Tag Archives: commitment of traders report

Volume & Open Interest 101

The following is reprinted from the Chicago Board of Trade

Volume and Open Interest

Next to price, volume is the most frequentlycited statistic in reference to a futurescontract’s trading activity. Each unit of volumerepresents a contract traded. When a traderbuys a contract and another trader sells thatsame contract, that transaction is recordedas one contract being traded. Therefore,the volume is the total number of long orshort positions.Open interest, on the other hand, refers to thenumber of futures positions that have not beenclosed out either through offset or delivery. Inother words, the futures contracts that remainopen, or unliquidated, at the close of eachtrading session.To illustrate, assume that a trader buys 15contracts and then sells 10 of them back tothe market before the end of the trading day.His trades add 25 contracts to the day’s totalvolume. Since 5 of the contracts were notoffset, open interest would increase by 5contracts as a result of his activity.Volume and open interest are reported dailyand are used by traders to determine theparticipation in a market and the validity ofprice movement. For instance, if a marketmoves higher on low volume some tradersmay not consider this an important pricemovement. However, the same pricemovement on high volume would indicatethat an important trend may be emerging.Combining volume and open interest alsoyields an interesting perspective on themarket. If a contract experiences relativelylow volume levels but high open interest,it is generally assumed that commercialparticipation, via the commitment of traders report is high. This is becausecommercial hedgers tend to use the marketsfor longer-term hedging purposes, puttingtheir trades in and keeping them until they’reno longer needed to manage a given pricerisk. Conversely, high volume with low openinterest may indicate more speculative marketactivity. This is because the majority ofspeculators prefer to get in and out of themarket on a daily basis.

Mass Commodity Liquidation

The past week’s action has seen a large decline in many of
the commodity markets. We’ve seen declines in oil, platinum, copper, corn,
wheat, sugar, OJ and others. Therefore, one has to ask, “What is the
justification for such a broad based selloff?” The answer, in short form, can
be found in the Commitment of Traders report. I track the commercials and large
and small speculators every week. However, Steve Briese, author of Commodity
Trading Bible
, also tracks the Commodity Index Traders. This group makes up
the long only index funds that have been at the center of the Capitol Hill
rhetoric as it relates to high commodity prices. Over the last two months, we’ve
seen this group begin to liquidate their positions. Over the last two weeks,
they’ve begun to liquidate in earnest.

Certainly, some of the commodity markets have been trading
at prices far above any fundamental justification for quite some time. I’ve
written at length that there is little justification for crude above $100 per barrel.
Power outages in South Africa were a major contributor to the rise in platinum
and cocoa, as usual, is subject to the usual political and social turmoil. However,
the grain markets, have a substantial fundamental foundation to build from.
Just as there has been little justification for $140 oil, there is considerable
justification for “beans in the teens,” and corn at $6.50+ per bushel. In
general, this appears to be a case of, “throwing the baby out with the bath
water.”

Given the broad nature of the selloff and its corresponding
volatility, the most effective way to take advantage of a rebound in commodity
prices may be through the purchase of a commodity based currency like the
Australian Dollar futures. This currency is highly correlated to the commodity markets
and is also coming under technical pressure. The successive highs from June 6th
and July 18th were not confirmed by increasing open interest (black
vertical lines and lower magenta graph). Also, we have seen tightening
consolidation as the trend developed in ’08. Currently, we are sitting on the
weekly trend line at .9430. I would not be surprised to see the market violate
this trend. If the market trades down to its deeper support between .9221 –
.9321 and open interest does not increase on the violation of the weekly trend,
I think we have a golden opportunity purchase the Australian Dollar as a proxy
for a continued commodity based rally and further appreciation of the
Australian Dollar.

Rare Occurrence in Crude

The fundamentals in crude oil have continued to erode since February of this year. The highs, over the last $40, can be viewed as a “bubble.” This bubble has been fueled neither by Commodity Index Traders and large speculators, nor Hedge funds and carry trades. I think a strong case can be made that the last leg of this rally should be attributed to large producers unwinding their forward hedges. Producers and forward short hedgers are subject to human error just as individual traders are. Hedge transactions manifest themselves in the Commitment of Traders data as commercial purchases when the market makes new lows and as commercial sales when the market rallies. Just as most economic decisions are made, “at the margin,” so too are the hedger’s trading decisions. Their traders use their understanding of the fundamentals in their market to create oversold and overbought zones within the market’s natural movement and attempt to trade accordingly.

This strategy works for them the vast majority of the time.  However, when a market unhinges from fundamental factors and begins trading on sentiment, the commercials find themselves at the mercy of the public at large. Using the chart below, the white line represents the commercial index of positions on a scale of 0 to 100. Zero equals totally short and can be seen at the following points, (5/06, 7/07, 8/07). One hundred equals totally long and can be seen at, 6/05 and 10/05. Currently, the index is at 78, the highest since a 79 reading in February of ’07.

The yellow line represents total open interest. Technically, speaking, in a healthy trend, open interest should increase as the market moves out to new territory, either higher or, lower. This has not been the case with crude oil. Open interest peaked in July of ’07 and has continued to decline ever since. Open interest now stands at 1.3 million contracts, the lowest since March of ’07.

Furthermore, I have discussed, at length, the negative spread we’ve seen between the front month prices and the later expirations. In real terms, this backwardation in prices is evidence that producers don’t believe that we will be near these prices as the deferred contracts come due for delivery. Producers continued to sell the deferred contracts in order to lock in profits at levels they don’t believe will hold into the future.

Lastly, over the last previous weeks, we have seen the total commercial position shift from net short, to net long, with the market at all time highs. Therefore, I would suggest that the rally from the January highs, under $100 per barrel through the current highs, over $145 has been driven by commercial capitulation and a speculative blow off, rather than fundamental supply and demand issues. Ultimately, it proves the old adage true for everyone, even the big guys, “The market can remain irrational longer than one can remain solvent.”

Historically, there have only been three times when commercial positions have shifted from net short, to net long while the market was at all time highs.  The market declined, twice, by an average of 22.5% and once, the market rallied by 5.8%. Clearly, we are on the cusp of a top. Given the magnitude of a possible decline, one may be advised to purchase put options. Those wishing to sell futures may wish to wait for a close under $140 to initiate a short position.

US Dollar Index

Here is one for the statistical folks out there. It is a very rare combination to have a large speculative long position, which can be checked in the Commitment of Traders Reports in the face of large one day gains in both oil and gold. In fact, it has happened only 4 times. Three out of four occurrences saw the Dollar decline by an average of 2.1% relative to yesterday’s close 72.79. The trough of this decline comes approximately 26 days after the event. Therefore, we can look for a Dollar objective of 71.34 around August 8th.This fits pretty well with the last Dollar trade posted….expecting a test of the 71.00 lows.

 

Corn Crop Deterioration

The fundamentals f the corn market continue to point towards higher and higher prices. I understand that many people had a hard time forcing themselves to buy new crop corn $6 a bushel. Unfortunately, $7 is here and $7.50 is not far off. The corn market is experiencing a “perfet storm.” The short list of contributing factors are:1) Tight ending stocks leave us very dependent on this year’s crop.2) Increasing global (Asian) demand for red meat funnels more corn to feed.3) Declining Dollar increases global demand for our exports.4) The late start to this year’s crop will have a material effect on yields.5) Growing position of index trader positions in the Commitment of Traders Report.

The following article on Bloomberg goes into more detail without having to source each piece of the puzzle individually. If anyone wants more detail than it provides, please contact me directly.

Corn Deluged by Iowa, Illinois Rain Cuts Yields, Boosts Prices

By Jeff Wilson

Enlarge Image/Details

June 10 (Bloomberg) — Rainstorms sweeping the biggest corn states in the U.S. are damaging a crop that’s already failing to keep pace with global demand for food, fuel and cattle feed.

Farms in Iowa were drenched with 5.78 inches of rain last month, or 37 percent more than normal, according to :S:d1″>Harry Hillaker, the climatologist for the biggest corn-growing state. The 22.23 inches that fell on Illinois from January through May was 45 percent above normal and the third-wettest on record, according to data compiled by the state.

Corn rose to a record $6.73 a bushel yesterday in Chicago, extending this year’s gain to 44 percent. Yields in the U.S. may fall 10 percent short of government forecasts, the biggest drop in 13 years, and send prices up another 34 percent as storms delay planting, stunt growth and leech fertilizer from the soil, said :S:d1″>Terry Jones, who farms more than 6,000 acres near Williamsburg, Iowa.

“It’s already a disaster,” said :S:d1″>Palle Pedersen, an agronomist at Iowa State University in Ames.

About 60 percent of the crop in the U.S., the world’s largest grower and exporter, was in good or excellent condition as of June 8, down from 63 percent the previous week, the Department of Agriculture said yesterday in a report. A year earlier, 77 percent got the highest rating. Iowa, Illinois, Nebraska, Minnesota and Indiana, the five top-producing states, reported declines.

`Midwest Flooding’

Check USDA Grain Reports

Rainfall across the Midwest was as much as four times normal over the past 60 days, according to National Weather Service data. In some places, storms dumped 15 inches more than average, the data show. The increase is equal to the typical rainfall some fields receive in a year, said :S:d1″>Roger Elmore, who is also an agronomist at Iowa State.

“The Midwest flooding is widespread and that has already hurt the crop,” delaying development and drowning some immature plants, said Jones, who is vice president of Russell Consulting Group in Panora, Iowa. “We could see national yields fall at least 10 percent, even with normal growing conditions the remainder of the year.”

Spring planting was delayed by rain and unusually cool weather that left fields too muddy for tractors and limited growth. U.S. corn planting was 51 percent completed by May 11, less than 71 percent the previous year, USDA data show.

The yield potential for corn drops unless plants emerge from the ground before the end of May in the Midwest, according to a University of Illinois study. The USDA estimated 78 percent had emerged as of June 1, compared with 92 percent a year earlier. To produce the best yields, corn needs to pollinate before the arrival of summer weather.

$8 a Bushel

“The crop is in serious trouble,” said :S:d1″>Jim Stephens, president of Farmers National Commodities Inc. in Omaha, Nebraska, who helps manage more than 3,600 farms across the Midwest. He said corn will top $8 a bushel this year.

The weather is endangering a U.S. crop already expected by the USDA to decline from last year’s record harvest after farmers planted 8.1 percent fewer acres. Global inventories may fall to the lowest levels in 24 years by Aug. 31, the USDA said.

U.S. farmers shifted to soybeans and wheat because the costs of corn is high relative to other crops. The USDA will update its yield and inventory estimates today in Washington and its estimate of U.S. planted acreage on June 30.

Demand for corn to feed livestock jumped 24 percent in the past decade as economic growth boosted incomes and meat consumption in developing countries. The prices of corn, soybeans, rice and wheat surged to recor
ds this year as food demand outpaced production. In the U.S., the cost of corn was increased by government subsidies and mandates for ethanol.

Rising Prices

In the top eight producing states, which grew 75 percent of last year’s crop, there is more acreage at risk than in 1993, when yields plunged 23 percent, said :S:d1″>Chip Flory, editor of the Professional Farmers of American advisory in Cedar Falls, Iowa.

Corn futures for July delivery rose 6.5 cents, or 1 percent, to $6.5725 a bushel yesterday on the Chicago Board of Trade, after touching a record high for a third straight session.

The saturation of soil moisture is in the 98th percentile of the highest levels in the past 40 years from South Dakota to Ohio, according to government data, increasing the risk of reduced yields from the loss of nitrogen fertilizer, Iowa State University’s Elmore said. The saturated soils are depleting fertilizer at a rate of as much as 4 percent a day, he said.

Farmers were expected to produce about 153.9 bushels an acre on average, up from 151.1 bushels last year, the USDA said May 9. Instead, yields probably will drop below 139 bushels and may fall even more, said Jones, the Iowa farmer.

To contact the reporter on this story: :S:d1″>Jeff Wilsonjwilson29@bloomberg.net

 

Defending the $ and Popping the Bubble

Yesterday, Bernanke stated that a weak Dollar was not in America’s best interest. Typically, this statement would be argued against based on a weak Dollar’s contribution to exports helping to grow a weakened domestic economy. Bernanke’s point, I think, is that inflation is a bigger worry than recession. Dollar based commodities, primarily grains and energy are having a greater negative impact on our economy than can be offset through higher exports. Inflation in these primary goods is acting as a tax on the American consumer. Right now, the economy cannot create enough high quality jobs fast enough to offset the economic pain that is felt at the gas pump and grocery store.Further more, Bernanke also stated that he will work with Secretary Paulson to defend the Dollar’s decline. This is important because the Federal Reserve and the Treasury are separate entities. It is a big deal that Bernanke used language such as, “In collaboration with our colleagues at the Treasury…” as well as, “…ensuring that the Dollar remains a strong and stable currency.”

These are strong words from the chairman of the Federal Reserve. The perfect storm could be brewing……strengthening Dollar combined with regulatory action, via the CFTC closing the “swap loophole” on Commodity Index Traders could bring liquidation across the commodity spectrum. It will be important to check the Commitment of Traders Reports for position changes.

Commodity Index Funds & Investment Banks

This is from John Mauldin at http://www.frontlinethoughts.comI think he does a wonderful job of explaining how the Commodity Index Funds stay off of the CFTC’s radar in their weekly Commitment of Traders reports.

Swapping out Commodities

The Commodity Futures Trading Commission announced yesterday that they are
looking very hard at possibly closing a regulatory loophole that allowed some
extremely large commodity index funds to get around position limits. For those
not familiar with the concept of limits, it basically works like this. No trader
or fund is allowed to own more than a specific amount of a commodity traded on
the futures exchange. This limit varies from commodity to commodity and exchange
to exchange. The point is to keep one group from manipulating the price of a
commodity, as the Hunts did with silver in the early 80s.

The loophole is one where large investment banks can sell a “swap” for a
specific commodity like corn and then hedge their position in the futures
markets. There is no limit on the amount of the commodity that can be hedged.
So, a fund can accumulate sizeable positions far in excess of what they could do
directly by working with an investment bank. In essence, the swap is a
derivative issued by a bank which acts just like a futures trade, but it is with
the bank as guarantor and not an exchange. Swaps are not regulated as such. And
up until now, the banks were seen as legitimate hedgers so there were no limits
on what they could buy in the futures markets.

This works for very large commodity index funds which try to mirror a
particular commodity index and need to be able to buy very large positions in
excess of the normal limits (and there are scores of them), and for the banks
that make the commissions and profits on the swaps. Remember, the fund gets a
management fee, so growing the size of the fund grows their fees.

These indexes typically have about 26 commodities, with the largest
allocation to oil, but almost anything that is traded has some small portion of
the allocation. As I noted last week, there are some who believe this is working
to drive up the price of commodities beyond the simply supply and demand
principles. Whether or not you believe this to be the case, the CFTC is looking
at the loophole.

The key word in the announcement yesterday was the word “classification.” Their classification can be tracked in the Commitment of Traders Report classified as hedgers and as such have no limits. But
they are not rea lly hedging the actual physical commodity as a farmer or
General Mills might do, but the hedge is their financial position.

CFTC vs. Commodity Index Traders

High grain and energy costs have finally generated enough momentum for the politicians to get involved. This past week, a paper was presented to Congress by Michael Masters of Masters Capital Management. He attributes the current price levels to creating an artificially high floor price due to the asset class categorization of commodities. The long only money that has poured into the markets is creating, “demand shock from a new category of speculators: institutional investors like
corporate and government pension funds, university endowments, and sovereign
wealth funds. He also, matter of factly states, “Index speculators are the primary cause of the recent price
spikes in commodities.”

One statistic that is being roughly, though widely, quoted, is the assumption that demand for exchange traded commodities over the last five years has increased equally between China and Commodity Index Funds. The CFTC is prepared to overhaul its system of reportable trading categories and players to try and pinpoint who is trading what and how much. The purpose is to differentiate between true physical price discovery and speculative froth.

Congress is prepared to assist the CFTC in outing the institutional speculative money by closing the swaps loophole that has allowed the billion dollar funds to enact futures transactions as swaps through their securities brokers (Merril, Goldman, etc.) who then hedge the swap in the futures market. This is how every individual fund has managed to stay off of the CFTC’s Commitment of Traders reports. The commodities are held assets with their broker while the broker executes the hedge and reports the position as their own.

The CFTC and Congress working hand in hand could bring an end to this bubble far quicker than peace in the Middle East or a bountiful global harvest.

Please, feel free to comment or, question. This is a small picture painted in broad brush strokes.

Have a wonderful weekend, Andy.