rwin, S. and D. Good, “Some Perspective on the USDA’s August 1 Corn and Soybean Yield Projections.” farmdoc daily (6):153, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, August 12, 2016.
Our business focuses on the commodity complex. We rely on the Commodity Futures Trading Commission’s (CFTC) Commitment of Traders report to sort out what the major players are doing in the commodity markets. Our focus lies with the commercial trader category of this report. These are the traders who either have the commodity to sell or, will be using the commodity in their manufacturing processes. Following the commercial traders category, as a whole, for a given commodity can provide us with a consensus opinion from the world’s largest producers and end users of a commodity. There are times, like now, when their collective actions in the commodity markets can pay direct dividends to equity traders, both in individual stocks as well as commodity based ETF’s.
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.
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.