Category Archives: Gold and Silver

Trading the Coffee Market

Is the price of that morning cup of coffee doing more to wake you up than the coffee itself? Lost among the commodity headlines of gold, silver and oil prices, the price of coffee has risen to a thirteen year high over the last three months. Starbucks, Millstone, Caribou and others have all been forced to raise their prices to account for the increased price of their raw materials and the rise in prices has not been confined to high- end purveyors. Both J.M. Smuckers and Kraft Foods have been forced to raise prices on their Folgers and Maxwell House brands respectively.Currently, McDonalds is the only outlet able to hold their prices steady.

Coffee prices have risen 45% since the beginning of June due to serious production issues in multiple geographic locations. The extended length of the Asian monsoon season has affected the harvest of India, Vietnam and Thailand. These countries are responsible nearly 30% of global coffee production. While an extended rainy season has delayed the Asian crop, Brazil’s has been hampered by lack of rain. Brazil is the world’s largest producer and according to the Brazilian Coffee Council, the drought they’ve suffered through could cut production levels to the lowest output in four years.

The fact that retailers have been able to keep their prices reasonable, raising their prices around 11% on average is a testament to the necessity of the futures markets and their role in the economy. The futures markets were originally designed to allow producers and end line users of commodities to create binding contracts that specified the delivery date, price and quantity of the given commodity. Coffee retailers have been able to stay ahead of the rising prices by hedging their price risk in the coffee futures market. Contracts that were purchased prior to June have the benefit of the stable prices that coffee had been trading at for nearly two years.

Trading agricultural commodities entails an understanding of the price risk associated with each individual market. Broadly speaking supply and demand are the two types of risk that need to be accounted for. Agricultural commodities have a supply risk factor factored in to rising prices. This protects against any setbacks created during the growing season by the weather as well as accounting for any labor unrest during the harvest season. This is exactly the opposite of the risks associated with investing in the stock market. The fear is on the downside and there is a built in risk premium to the downside. The stock market deals with demand based risk.

Commercial traders are made up of two groups, the commodity producers who control the supply of a commodity and the end line consumers who create demand for the given commodity. These two groups are responsible for the battle to create value. When a market gets over valued, commodity producers come into the market and sell the crop they expect to produce within a given time frame. Conversely, when the price of a commodity falls below a perceived fair value, end line consumers like Kraft Foods and J.M. Smuckers will come into the market and stockpile the commodity to meet their future production needs.

This is the battle that’s currently unfolding in the coffee market. Coffee retailers are being forced to pay higher prices to ensure their raw materials for future production while coffee producers are taking advantage of the higher prices to make up for their lack of output. Tracking the movement of commercial trader positions through the commitment of traders report shows that end line consumers were large purchasers of coffee futures beginning at the end of June. We can also see that their buying appears to have peaked in early September. This cycle ensured delivery of the necessary raw materials through the end of the year.

Right now, the producers still have control of the market and we will continue to look for opportunities to buy selloffs in the coffee market. This allows us to put the purchasing power of major retailers behind us as well as the seasonal strength that tends to accompany the coffee market harvest period and into January. Our opinion will change when we begin to see the coffee producers rush to get their future crops sold. Whether the rush comes at higher prices or lower prices isn’t as relevant as the fact that farmers believe they won’t be able to sell their crops at these prices in the near future.

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.

Perhaps We’ve Gotten Ahead of Ourselves

Commodity Prices have been on a tear. No question about it. Gold has traded over $1,300 per ounce and silver is over $21 an ounce. The grain markets have seen huge gains in corn, beans, rice and oats. Even markets like coffee, orange juice and cotton have participated in the broad commodity rally. Does this mean it’s a good time to put more money in commodities? Not necessarily. This is where our philosophy diverges from stockbrokers. We don’t generate revenues for the firm based on equity under management. Therefore, our best business practice is to provide our individual traders with information that will help them be successful over the long term.

The commodity markets as a whole, have built this rally on the economically sound principals of inflation, which include a declining dollar and low interest rates. However, according to the data that I’ve been watching, it’s quite possible that we’ve gotten a bit ahead of ourselves in the economic cycle. At this point, the anticipation may be greater than the event.

Starting with the big picture. There is a third component to inflation that hasn’t gotten much press over the last year and that is, velocity. Velocity in economics is how quickly money is changing hands. The higher the velocity of a dollar and the more it circulates, the more action there is in the economy and the closer we are to potential inflation. What we’ve seen since the economic crisis began and the housing bubble collapsed is that the Federal Reserve Board has flooded the economic system with Dollars.

The adjusted monetary base of the United States has increased nearly 25% since September of 2008. Broadly speaking, this means there are 25% more dollars in our pockets and in our checking, savings and cd accounts at the bank. However, as I wrote last week, Americans are finally starting to save their money. This is why the velocity of money has declined by more than 17% since the economic crisis began in 2008. This is in spite of the Federal Reserve Boards attempts to stimulate spending.

The United States is the financial trading center of the world. We have the most mature stock and commodity exchanges. They are the most highly regulated and also the most liquid. Therefore, we are the hub of the global financial network. The commodity markets here in the U.S. service 40% of all traded commodities. Therefore, the prices of commodities traded here in the U.S. actually reflect a global view of fair value. The decline in the U.S. Dollar has made trading prices in the U.S. seem like the latest sale at Kroger, just bring in your Treasury coupon for double points.

Finally, in the weekly Commitments of Traders Reports, we have seen a very large build up of large speculator and commodity index trader long positions with the commercial traders increasing their short positions as the markets have climbed. The fact that many of these markets are significantly below their pre financial market collapse highs of early 2008 is a telltale sign that the current market rallies may be over extended. It’s important to note that the two groups supporting the commodity markets have no ties to fundamental value. The large traders are simply trend followers. They are willing to be long or short any market at any time. The commodity index traders are only allowed to purchase commodity contracts to keep their portfolios properly weighted. They will add positions as the market climbs and offset positions as needed on a market decline.

Commercial traders are the producers or, end line consumers of the actual commodities themselves. They are keyed into the entire production mechanism and have a keen understanding of the issues affecting their markets. The general theme I see building is that they believe many of these markets are substantially overbought and inflation is further away than we think. While they do believe there is inflation coming down the pipeline, they believe it is further off than the commodity markets are making it look. They have bought up large positions in short term Treasuries while taking a decidedly more bearish tone towards the long end of the yield curve. In fact, the commercial trader net position in the 30 year bond is the most bearish it’s been since 2005, prompting me to consider taking profits in our bond trade from several weeks ago.

The combination of an economy flooded with cash led many investors to anticipate inflation down the road, which makes commodities a very sensible place to put money. However, given America’s newfound desire to save, the flood of cash hasn’t quite had the textbook multiplier effect that was expected to increase GDP 50% for every dollar spent by the government. Given the over extended state of some markets combined with fundamental data supporting declining velocity, it may be a good time to adjust risk in the commodity markets.  Velocity will increase and repurchasing commodities on a pullback could be an effective strategy once the actual race finally gets going.

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.

Don’t Pay Up for Precious Metals Diversification

Gold and silver have exploded in recent years. The contributing factors of low interest rates, economic uncertainty, global fear and pending inflation have done their share to boost precious metals’ outsized gains relative to the stock market. Gold has rallied more than 150% over the last five years while the broad stock indexes are all flat to lower, depending on the day. Silver, for its part, has nearly doubled in the last five years. Given our still historic low interest rates and the growing economic trouble overseas as well as our ballooning governmental budget deficit, it’s reasonable to believe that the forces behind this trend continue to remain intact. The question has changed from, “Should I be invested in precious metals,” to “What’s the most cost effective way to maintain a presence in precious metals.”

The boom in the precious metals market has brought with it the familiar hype of the gold bugs. It has also fostered the invention of precious metal Exchange Traded Funds (ETF’s) and cash for gold TV commercials. Commodity futures markets have also benefited from the added attention being paid to gold. Each of these has a place in the marketplace and each has a vested interest in hyping their product as the one that’s best suited to your needs. However, if you are ascribing to efficient portfolio theory and seek to include precious metals ownership as a part of your portfolio diversification plan, the best bang for your buck is through commodity exchange traded contracts which are regulated by the Commodity Futures Trading Commission (CFTC) and guaranteed by their appropriate exchange.

The market sectors mentioned above can be lumped into two categories: small speculators and investors. Gold bugs and cash for gold are for people with left over jewelry, some family heirlooms and gold coins like American Eagles or South African Krugerrands. Typically, this type of gold ownership sell side biased. This means owners of small pieces or collections are keeping an eye on price and hoping to sell when they think the market has peaked. When they bring their physical collections to market, they will end up at the coin shops, pawn shops, cash for gold, or their local jewelry shop. The willing buyers are always waiting and ready to pay below market value for collections that may have taken a lifetime to accumulate. Upon recent survey of the available outlets, prices to be paid were typically $40 per oz under market value for gold and $.30 per oz under market value for silver. Those on the buy side of this equation, looking to add to their private physical collections will find themselves paying up $30 – $50 per oz over market value in gold and up to $1.20 over per oz in silver. Therefore, small speculators in the physical precious metals market may lose more than 10% of the value of their collection in the buying and selling process.

Passive investment in the precious metals can be done in two ways, ETF’s and commodity exchange traded products. The benefits of ETF’s are that the amount to be invested can be determined beforehand and the investor can pick their own allocation, even if that amount is less than the price of one ounce of gold. The downside is these ETF’s typically underperform the actual market they are designed to track. Typically, one would expect a dollar for dollar rise and fall between the price of the metal and the value of the account. However, due to administrative fees, expenses, incentive fees, cost of acquisition, advertising, etc, the longer the ETF trades, the further behind the actual price they fall. Therefore, it is possible to lose money in a flat market, or realize a smaller return than one would expect in a rising market.

Finally, exchange traded commodity contracts like those listed with the Chicago Mercantile Exchange Group are the actual proxy to which ETF’s and local dealers tie their prices. Perhaps the single biggest drawback to these products is their preset size. There are about half a dozen precious metals products listed ranging in full cash value from $18,000 to $125,000. These contracts have several benefits for passive portfolio diversification. First, these are standardized products fully assayed and certified by the appropriate exchange. This assures the investor that their 100 ounces of gold is 24 carat and their silver is .9999 fine and that the value of your holdings can be found 24 hours a day, rather than being quoted by the guy in the shop down the street.  Secondly, there are no administration fees, advertising costs, or incentive fees. The only charge is a one- time commission to your commodity broker, typically, around $50 per contract. Also, you will control the actual metal and not find yourself invested in mining sales or land right options because you didn’t read the prospectus thoroughly. Finally, the biggest reason exchange traded products are so much more cost effective is the use of margin and the amount of cash it frees up for the individual investor. The $18,000 contract mentioned above requires a cash deposit with the exchange of $1,150. This allows the individual investor to use the remaining $16,850 in excess cash for a money market account and earn interest on top of any return produced in the actual market itself. Therefore, those wishing to pursue efficient portfolio theory and diversify their holdings can most efficiently implement this process through the use of commodity futures markets.

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.

Uncovering Value in the Commodity Markets

Uncovering Value in the Commodity Markets

The electronic meltdown in the stock market also cued a selloff in many commodity markets. Typically, markets move in their own individual rhythms. However, when fear dispossesses logic and panic takes over, it becomes a case of sell first and ask questions later. As the stock market selloff accelerated and we watched the media reports of the riots in Greece, survival became the primary concern. Now that the dust has settled, it’s time to appraise the current state of the markets. I believe the shock to the system uncovered some fruitful trading opportunities.

First, let’s examine the context of the markets prior to the selloff. In the currency markets, the Australian and Canadian Dollar as well as the Japanese Yen had been consolidating near the upper end of their ranges. All three had been holding their own since the U.S. Dollar’s rally has come, primarily, at the expense of the Euro, Swiss Franc and British Pound. The same pattern appears in the metals and energies as gold, silver and platinum as well as heating oil, unleaded and crude had also had been consolidating near their highs.

Secondly, let’s consider the composition of the markets’ participants through the Commitment of Traders Report at these price levels. Commercial trader positions in the markets above were gaining momentum in the direction of their established trends with the only exception being the silver market. This means that even as the markets were moving higher, the traders we follow, commercial hedgers, anticipated higher prices yet to come. For our purpose, we track the commercial hedgers. Prior to the market shock, we presumed that we were in a value driven futures market and no one knows fair value like the people who produce it or, have to use it. In fact, it is precisely their sense of value that provides the commodity market’s rhythmic meanderings that swing traders love so much. Let’s face it, producers know when their product is overvalued and it should be sold just as well as end line users know when they should be stocking up at low prices.

Finally, in the wake of “Volatility’s Perfect Storm,” we have seen the commodity markets snap back from losses of 3% – 4% in the world currency markets to 7% – 10% in the physical commodity markets. This sharp selloff and snap back to the previous range of consolidation prices is called a “Spike and Ledge” formation in technical analysis and pattern recognition. Typically, this occurs when an outside force creates a counter trend shock to the market and scares everyone out. The fear of being in the market is replaced immediately by the fear of NOT being in the market and missing the move. The shock forces out the market’s weaker players while allowing the strong to accumulate more positions at better prices. This is why COT Signals has been kicking out buy signals since the meltdown. Following the commercial trader positions has allowed us to buy into oversold markets. Our targets for these positions can be calculated by adding the depth of the market’s decline to the top of the consolidation levels. If the market you’re following sold off 5% from its highs, a spike and ledge projected target is 5% above the market’s previous highs and a protective stop would be placed just beyond the spike.

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.


Who’s Right?


This blog is published by AndyWaldock. Andy Waldock is a trader, analyst, broker and asset manager.Therefore, Andy Waldock may have positions for himself, his family, or, hisclients in any market discussed. The blog is meant for educational purposes andto 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 suitablefor all investors. There is substantial risk in investing in futures.

This morning, (11/9/09) the U.S. Dollar is significantly lower and testing the ’08 lows. Gold is making new highs and holding over $1000 per ounce and crude is up $1.60. This is as it should be in a Dollar devaluing world, global assets priced in Dollars should climb in response to its decline. Economics 101 tells us that there is a negative correlation between global asset price and the price of the Dollar.

So far so good, right? Not so much. Every weekend, I download the Commitment of Traders Reports to see what the different categories of traders are doing. The three main categories  I track are the commercial traders, the small speculators and the funds. As many of you know, a big portion of my trading is based on the momentum of the commercial traders actions. There are three main reasons for this. First, they understand the fundamentals of the markets they trade – their markets are their business. Second, as the fundamental players in the business of their markets, they have a vested bottom line interest in pricing their products profitably. Finally, when they act collectively, based on their fundamental knowledge of their markets, they have the resources to move markets. Therefore, when they move, I want to be on their side.

Typically, the commercial positions rise and fall with the ebb and flow of the markets. They may act within the channel boundaries of a trending market or, they may be trading against support and resistance in sideways markets but, typically, they use their fundamental knowledge to pick the right side for the coming period of time.

Occasionally, we see these relationships pushed to the extreme and this is one of those times. I’ve selected three markets to illustrate this point – Gold, Crude Oil and the U.S. Dollar. As the Dollar has declined over this past year, we’ve witnessed a steady building of commercial long positions with a net accumulation of approximately 20, 000 contracts. Crude oil has seen commercial net short positions increase by more than 100,000 contracts since July. This also places Crude at a new net short record, eclipsing the August of 2007 mark. Finally, we have the Gold market. It’s been in the news everyday. Beginning in September, we can see that once the market started to breakout above the $990 level, commercial traders began to increase the pace of their selling. They have increased their net short positions by more than 30%. The final point to make is that people on the other sides of these trades are just that, people. Remember that it takes both a buyer and a seller to create a trade. The commercial entities need someone to take the other side of their trades. Those someones are the small speculators and the commodity funds. The commodity funds will always maintain a certain percentage of their assets in a given market. They adjust their asset base according to price, adding to their positions as prices rise and paring back their positions as the markets fall. Most importantly, they position themselves from the LONG SIDE ONLY. The small speculators can and do, trade both sides of the market and they are typically long at the top and short at the bottom. So, if the commercials have accumulated large, in some cases historical, positions that are opposite the markets’ current direction, who do you think is on the other side of their trades with historically sized positions betting on the trend to continue?

These are interesting times with the elastic band of the markets stretched to historical proportions. As a trader, I’m never one to bet my money against a trend’s continuation as my bottom line is only effected by the last traded price. Markets can remain irrational far longer than I can hold a bet against them. However, it would behoove those participants on the side of the small speculators to tighten up their protective stops as a reversal of fortune could send a record number of players heading for the exits.


Spread Trading Gold vs. Platinum

Many customers have been asking spread strategy questions
and last week’s action in the gold and platinum markets provides us with a
wonderful opportunity to have this discussion.

Take a look at the
attached chart.

The red line on the
bottom is how much gold is worth relative to platinum (gold close/platinum
close). This is a monthly chart and you can see that the spread, along with
platinum, have broken their trends going back to ’01. This means that the
prices of these two metals are converging. One should be short platinum and
long gold. The way I see it, the price of platinum has been beaten up far worse
than gold. I think the global slow- down scenario may be impacting the
manufacturing base for platinum more than inflationary/deflationary issues are
effecting the speculative nature of the gold market. Gold has also held above
its trend line, in spite of the U.S. Dollar’s significant rally.

Profitable spread trading requires more than predicting the
general directions of the two markets involved. The size of the contracts, tick
size and volatility also need to be considered. In this example, there is only
one platinum contract to choose from. However, there are four actively traded gold
contracts in three different sizes and on two different exchanges. Even the simple
assumption that one full size contract of each should be sufficient would be
incorrect. Recently, platinum is moving around $67 per day in the futures
market and gold is moving around $25 per day. Would it be appropriate to try to
even these out by trading two gold contracts versus one platinum contract?

Here is the method I use as a commodity broker to appropriately size my spread
trades. First of all, I calculate the average range for each market relative to
the time frame I expect my trade occur in. In this case, I am looking at
monthly charts. Therefore, I calculate the 21 day average range for each market
and come up with $21 for gold and $67 for platinum. The next step is to
multiply each of these average daily ranges by the market’s point value. Gold
is $21 X $100 = $2100 per day average movement. Platinum gives us $67 X 50 =
$3350 in average per day movement.

Clearly, one full
size contract of each is not an even spread. Now, since we know that we only
have one platinum contract to work with, our only opportunity for proper sizing
in the futures market (there are option strategies available, as well), is to look
at the list of available gold contracts. One full size gold contract gets us to
$2100 per day and leaves us with a $1200 per day deficit to make up. Chicago’s mini
sized gold contract is 33.2 oz. (1/3 full size). That would bring our total to $2793
on the gold side of the trade. This won’t square the ledger. New York’s mini
sized gold contract is 50 oz. (1/2 full size). That would make our total $3150.
That’s pretty close. Obviously, the other option is to use two Chicago mini
contracts and bring our total to $3486. At this point, it comes down to
personal bias. Would one rather be more or, less long gold relative to

I hope this brief description answers more questions than it
creates. However, please feel free to post any ideas, comments or, issues.