Category Archives: COT Signals

Commercial Traders Pressure RBOB Unleaded Futures

rbob unleaded gas commercial trader sell signal
COT Signals commercial trader sell signal for RBOB unleaded gasoline.

We published this short sale in RBOB unleaded gasoline Monday night for COT Signals subscribers and followed it up with commentary for Equities.com on Tuesday morning. You can read, “Are Rising Gas Prices a Trading Opportunity?” at Equities.com. You can see the effects of commercial traders buying and selling RBOB unleaded gas and the summertime peak gas price on the chart we posted at COT Signals.

This trading setup is a classic Commitment of Traders Sell signal and shows why we use the CFTC Commitment of Trader reports as the primary basis for screening our trading opportunities. Follow the links to see how we do it or better yet, call us and ask us how.

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Commercial Traders Own the Stock Market’s Gyrations

The stock market doesn’t seem to know whether good news is good or bad news is good. The equity markets have sold off between 4 and 6 percent since we published this key reversal in early March with the small cap Russell 2000 and Nasdaq 100 tech stocks peaking a month before the big Dow and S&P stocks rolled over. April’s unemployment report supplied the catalyst for the Dow and S&P sell off but again the question becomes, “is bad news still good for business friendly easy monetary policies or, does good news mean we’re finally back on track?” Based on a number of factors, it appears the answer is somewhere in the middle. The Goldilocks equity market likes its data neither too hot nor, too cold.

Continue reading Commercial Traders Own the Stock Market’s Gyrations

Wheat May Have Bottomed Out

The wheat market is a primary staple in human diets as well as global trade. This causes the wheat trade to be affected nearly as much by geopolitics as it is by price and weather. Therefore global trade prices have to factor in sanctions, duties and taxes as well as transportation fees. The simplest way to understand this is by looking at the surplus produced by the primary growers like Canada, Ukraine, Russia, Australia, Argentina and the European Union as well as us and then trying to determine why each one of those countries are also wheat importers. Due to the conflagrated nature of global trade negotiations, I find it easier to focus on the primary players here in the U.S. and plan my trades accordingly.

First, I screen the markets’ traders and their eagerness to participate in any market by reviewing the Commodity Futures Trading Commission’s weekly Commitment of Traders Report. This report breaks the markets’ participants into a few primary categories – index traders, non-commercial traders, commercial traders and non-reportable. Briefly, Index traders manage the long only allocation portion of the fund they represent. Non-Commercial traders tend to be the money managers within the futures industry. They trade from both the long and short side as they see fit. Commercial traders are either the producers of the commodity or, the end line users of it. Their trading is based on managing their costs from the production side and maximizing their profits on the producer side. Finally, the non-reportable category is left to small speculators, producers and end line users who are too small to qualify for a larger group.

Hedge funds fall into the non-commercial trader category and their movement finally began to be tracked by the CFTC in 2006. The last three weeks has seen the largest jump in their short position since their trading has become a matter of public record. There are three important factors at work here. First of all, most of this selling took place prior to the November 8th USDA crop report. Secondly, commercial traders in this case, the end users, have absorbed every bit of selling the speculative money has thrown at them. Finally, this dynamic shift in market participant makeup comes near major support near $6.50 per bushel in the March Chicago Board of Trade contract.

This sets the stage for a climax. Our bet is that most of the price decline has passed. Commercial traders are value players. We are looking at the end line wheat consumers locking future delivery prices in order to generate their business models for 2014. Cereal and bread producers are fully aware of what their input costs are and they clearly view this as a bargain. The non-commercial traders who’ve taken the short side of this market are typically trend followers and pay little attention to price. They’re simply riding the wave….until it crashes.

I believe their wave is about to crash. First of all, wheat hasn’t been this cheap since July of 2010. Secondly, in both June of 2010 and May of 2012 commercial and non-commercial traders squared off in a similar manner. These market imbalances strongly favor an outcome in favor of the commercial traders. In fact, most solid wheat rallies start by commercial traders putting a floor in to support prices and lock up future inputs. Conversely, every trend trader trades the trend until it’s over then, they give back a chunk of their profits on the ensuing market turnaround. Finally, open interest peaked in September and has begun a much earlier decline than normal into the December futures expiration cycle. This means the market is failing to attract new players at these depressed levels.

The daily chart shows a solid basing pattern that is holding just above major support. The December wheat futures rapidly approaching expiration means that anyone who doesn’t intend on delivering wheat of the appropriate standard to an approved collection site as well as those who aren’t fully prepared to take delivery of the contracts they’ve purchased must offset their position. Obviously, end line consumers are looking forward to their delivery of cheap wheat. Meanwhile, none of the non-commercial speculative money will be able to make any deliveries. Therefore, I believe that the buying from non-commercial short covering will begin to fuel a rally in the wheat futures market.

You can find more on our application of this strategy at COTSignals.com.

Natural Gas Finding Support

Natural gas prices have fallen by 25% since its April high, which in and of itself is not a big surprise. Natural gas is notoriously volatile to the point that the market doubling or, halving in price is a common occurrence nearly every calendar year. What interests us is that the current low happens to come near the typical late August seasonal low and also coincides with solid technical support as well as significant buying by commercial traders. Let’s see if we can build a case for a natural gas bottom that may hold through the seasonal low run through the typical end of October seasonal peak.

Three dollars per million metric British thermal units has generally acted as good support going all the way back to the 2008 highs above $20. Rallies meanwhile seem to be stalling around $4.50. Due to the large size of the natural gas futures contract this represents a swing of $15,000 per contract from the $3 support area to the $4.50 resistance area. Therefore, if we can carve out a chunk of the next move while limiting the risk, the reward should take care of itself. The recent action is becoming indicative of a reversal since August 8th when the market made a new low at $3.129, below last July’s low and quickly rebounded to generate the first upside reversal bar we’ve seen since last September.

The fact that the natural gas market appears to be running out of new sellers as we near $3 doesn’t come as a surprise. Using the Commitment of Traders Report (COT) to measure historical trading activity can be a bit misleading, however since there have never been more participants in the futures markets than there are now. The COT report is very useful in determining the mix of market participants, though. Commercial traders in natural gas have been building a substantial long position as the market has declined and their position is now near record levels. Furthermore, short commercial traders (natural gas producers) have trimmed their negative outlook on the market and their corresponding positions by 18% in just the last week.

Seasonally, the natural gas market has a primary peak from mid-May through mid-June. The market then tends to sell off through the end of August before making a secondary peak towards the end of October. The secondary peak is usually fueled by the need to generate electricity to run the air conditioners due to late summer heat, which we’ve had very little of this year. In fact, according to the American Gas Association we’re nearly 12.5% below our average number of “cooling degree days” through August 10th. In spite of the favorable climate the Energy Information Agency shows that natural gas in storage has not grown by the expected amount with reserves running roughly .5% above last year’s level.

The trade that is setting up has very little to do with the long-term price of natural gas which should continue to decline over time. However, the combination of technical action combined with the commercial trader positions coinciding with a seasonal low definitely puts us on the lookout for some type of reversal into higher prices as we head into the fall. Considering the natural gas futures have fallen by 13% since July 18th, we think that a move back towards $3.7 per million cubic feet is totally reasonable. Measuring this against current risk levels we think that it should be quite possible to find a trade risking less than $2,000 per contract and expect a reward of at least $3,500 while holding the position for a few weeks, at most.

Using the COT to Buy Gold Futures

The 2013 rally in the metals markets appears to have run its course. The metal markets are now flushing the weak traders out of their positions and, at least for the gold futures and copper futures market, setting up a new bottom to create a summer rally. In the past, we’ve discussed the rotation of money flow through the metal markets. There are four primary U.S. metal markets and the rotation between them hinges on expectations of inflation versus industrial production.

The chain from most industrial to most speculative is as follows; copper, silver, platinum and gold. This is based on the percentage of the metal used, rather than by weight. Otherwise, silver would far surpass platinum. Investor sentiment for all four metal markets can be tracked through the Commitment of Traders (COT) report published each week by the Commodity Futures Trading Commission. This report tracks the amount of investment among the three primary market participants, commercial traders, index traders and small speculators.

Categorizing the markets’ participants and measuring their degree of participation within any market is a primary forecasting tool. We use this in the trading world to track the imbalance of positions between the smart money and the dumb money. Our research quantifiably defines the smart money as the commercial trader category in the COT reports. Index trader participation is neutral so that leaves the dumb money as the small speculator.

Don’t take this personally. Commercial traders have access to the best information, algorithms and intellects. This may include direct physical observation of the markets in question and it certainly includes the research and analysis of a team of highly trained specialists who focus solely on the market they make. We as small traders are at an immediate disadvantage simply due to our commodity trading taking a back seat to our day jobs, families and other obligations that prevent us from putting 40+ hours per week into any single market.

Our trading focus is on the size of the imbalance between commercial traders and small speculators. Commercial traders are, “negative feedback traders.” They have a sense of value for the market they’re trading and the farther away the market gets from their predetermined value area, the larger their position grows. They buy more as their market becomes increasingly undervalued and they sell more as their market becomes increasingly overvalued.

Market turning points occur when the commercial traders’ fundamental sense of value kicks in and the market begins moving back towards the expected value area. The forecasting value lies in tracking this imbalance and preparing for the market’s turn. This is part of what we were discussing five weeks ago in, “Not Quite Time for Gold to Shine.”  We wrote, “The absence of an expected rally in the gold market through the last few weeks leads me to believe that the internals simply don’t support these price levels, yet. Therefore, the market will continue to seek a price low enough to attract new buyers beyond the commercial traders’ value area. Typically, this would lead to a washout of some sort that may force the gold market to test its 2012 lows around $1,540 per ounce before finding a bottom.”

The metals markets as a whole have declined over the last three weeks. Silver has been hit the hardest, currently down more than 12%. Copper has held up the best, down 5.2% and gold and platinum are somewhere in the middle.

Commercial traders are net bullish in both gold and copper. Commercial traders have been net buyers in the copper market for four out of the last five weeks and net buyers in gold for each of the last three weeks. Both of these markets are providing us with exactly the type of setup we look for. Commercial traders are net bullish on the weekly charts while small speculators have cracked the market just enough to create an oversold situation on the daily data.

Our quantitative research shows that we can buy in once the gold market begins to turn higher as long as we place a protective stop loss order at whatever this low turns out to be. This defines the risk so we know how many contracts we can trade. We know we have a 65% chance of being profitable and an average profit of $3,865 vs. an average loss of $1,958. The exceptional aspect of this trade is that we’ll only hold the position for five days. This is about how long the market will take to bounce and define a new value area.

The numbers in the copper market are even more impressive. The same setup applies. Our risk will be to the low of this move and we won’t enter a long position until the market starts to head higher. Our analysis shows that we should win about 75% of the time and our wins are once again more than twice our average loss. Finally, we won’t hold the trade for more than five days.

Trading in line with the commercial traders and using the small speculators to compress our risk allows us to trade with commercial effectiveness on a small speculator budget and time frame.

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 Stock Market Bounce is for Real

We published a sell signal for the S&P 500 in our October 4th article, “Who is Pushing the Stock Market.” Several fundamental and technical reasons were laid out. The fact that the market topped out the very next day and sold off by 9% in the last month leads me to believe that this decline may have run its course. The easy money on the sell side has been made and perhaps, we should start looking at the buy side of the market.

Separating the, “what happened” from the “why did it happen” is always tough. Throwing political variables like the election and the Euro crisis into the mix along with individual accommodations for the fiscal cliff and estate planning leaves us with very real macro and micro implications currently in play. We’ll take a brief look at these and see why the odds may be stacking up in favor of the buy side of the market.

The markets clearly viewed the election results in a negative light by selling off 6.3% in eight trading sessions. I think the markets were fully prepared for an Obama victory prior to the debates however Romney’s debate performance was just enough to make it a bit of a race. Therefore, investors chose to hold on through the election just in case Mitt pulled it off. Had Mitt won, we wouldn’t have seen the selling pressure. Obama’s victory guarantees higher taxes going forward. Therefore, many people are rebalancing their portfolios to take advantage of the tax laws as they stand in 2012. That answers some of the, “why” for the decline.

Commercial traders greeted the sell off in the markets with open arms. Traders in the Nasdaq and Dow Jones were major buyers, doubling their net long position in the Nasdaq and increasing their position in the Dow Jones by more than 50%. The major surge in commercial buying has pushed momentum back in favor of the bulls. Furthermore, combining the recent sell off with commercial trader buying has provided us with a Commitment of Traders buy signal. This is the methodology I presented at the World Traders Expo in Chicago last month.

Further bullish indicators focus on the extremely bearish sentiment of the trading public. Without getting into too much detail, many of the indicators that measure investor sentiment are exceptionally bearish. These readings typically mean the opposite is about to happen because the investing public typically does the exact opposite of what they should do. This one of the primary reasons we follow the commercial traders, rather than the small speculators.

Technically speaking, there are two key points. First of all, the sell off pushed us to a new three month low. Secondly, the about face reversal the market pulled provided indication of a major rejection of that low. The rally on the 19th was so strong that 90% of roughly 2,800 stocks traded on the NYSE closed higher. That kind of rally provides a statistically valid bottoming signal. Merrill Lynch was the first to capitalize on the statistical relevance stating that since 2006 there have been 1,733 trading days and this type of day has been observed only 62 times. The relevant pattern is that we should pause for a couple of days before resuming our climb through the 10, 20, 30 and 65 day moving averages which come in at 1372, 1388, 1404 and 1417 respectively.

One last piece of evidence of the rejection of the new three-month low made on the 16th is that the market immediately opened .5% higher and continued to climb another 1.5% for the day. The strong rally off the multi month low has only occurred 9 times since the Daily Sentiment Report has been tracking this and their research shows 7 of the 9 led to multi week bull runs. The two that didn’t pan out were both in the months following the tragic events of September 11th.

The sell off that we anticipated came to fruition however, I believe it’s much harder to turn around and buy the market when the media is so full of naysayers. To them, I would concede that not coming to an agreement on the fiscal cliff would send the stock market much lower. However, I believe that they will reach some type of settlement. The market will gyrate according to the most recent piece of news but ultimately it will climb higher. Finally, we cannot let sentiment overrule quantitative analysis. To ignore the facts would be choosing to live in ignorance.

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.

Success Breeds Success

There are several sayings intended to keep us on the right path in our financial lives and in this day of data crunching, quantitative analysis, back testing and the never ending search for the best new method perhaps none is more true than, “Success breeds success.” When I first began my trading career in Chicago, I didn’t spend much time with new traders. Partly because many didn’t last long enough to get to know their last name and partly because I was married with a young child and a lot of bills to pay. I did spend time with as many of the grizzled veterans and established traders as I could. Early on, after what had been one of my worst days, I was full of self- doubt and felt the pressure of the world on my shoulders. I sat in the member’s break room, just off the S&P 500 trading pit with my head in my hands and an untouched cup of coffee in front of me. I hear a chair slide out at my table and a graveled voice of experience ask, “You bust out kid?” I look up to see Bill Katz who had been a member since the blackboard trading days on Franklin Street. I replied that I hadn’t and his point was that as long as you get to come back tomorrow, you’re still doing something right.

 

The point of this story is that many people ask me questions about why I follow the weekly Commitment of Traders Report (COT), what group I follow within the report and, why. The month of November has been a great illustration across multiple market sectors. This week, I’d like to explain how it all plays out.

 

The Commodity Trading Futures Commission (CFTC) tabulates the weekly Commitment of Traders Report based on the trading of several individual groups of traders. Over the last couple of years, in the interest of, “transparency,” the groups have been broken into several subsets as well. For our purpose, we can break it down into the following main categories.

 

Large Speculators – Any trader with an interest greater than the CFTC’s reporting level in any individual market.

 

Small Speculators – All individual traders with an interest less than the CFTC’s reporting level in any individual market.

 

Non-Commercials – Any organization trading in commodity futures with substantial reporting interest not tied directly to the production or consumption of the markets that they hold reportable positions in. These include Commodity Index Traders, Exchange Traded Fund managers and swap dealers.

 

Commercial Traders – Producers or consumers of commodities. These are the true hedgers in the commodity markets. These hedges can be directly tied to gold, corn and oil just as easily as bonds, currencies and stock indexes.

 

Following the commercial traders is, “Success breeding success.” This group of traders has a fundamental understanding of value either through the production of or, the end line consumption of the commodity market in question. These people make the calls on when to stock up on raw materials for future consumption or, when to sell forward production and base their livelihoods on their ability to ascertain value.  Furthermore, in the case of publicly traded companies like British Petroleum, Con Agra or General Mills, their research entreats themselves to the good graces of their shareholders and board members.

 

November’s trading was an excellent depiction of this mechanism at work. This month saw very strong rallies in metals, grains and the stock markets.  In these three market sectors non-commercial traders fueled the rallies. In fact, we saw soybeans, platinum and palladium either reach or, nearly reach record historical buying levels. The one thing these markets all had in common was momentum. These market sectors had all been in established upward trends. Many of the non-commercial traders represent commodity funds and exchange traded funds, which are obligated to maintain certain percentages of each market in their portfolios to match their disclosure documents. This forces them to buy more on the way up and sell more on the way down to maintain the proper allocation percentages. Their actions in the marketplace are mechanical and take little account of a market’s value when making their trading decisions.

COT Extreme Worksheet

Commercial traders played their hands like the World Series of Poker for the month of November. These same markets that rallied on the strength of non-commercial buying managed to reach their highs just as the threats of European solvency issues and a Chinese slowdown came in to turn the tide. The proactive analysis of the commercial traders throughout these recent market tops allowed them to position themselves favorably for the markets’ coming declines.  Their selling was quite obvious on the screens and reported by the CFTC in the COT report.

 

These reports also show us that the commercial traders have been active buyers of the energy market, decreasing their current net short position by more than 25% in the last week. This is representative of their perception of value in the face of the sell off early in the month in a market they’re expecting to be headed to new highs sometime in the near future.

 

There’s no shame in following the success of others. Following value driven trading actions by people whose livelihood depends on their successful analysis rather than the trading actions of someone following an allocation formula is my present day version of finding successful traders to guide me in the break room.

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.

Managing Volatility with Options

Last week we discussed the growing volatility in many of the best trending markets of the year. We noted that the uptick in volatility had to do with three primary sources. China’s attempt to cap inflation and put the breaks on their over heating economy, Irish bank solvency issues and the nervous anticipation surrounding Spain and Portugal and finally, money managers who were late to arrive are trying to capture year end performance and match their benchmarks. We can now add some certainty to last week’s assumptions. China did raise their rates. The European Union is actively striking a deal with Irish banks as well as taking an official look at Spain and Portugal and finally, money is flowing into stock index futures.

 

We can see through the Commitment of Traders data that commodity trader index funds are flowing into the stock index futures. This group has added approximately 50,000 contracts on last week’s minor correction and contributed greatly to the market’s ability to close virtually, unchanged for the week. Money managers will frequently use the added leverage of futures when chasing performance on the long side of the market or when hedging the risk of their portfolio when a downturn is expected. The fact that this buying pressure has been more than offset by commercial short selling only increases the uncertainty at these levels as the market’s largest players fight it out with ever growing conviction.

The same pattern is playing out in several sectors as these forces work their way through the markets. We’ve seen soybeans rally nearly 36% this year and silver was up 67%. The commodity market’s biggest winner for 2010 was cotton. Cotton was up more than 125% until news began leaking out of Asia that the textile industry was slowing down. These markets have all contracted considerably over the last two weeks as questions persist about the health of the global economic system and the stability of international trading relationships are re-examined.

 

Taking a look at any of these charts quickly makes clear two things. First, the trend is most definitely higher. Two, the pullbacks in these markets, when calculated on a dollar basis, are large enough to test even the strongest of commodity bulls. Commodity markets are leveraged instruments whose contract sizes were determined many, many years ago when prices were much lower. Consequently, the dollar value of the same percentage swings is much greater at these elevated prices. For example, a five percent swing in cotton at this time last year translated to a $1,671 swing in your account balance. Today, that same five percent swing is worth nearly $3,000.

 

The question that I’ve been asked most frequently over the last two weeks is, “How can I trim the dollar value risks of my commodity account while maintaining a comfortable diversification in case the stock market craps out in the face of a Euro Zone meltdown and a constricted China?”

 

My first response is that some commodities offer multiple contracts in various sizes. There are currently four listed contracts for gold. These range from the full size, 100-ounce contract down to a micro contract of 10 ounces. If this doesn’t work for your market of interest, I suggest using options to construct a hedge on an existing position or limit the risk when initiating a new one. Many people hear the word, “options” and their eyes glaze over as their memory drifts back to trigonometry and exponential curves. A better way to think of options involves using the insurance industry as an example.

 

Insurance is used to transfer risk. Buying the policy limits the potential of loss for a fixed cost up front. The seller of insurance collects a fixed fee up front while assuming the liability of the risk associated with the policy. This means that there are two ways trade options. Buying an option provides you with full protection for a flat fee. However, like most insurance policies, you may never have a covered incident to collect on. The premium you’ve paid in for the coverage you’ve selected will expire just like any other policy. The alternative is to be the seller of the option. You will collect the premium up front and if there is no collectible claim during the period, you keep the all of the premium when the contract expires.

 

I’d like to introduce one technical term for options trading and provide one example of how this all fits together. Insurance agents have actuaries. Actuaries are the number crunchers that provide them with the expected payout on any given policy. They’re the ones that make car insurance more expensive for a 16-year-old boy than for his 40-year-old mother. In options trading, the actuary is called, “delta.” Delta determines the probability that that option will be, “in the money,” at expiration. If an option is in the money, then it would be a collectible insurance incident. Delta is a probability and is bound by the 0% to 100% probability scale.

 

Given the large imbalance of positions in the stock market, options can be used based on the degree of protection one wishes to purchase. An option with a delta of 15 means that the market believes there is a 15% chance that the it will qualify as a covered incident on the policy issued. This option can be used to provide 15% protection to an existing position or, cut the contract size of the given market by 15%. Either way, the option can be combined with a futures position to limit the volatility of the account’s balance. Given the magnitude of the global issues being discussed and the elevated levels that many markets are still trading at, limiting the volatility of the account’s cash balance seems like a worthwhile endeavor.

 

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.

Natural Gas Bottoming?

November natural gas may very well be forming a tradable bottom at these levels. There are several reasons for this.

1) Seasonal patterns in November natural gas tend from the last week of August through the first week of September.

November Natural Gas Seasonal Chart

2)The commitment of traders commercial category continues to add to their positions, adding 11,000+ contracts last week which places them within shouting distance of their all time record long position. Perhaps, more importantly, commercial traders are becoming increasingly bearish on crude while building net long positions in natural gas.

3) The crude oil spread versus natural gas is bumping up against solid resistance at crude oil priced at 20 times the natural gas price. This is reflective of the commercial traders price action.

4) The COT Signals triggered a buy signal for Monday’s trade which corresponded with a technical breakout to the high side.

There are two natural gas futures contract sizes. The full size carries a margin of $5,400 and recent average day range of $1,600. The mini contract is 25% of the full size contract. The margin requirement is $1350 and its daily range is around $400.

Please call with any questions.866-990-0777

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 in investing in futures.

Is the Commodity Pullback Over?

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 in investing in futures.

The last two weeks have brought considerable pullbacks in major trends including, the stock indexes, metals, grains and energies. We’ve also seen the most convincing U.S. Dollar rally in a year. This seems like a good place to take a step back and assess our positions on the broader markets.First, let’s break down the numbers and the correlations. The march of the commodity rally has been timed by the Dollar’s decline for nearly a year. Over the last month, we’ve seen the Dollar rally about 4% off of its lows. The rally became news over the last three weeks. Looking at a weekly chart, one can see that this is the first time the Dollar has taken out a previous week’s high and not immediately, closed lower the following week. Fortunately, we were able to see that the commercial trader’s momentum by using the Commitment of Traders Report had turned bullish on the Dollar beginning around Christmas time and we finally published a buy signal on January 19th’s COT Signals.The issues facing the commodity markets are twofold. First, the Dollar’s decline made our raw materials cheaper to purchase on the world markets. Secondly, as the commodity markets rallied, Commodity Index Traders, (CIT’s), are forced to buy more futures contracts as the value of their index rises. They are required to maintain a certain percentage of their indexes value allocated to the markets as stated in their prospectus. Consequently, as the commodity markets have declined, they’ve been forced shed contracts to maintain their waiting. Their influence on the markets can be seen in the disproportionate moves in the commodity markets – both on the way up, and on the way down. This is one of the reasons why the Dollar’s 4% rally has created the following declines:6.5% – 8% in the stock market15% give or take, in the grain markets15% in silver10% in platinum5% in gold14% in crude oil13% in unleadedOak, so where do we stand? Throughout this decline, the Commitment of Traders Report has seen commercial traders increasing their rate of buying in the raw materials markets and increased their selling in the stock indexes to correspond with their buying of the Dollar. We have watched the momentum of their purchases increase in the raw materials just as the Commodity Index Traders positions have declined and watched the opposite hold true in the negatively correlated U.S. Dollar vs. stock indexes. This is the classic example of why we follow the momentum of buying or selling within the commercial trader category. We’ve been patiently waiting and waiting with relatively few trading opportunities. As of Friday, we reached oversold levels in many of the markets that still maintained bullish momentum. Beginning on Tuesday’s trade, our proprietary indicator began ticking out buy signals in the energies and metals. This was followed immediately with buy signals 9 other markets. This means that our methodology has kicked out 16 buy signals in the last two days. That’s 16 buy signals out of 36 markets tracked. Finally, I would like to briefly note the background themes over the last month as this has built. We have the Dollar devaluing concerns of the health care bill which were mitigated by Brown’s victory. The equity market concerns over earnings realized through labor market cost savings and finally, the governmental budget issues which are beginning to kick out inflationary signals in our own programs. Our end of January position leaves us with reasonable demand for raw materials and inflationary concerns over the bond market leading to weakness in the stock indexes.