The ratios are then used in conjunction with peak and trough analysis to determine not only potential support and resistance levels but also, the energy required to turn the tide and begin a new sequence in the opposite direction. The two primary Fibonacci ratios used in trading are .38 and .62. These are rounded for the sake of simplicity. A trip to the beach will explain their importance in that wave one and wave two typically encroach upon the beach by a third of normal shoreline measurement while the third wave may advance nearly twice as far prior to its retreat.

Putting these ratios to use in the metal markets we can see that gold, platinum and copper have all retreated by approximately 38% from their all time highs made in 2011. Platinum has retreated by a third, copper by 36% and gold by 39%. Silver, as the outlier has retreated by 63%, almost stopping exactly at the .62 ratio. The depth of silver’s decline also helps it hold its crown as the most speculative and volatile of the metals.

The Fibonacci numbers don’t possess enough voodoo to generate trading action on their own. However, when combined with the considerable commercial buying we’ve seen on this decline these retracements must be viewed in the context of a pullback within a longer term upwards trend. Beginning with the recent biggest loser we see that commercial traders have been net buyers in the silver market for 19 of the last 23 weeks, nearly tripling their net long position within that time. Gold, copper and platinum are also getting strong support by the commercial traders on this decline. Their actions tell us two things. First, they don’t expect the end of cheap money to be the end of strength in the metals markets. Secondly, this decline is a buying opportunity.

Specifically, we view platinum as the most attractive buying opportunity. This is based on its industrial use as well as the escalating mining cost of platinum going forward. Currently, platinum is trading below its cost of forward production. The mining cost is about $1,500 per ounce while the futures market is trading around $1,350. Furthermore, platinum is the primary component in catalytic converters of diesel engines. Diesel engines continue to take market share in Europe, India and China. This leads us to believe that in the wake of the metal markets’ declines; platinum is most likely the safest one to buy.

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.