Tag Archives: copper

End of the Metals Rally

The mineral and industrial metal commodities may be nearing the end of their decade long rally. I think a very good case can be made for the highs to be put in sometime in the next twelve months.   Political agendas and inaction should support the metal and mineral markets heading into next year. However declines in global demand, a slow down in infra structure creation, higher production taxes and the eventual global debt crisis will bring these trends to an end.

First of all, the supporting case comes from a global political cycle that is determined to maintain the status quo. Here in the U.S. QE 2 is set to end next week. Most of the money that went into this program that was designed to stimulate the economy never made it out the front door of the lending institutions that received it. The money was used to strengthen the banks’ internal lending reserves, rather than passing it on to the public at the low rates at which they received it. Therefore, the individuals and small businesses never received the assistance and won’t miss it when it ends. Furthermore, the debt ceiling, which has been kicked down the line until August will find a way of being raised, extended, supplemented, etc. Neither political party in the U.S. wants to be responsible for causing a governmental work stoppage or promoting an unpalatable solution in an election year.

Globally, support comes from both the European Union, determined to postpone the situation in Greece as long as possible as well as the coming Chinese elections. This most certainly means bigger problems down the road. Until then, these two will both keep throwing good money after bad in two of the largest economies in the world. Europe has no solution to the Greek debt problem and the Chinese leaders vying for President will keep their individually governed areas rolling in the fiscal stimulus and distorted GDP figures until after their elections in January of 2012.

Unfortunately, the headwinds facing the industrial metals and minerals markets have been gaining traction for quite some time and are far more widespread. The obvious follow up is the pending global slow down. The debt issues of Europe and the U.S. must be reckoned with. When this is combined with cutting Chinese building subsidies and severely raising the mining taxes in Africa and South America, the markets will be forced to absorb the excess capacity of the Chinese buildup in the face of declining profit margins at the mine.

Platinum, copper, and mineral mining have increasingly shifted to African countries. Many of these countries have not received the compensation from the development of these industries they had expected. Some of this is due to corporate accounting that kept revenues off the books. Let’s face it, if General Electric can avoid paying U.S. income tax like it did in 2010, it shouldn’t be too hard to assume that corporate accountants for multi-national mining companies can evade the tax collectors in third world economies like Tanzania, Zambia and Ghana. The local governments, feeling slighted after the metal and mineral price run up in 2008 are enacting much tougher tax laws and strengthening their central governments in order to nationalize (seize) assets that have underpaid. These actions are similar to state run South American enterprises and will make ownership of publicly traded companies less attractive.

Finally, there is no question that global liquidity is at an all time high. Currency depreciation will continue to influence the metal markets as investors look for a safe haven store of value. However, if governmentally stimulated demand dries up or if the sources are over taxed, we will be left with empty buildings and unemployed workers. This decline in demand will outpace the draw on warehouse stores and lead to a decline in prices as the global economy finally comes to terms with itself in 2012.

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.

Trading the Tsunami

The earthquake and tsunami in Japan are tragic and I don’t want to minimize the human devastation, loss and ongoing fear. However, it’s my job to try and explain how this has affected the markets and what I believe is yet to come. The markets’ initial reaction to outside shocks is based on its participants’ fear. The market sells off due to uncertainty. If you or I had direct investments in Japan, we would want to get out and convert to cash while we waited to see how things unfolded. It’s human nature to retreat to a defensive position when confronted with disaster, whether financial, physical or emotional. Japan’s stock market sold off 16% in two days.

The specifics of the disaster in Japan are tied to demand destruction. Japan imports nearly everything it needs to run. The disaster has massively cut imports. Petroleum products, food, manufacturing raw materials and more have slowed to a crawl. Australia is one of Japan’s primary import sources and Australia is an export driven economy.  As a result of this, the Australian Dollar declined nearly 3% immediately.

The other major component of demand destruction lies in Japan’s 30 years of dominance in the manufacturing sector. Japan no longer has the competitive advantage it once held in technology over the rest of Asia or, the labor advantage that it held over the United States. There is a great degree of uncertainty regarding which manufacturing facilities will be rebuilt and which will simply be relocated elsewhere in the world. Japan has lost a large share of its competitive advantages.

The massive mobilization involved in the rescue efforts combined with the destruction of Japan’s refineries and nuclear reactors will squeeze global petroleum supplies. I expect Japan to begin importing large amounts of refined petroleum products from the west coast of the United States. Our refineries are running around 85% of capacity, our crude storage tanks are nearly full and our trade relations with Japan are already in place. China’s Sichuan earthquake in May of 2008 killed 68,000 people and left nearly 5 million homeless. The scale of the military operations required to rescue people and stabilize the infrastructure pushed crude $20 higher per barrel in less than a month. Approximately 430,00 people have been relocated in Japan, thus far.

Once the people are safe, they’ll need to be fed. Every piece of food near the damaged areas will have spoiled. The growing radiation fears are already making their way into the food chain. Japanese people are afraid to consume food that may have been tainted. This will place a large strain on current grain and meat supplies. Current grain and meat stocks cannot be increased. Our inventories are what they are. Fixed supply plus greater demand means rising grain and food prices are on their way. Live cattle prices climbed more than 20% immediately following the ’03 blackout and power was only out from 4-8 hours. Obviously, the length of the outage is much greater in Japan while the population base is smaller. We’ll need more data to quantifiably compare the two.

The reconstruction process is the final phase to discuss. Financing the reconstruction will be difficult on Japan’s ailing economy; in fact this topic deserves its own article. Heavy equipment companies like Caterpillar and John Deere have already attracted some attention. Oil refinery companies will also benefit. Nuclear reactor technology is a short term negative as General electric has taken a hit even though Japan may rebuild their reactors. Commodity prices will rise as Japan re-stocks and this will be evident in meat and grain prices. Copper and steel will also see increased demand. The wild card in the reconstruction process is natural gas. The radiation scare may be enough to push the political conversation of natural gas to the front burner.

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.

J.P. Morgan Locking in Silver Losses?

There’s an old investment saying that says, “Never marry a loser.” When the ego gets in the way, the trade becomes more about being right, than about being profitable. When J.P. Morgan used Federally backed funds to acquire Bear Stearns in March of 2008, it seemed like the steal of the century. They bought Bear Stearns at $2 a share and the Federal Reserve guaranteed Bear’s illiquid debt and counter party risk allowing J.P. Morgan to step in and take immediate control of Bear’s trading operations.

 

Apparently, part of Bear Stearn’s proprietary portfolio included a rather large short position in the silver market. J.P. Morgan, rather than liquidate the position at a loss, clean up their new balance sheet and pocket the profits decided they were smart enough to trade their way out of it using the profits accrued from Bear’s acquisition to sustain the ongoing trading losses. Thus, they’ve continued to add on to their short position selling more silver futures to increase their average price the entire way up. It has been reported by the UK’s Guardian that J.P. Morgan may now be short the silver futures market to the tune of 3.3 BILLION ounces. As a comparison, the total outstanding deliverable interest in the silver futures market is 320 million ounces and annual global supply is approximately 900 million ounces.

 

Short positions in the futures market can only be settled in two ways. First, the contracts can be repurchased at the current market price, which in J.P. Morgan’s case would be a losing trade. The second way out is to physically deliver the silver itself. This would make the people who bought the silver from J.P. Morgan, whole.

 

J.P. Morgan has the ability to hire some of the top minds in the trading game and over the last two years, they’ve been working hard to try and trade their way out of this mess. Their primary strategy thus far has been to take advantage of the limited trading in the overnight electronic markets to manipulate the market prices. The basic plan they’ve been following is to place large orders to sell more silver which make the overnight markets appear to have an abundance of sellers. When normal market players come in and need to get their own silver sold, their own human instinct takes over and they make their offer at a lower price than what they’re seeing on their screens. Once J.P. Morgan feels that enough sell orders have piled up under their own bluff of an order, they come in and buy up the lower priced offers and withdraw their large bluff sitting over the market. They have been under investigation by the Commodity Futures Exchange Commission for their manipulation of the silver market for the last year.

 

Clearly, J.P. Morgan has a problem. They owe the market more silver than the world produces and their previous attempt to unwind their position is under investigation. So, what’s the next logical move? They’re currently attempting to corner the copper market from the long side. They are essentially, creating a hedge. The idea is that they’ll make in the copper market what they’re losing in the silver market. Over the last three months as silver as silver has gone from $19 an ounce to more than $30 an ounce, J.P. Morgan has been managed to accumulate between 50 and 80% of the copper traded on the London Metals Exchange.  It’s no coincidence that they also announced their plans to offer an Exchange Traded Fund backed by physical copper. Clearly, they’re hoping to recoup some of their losses through price appreciation in copper while the generating a new revenue stream, as well.

 

Time will tell how this plays out on their balance sheet. History has shown that traders who lock into one idea, like selling the silver market, typically go broke before they are proven correct. J.P. Morgan’s dominant purchases in the copper market reflect their fear of outright loss in the silver market. Considering the notional amount (3.3 billion ounces) they are short relative to the size of the silver futures market and the global supply of physical metal, it will be interesting to see how they manage to divorce the loser they’ve inexorably hitched their wagon to.

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.

Commercial Traders Ahead of the Game

The Commodity Futures Trading Commission publishes a weekly report entitled, “Commitment of Traders Report.” This report totals the positions by all major commodity market players and breaks them down into a few important categories. The category that is most predictive of future moves in the commodity markets is the Commercial Trader category. This group is made up of people who are hedging their need for the physical commodity to meet future production as well as the producers of physical commodities who are trying to get their future production sold at the best possible prices. These are the professionals whose livelihood depends on their ability to ascertain value in their particular markets. Following their behavior in the commodity markets is very similar to following the reportable insider trading in the stock market, in which employee transactions of large amounts of stock must be reported to the Securities Exchange Commission.

Following the commercial trader category provides keen insight into the commodity markets. Some examples are seasonals, divergences and macro economic expectations. Comparing year over year action against established seasonal trends can allow traders to catch a glimpse into the expected strength or weakness of the current cyclicality in a market. Crude oil typically experiences its greatest strength from early July through the end of August. This year, the commercial buying came in just as expected and the market made its most recent low on July 6th and has rallied from $71.50 to almost $83 dollars per barrel.

Divergences appear when a market makes a new multi month high or low that is not validated by the commercial traders’ actions. For example, today’s news that China’s property market is cooling off has already been reflected in the market by commercial traders who have sold this rally relentlessly and capped the rally for six straight trading sessions under $3.40 per pound.

Both of these examples tie into the macro economic expectations of commercial traders. The seasonal rally in crude oil has been cut short by heavy commercial selling over the last two weeks due to expected softness in global crude oil demand. Recent energy reports show that gasoline levels here in the U.S. are at a six-week high and our refineries are trending toward decreased capacity utilization. Furthermore, China, the world’s largest crude oil consumer, has decreased their imports 15% since June.

The capping of prices in the copper market by commercial traders is further evidence of an expected economic slowdown. Commercial traders who follow the markets that provide their livelihood are among the first to know and analyze important information. They were aware that China’s copper and iron ore shipments are down for the first time in four months and that their crude oil consumption is 15% lower for July.

Finally, we can extend this same analysis to commercial positions in other actively traded markets as well. The disappointing projections are for a weaker stock market, low bond yields and higher agricultural prices. The build up of short positions in the stock market over the last three weeks has been considerable. Clearly, professional traders’ expectations of the stock market are negative. This can be partially verified by the buildup of short maturity debt. Interest rate futures across the strip expect to see continued buying even in the face of added government stimulus and a weakening U.S. Dollar. In fact, one of the most fundamental traders of all time – Warren Buffet, has shown that they are increasingly buying short- term treasuries. This omen portends the possibility of profiting on a flight to quality as people pull money out of a falling stock market and place it in U.S. Treasuries for liquidity and protection.

Finally, professional traders in the grain markets have been making their stand in two ways. First, buyers of grains are supporting higher and higher floor prices. This means the folks at Nabisco, Quaker Oats and Frito Lay are all expecting the growing overseas middle class to put a squeeze on the United States’ ability to remain the, “bread basket to the world.” Sellers of grains, on the other hand, are more willing to let the markets spike higher and higher before capping their profit potential. This was witnessed over the last month as overseas growing issues forced U.S. grain prices up 28% in corn, over 50% in oats and the price of wheat nearly doubled.

Trading alongside of the commercial traders has been quoted as, “Following the elephants.” This provides three benefits. Their actions are reported weekly, making their path easy to find. They cut a wide enough swath through the market to allow us to slip in and out at our convenience. Finally, they offer a tremendous amount of protection. Trading the markets is hard enough on your own. Why not allow the elephants to guide you?

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.

Major Turning Point

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.

Today’s price action appears to have trumped the
deflation/reflation argument that has been building over the last month. Many
of the markets have been rallying on small speculative buying as seen in the portfolio
rebalancing by the major long only funds.

Looking at the Commitment of Traders reports over the last
few weeks, we can see an increase in the net long positions of small
speculators in the following markets:

Swiss Franc, Japanese Yen, Canadian Dollar, Unleaded Gas,
Wheat, Beans, Bean Oil and Meal, Corn, 10yr. Notes, Eurodollars, Live Cattle,
Hogs, Copper, Orange Juice, Coffee, Sugar and Dow Jones futures.

The commercial hedgers have gladly stepped in to take the
short side of these trades with their numbers building as we’ve neared the
October – November resistance in many of these markets. Obviously, the interest
rate sector is the exception, although, there is strong short hedging taking
place at these levels.

There are a few major reasons for the resistance at these
levels. First, the U.S. Dollar Index has a strong bias towards setting a high
or low for the coming year in the first two weeks of January. If the Dollar’s
trend is going to be higher, the global demand for American commodities will
decline. Secondly, portfolio rebalancing by the major index funds for 2009 is
going to balance smaller gold weighting against heavier crude oil weighting.
Today’s collapse in crude oil futures is an indication that they may have filled their
need for crude. This also helps explain Gold’s inability to rally through $900
even on weak U.S. Dollar days. Lastly, the economic numbers continue to get
worse with each release. Last week’s ISM numbers were the worst since 1980.
Unemployment this Friday should continue to rise and eventually head north of
8%.

This is a very brief outline of the weakness I’m expecting
in many markets in the near term. Please call with any questions.

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.