Category Archives: Grain Markets

Wheat and Corn Spread at 25 Year Highs

There are prices we accept in life as absolutes. We accept
that gold is more expensive than silver or that a Mercedes is more than a
Chevrolet. Sometimes, things change. Remember when diesel fuel was cheaper than
gasoline? Not only is diesel more expensive, it has maintained its premium for
more than ten years now. Recently, another market relationship has been called
into question – the relationship between corn and wheat.

Historically, wheat futures trade at a premium to corn
futures. In fact, over the last 40 years, there are only about ten periods
where corn closed at a higher price than wheat. Going through 15,000 days worth
of data, I found that there were a total of 56 trading sessions that corn
closed at a higher price than wheat. This is .0037% of the time. Nineteen of
these closes have occurred this year and fifteen came in 1984. There have been
no instances of this for more than 25 years.

The typical eyeball range for the spread is around $1.50.
Wheat is normally worth about $1.50 more per bushel than corn. The widest this
spread has been is $7.15 in March of 2008. The recent peak was in August of
last year at $3.82. Conversely, when this spread has gone the other way, as it
is currently sitting, the widest we’ve seen it was corn trading $.40 cents over
wheat last month.

I went back through the USDA Acreage and Crop Production
reports from the periods when this spread went negative and found some
similarities between 1984 and 2011. The carry out stocks for the new crop years
were exceptionally tight in both cases. The carry out stocks at the end of the
1983 crop year were lower due to two factors. First of all, fewer acres were
planted in 1983 due to governmentally implemented acreage reduction programs
following record production in 1982. Secondly, crops in 1984 experienced severe
drought conditions, which led to the second smallest harvest in history. In
fact, the 1984 harvest ended up being 49% lower than 1983’s.

We started 2011 back at the same record low stocks to usage
ratio we were at 25 years ago. This year, the governmentally sponsored ethanol
production intends to take 40% of the 2011 crop off of the market and we have
had lousy planting weather on top of that. Combining governmentally driven
demand and lousy weather we begin to see the similarities between the 1984 and
2011 crop years.

The corn and wheat contracts for September delivery are still
trading back and forth of even money. The trading idea is to sell corn at a
higher price than we buy wheat. This strategy will profit as these two markets
return to a more normal trading relationship and wheat begins to rebuild its
premium over corn. This spread has recently traded as far as $.33 cents towards
corn over wheat at the end of June. The highest it has been is $.40.

Calculating the trade on a cash basis, we can determine our
trading parameters. Forty cents is equal to $2,000 per spread position in risk
to a trading account’s value. Conversely, a quick reversion to the spread’s
normal range of $1.00 to $1.50 in wheat over corn would equal a cash value of
$5,000 to $7,500 in trading account profits per spread position. However, as
with the diesel fuel to regular unleaded example, it’s possible that these
market relationships can shift from anomaly to a new normal. Therefore, risk
must always be the first consideration when deciding whether or not a trade is
suitable for your account.

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.

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.

 

Right vs. Profitable

As many of you know, I’ve suggested being long the cotton market for a while, now. The recent setup can be seen here http://www.youtube.com/watch?v=qXUynIIiTNk . I suggested this trade on the 26th, knowing that the crop acreage report which can be found here with other USDA Grain Reports came out this morning. I expected a decline in cotton acreage of 10 – 15%. The number came out at 15% fewer acres planted. Clearly, I should have seen a swift rally through the 8230 – 8250 resistance. However, the market’s reaction to this number was to sell off 250+ points…..IMMEDIATELY! The market fell so swiftly that my protective sell stops were elected but, unable to be filled on the way down. Currently, I find myself sitting with a losing trade below my protective stop point in a market I was dead right on. I’m now tied to the screen trying to find a place to take my loss. The point is, “Being right, isn’t always profitable.”