The U.S. Treasury Bond market has been held hostage for the last year as the developed world argues about economic stimulus. The argument began to grow back in December of 2014 as Janet Yellen and the Federal Open Market Committee (FOMC) stated, “The committee considers it unlikely to begin the normalization process for at least the next couple of meetings.” This sent rates plummeting and Treasury Bond and stock prices screaming higher. This move was widely anticipated and was perhaps, the last choreographed move between the Treasury and its markets’ participants as market participation since then has declined dramatically. This has left the biggest traders in the deepest markets debating domestic Fed policy in a world of increasingly negative interest rates, while raising domestic rates for the first time in nearly 10 years.
While many of the agricultural markets are finding increasing acreage on a global basis thus decreasing U.S. domination, the corn market is still the primary domain of the U.S. agricultural markets. As such, the Chicago Mercantile Exchange Group’s corn futures contract is the primary hedging tool. As such, the actions of this market’s biggest players are tracked on a weekly basis by the Commodity Futures Trading Commission’s, Commitment of Traders (COT) report. Here’s how to use this report to determine market bias in advance of major governmental agricultural reports by the USDA and World Agriculture Board. While the illustration is based on the current events of the corn market, the methodology is robust across many commodity markets.
The Euro currency was in free fall for nearly a year as the world thought it was heading to parity with the U.S. Dollar. The further it fell, the more they talked about it. Parity appeared to be right around the corner. However, the market’s internals began to re-balance themselves as the commercial traders stepped up to defend even money to the tune of a new net long record position being set as the Euro currency traded down to $1.05 vs. the U.S. Dollar. This is when things got interesting.
The Commodity Futures Trading Commission(CFTC) publishes a weekly report entitled, “Commitments of Traders.” This report classifies the markets’ largest positions by trading groups – speculators, managed money, index traders and commercial traders. Our research focuses on the commercial trader group. We’ve been able to quantify correlated movement between the commercial traders’ net position and commercial trader momentum with the underlying market movement accurately enough to use this as the first screen in our trade selection process. We hypothesize that their accuracy is due to the laser focus necessary when one’s livelihood is derived solely from the movement of an individual market.
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.
The month of May has not been kind to the soybean market. In fact, I’d say it’s bearing the brunt of a perfect storm of bad news. Old crop, July soybeans are down more than 10% for the month while this year’s crop is fairing only slightly better. This beat down has come from all angles, including weather, speculative traders and the global economy. However, once the dust settles, this may prove to be the best buy of the summer.
The U.S. agricultural markets are all well ahead of schedule thanks to the exceptionally warm spring. The most recent crop reports show that soybeans are 76% planted. This record high is 34% above the five-year average for this time of year and 31% ahead of last year’s pace. These figures account for the 95% of U.S. acreage. This amazing crop progress has taken the starch out of the spring planting fear premium we normally see.
The crop progress reports signaled a cautionary note to the upward trend that began in earnest this past February. The early rally was fueled by the tightening global supply and exports to China far ahead of schedule. Small speculators and managed funds jumped on this rally in record numbers. I posted the overbought nature of the bean market when they set their first long position record in the March 20th Commitment of Traders report at 385,619 contracts. This compares to a net position of just 18,082 at the end of January. I think it’s safe to assume that last week’s record position of 480,586 will set the high water mark as many of these traders have been forced out of the market during the course of its 10% decline.
The final straw that’s broken the soybean bull market’s back has been the increasing concerns of a fractious European Union and its effect on the U.S. Dollar as a safe haven currency. The month of May has seen currency fly out of the European Union pushing the Euro to its lowest levels since September of 2010. Considering that the European Union is now China’s largest trading partner, it’s no wonder that China’s economy has also shown unexpected weakness. The last link is that China is our number one soybean export market. Therefore, it is expected that China’s purchases may slow, as U.S. beans become more expensive on the global market.
Now that we’ve identified the causes of the decline, let’s focus on where the bean market is headed. The early plantings were no free lunch. The early spring and the continuation of the same weather patterns are now raising concerns. The lack of rain is causing a crust to form in the fields and hinder the germination process. Furthermore, farmers who intended on growing early wheat and late soybeans (double cropping), need more moisture in the soil to get their late beans in the ground. Estimates vary as to how much double crop beans will add to total U.S. output but there is certainty that the weather is the key for next couple of weeks.
Finally, now that the froth is off the top we can return our focus to the supply and demand factors that called so many speculative dollars to the market in the first place. Soybeans and more specifically, high protein soybean meal are near record low supply levels. The decline in South American production has amplified the emphasis on this summer’s U.S. crop. Bellies must be filled regardless of the economic uncertainties. Global demand for food will be the last of the cutbacks made. Therefore, this decline is fortuitous for patient traders. There is strong technical support for this year’s crop near current prices of $12.50 per bushel. There is the possibility that a complete, “risk off” event could push the market to $12.25 or lower. Either way, the supply and demand numbers certainly suggest a test of the all time highs above $16 per bushel is well within the realm of reality.
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.