Tag Archives: markets

2015 El Nino and the U.S. Grain Markets

The National Oceanic and Atmospheric Administration (NOAA) has repeatedly stated the growing case for the 2015-2016 El Nino event. While much has been discussed in the headlines, very little of the conversation has focused on the commodity price impact that the most significant El Nino weather pattern since 1997 could have on U.S. crops. This week, we’ll begin our look at how the U.S. grain markets performed during 1997-1998 El Nino and continue this line of thought through the global grain markets next week before finishing this segment with a look at El Nino’s impact on energy prices.

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Commitment of Traders Report Supports Cocoa Market

This morning’s piece for TraderPlanet combines all of the classic elements necessary to create a Commitment of Traders buy signal in the cocoa futures market. We discuss the macro factors that have kept the commercial traders on the short side of the market during its extended sideways range near the highs as well as the cause of the recent sharp sell off. Finally, we examine the technical nature of the market and exactly what this trade is setting up and the risk entailed.

Fully mechanical Commitment of Traders markets and equity curves.

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Gold’s Precarious Support

The gold market has simply been stagnant for more than a year now. Prices may be higher year to date but virtually any gold traded at $1,300 per ounce over the last year has seen both sides of the ledger. The trading pattern that’s developing continues to consolidate. The tighter this consolidation becomes, the more explosive its breakout should be. This week’s piece will be short because this is one of those instances when a picture really is worth a thousand words.

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Gold and Bonds Getting Back to Normal

Gold, interest rates and the stock market have a very interesting relationship. Normally, declining interest rates are good for business and bad for gold. Post 9/11 and housing bubble, zero interest rate policies (ZIRP) created an artificial situation that fractured this relationship rendering it virtually useless over the last decade. This began to change last summer when the Federal Reserve Board stated that they would begin slowing the stimulus they’ve provided to the economy thus allowing interest rates to gradually rise. These relationships have begun to sort themselves out over the last three quarters and may actually be telling us something about the current pricing in the gold market.

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Trading Ukraine Uncertainty

Removing the politics of the Russia-Ukraine issue and focusing on the economic implications of Russia’s bloodless annexation of the Crimean peninsula puts some trading opportunities on the table as global risk premiums jump. In order to do this, a couple of suppositions must be declared. First and most importantly, the United States will not actively engage Russian troops. In many ways, this is a replay of the Georgian conflict in 2008. Georgia was in revolt against Russia and wanted closer ties to the European Union and the US. Their cause was quickly championed by Western leaders until it became obvious that neither the European Union, The United States nor, NATO would take any military action to defend Georgia against Russia. This episode set the precedent for the current situation.

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Market Reactions to Debt Ceiling Changes

The ongoing budget and debt ceiling issues have arguably become as contentious as the Trayvon Martin case in social media. This is as vocally divided as I’ve seen my social media feeds. The left claims that the Republicans are solely to blame for our issues while the right insists we cannot spend forever what we haven’t got. Personally, I think both sides have their heads shoved very deeply up a warm and dark bodily cavity. While Congress argues about how to spend our money and money we haven’t got, they receive a lifetime’s salary plus benefits for 4-6 years of work yet have the nerve to use the term, “welfare state,” in public.

Whether you agree with the left, right or somewhere in the middle is irrelevant in the world of managing finances and trading. What matters is empirical data, not conjecture. A quick survey clearly shows that the economy is starting to slow due to the government shutdown. Consumer confidence is plummeting along with Congress’ approval rating. Government loans are being stalled for small businesses. Mortgages are stalling because government guarantees can’t be secured. Customs is turning into a choke point for global trade as inspections can’t be done and clearances can’t be granted. These are all quantifiable drags on our economy and will be reflected in lower GDP numbers.

The previous points are all uselessly valid. We don’t trade US Customs volume and our assets aren’t invested in Brazilian oranges left rotting at a dock. Our assets are directly placed in the US financial markets. I’ve spent the last week compiling a spreadsheet of debt ceiling negotiations and raises (there haven’t been any decreases) from the last twenty years and compared it to the most likely assets to be affected: interest rates, the US Dollar, gold and the S&P 500. Professors always say that economic choices are made, “at the margin.” Our philosophy has always been to stay ahead of the margin calls in the first place.

The debt ceiling has been raised 18 times since 1993. I chose this start date because it gives us 20 years worth of data during the most politicized portion of our history. Furthermore, the past twenty years have participated in the boom of the information age where the average person on the street has had more and more access to more and more information than ever. This allows all of us to make investment decisions based on fully formed opinions on events as they unfold. Therefore, the data set should be representative of the current investment climate.

Based on what has happened in the past, how can we best position ourselves for the future? Unfortunately, the data is mixed, at best. Because I’m old school and still do charting and modeling by hand, I chose a simple premise. “Where did the markets close the day before the debt ceiling was raised and where were they trading ten days later?” The range of results varied little by direction. The most predictable asset class is the interest rate sector by using the 10-year Treasury Note as a proxy. Ten year Treasury Notes traded lower (higher yields) 11 out of 18 times. This seems logical as raising the debt ceiling should force us to pay more in future obligations. It is worth noting that the declines in the 10-year Note came against the backdrop of a 25-year bull run in the interest rate sector.

The S&P 500 was the second most bearish market as it was lower ten days after the announcement in 10 out of 18 instances by an average of 1.6%. The S&P also retained its typical character of panic sell-offs. The largest gain was only 4.82% in May of 2003 while there were four occurrences of losses greater than 5%. Two were greater than 10%. The largest 10-day loss was a whopping 22.7%. Therefore, raising the debt ceiling and conducting government business as usual is not always a positive for the stock market.

The lone bull in the markets examined was the US Dollar. The slight bullishness in the US Dollar surprised me. The Dollar was higher in 10 out of 18 instances by an average of 1.3%. This is where multiple types of analysis really work together. Last week, we suggested that the Dollar is setting up for a downward trending run. I stand by that analysis. Monday, October 7th, Trader Planet published a piece I wrote on the counter trend bounce typically found in the US dollar after multiple moves to new 30-day lows. The Dollar situation as a whole confirms this theory. I expect the Dollar to rally short-term but fall over the course of time.

Gold was the final market we went into. I didn’t expect to find much here and I didn’t. Perhaps, the biggest point to be made here is that anyone trying to talk you into buying gold because the government is failing, inflation is coming, the Dollar is dying, etc must have a hidden agenda. The data simply doesn’t support the sales pitch. In fact, the biggest moves in the post debt ceiling adjustments in gold were to the downside. The general direction however remains a coin toss as the gold market moved up and down with equal frequency over the last 18 instances.

Finally, there’s one last point to be made of historical proportion and I have to credit my brilliant nephew, Erik VanDootingh for tipping me off to it ahead of the news curve. The markets are scared. Big, BIG money is scared. This can best be measured by the difference between the interest rates that the US government is paying for loans versus what international banks are charging to borrow from each other. Technically, this is the spread between Treasury Bill rates and LIBOR (London Interbank Overnight Lending Rate). For the first time in history, including the 2008-2009 implosion, our government is being charged a higher interest rate to borrow money than banks are charging each other. Interest rates are based on risk. The higher the risk, the higher the rate charged. Let that sink in awhile as you ponder, “too big to fail.”

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.

 

Commodities Still Strong Amid Global Uncertainty

The Eurozone debt concerns have finally taken their rightful place as a daily front -page news story. Tuesday, Spain brought 2.5 billion Euros to market in 12-month bonds. The average rate for the auction was 3.45%. This is 45% higher than previous month’s auction rate. For the sake of comparison, it’s hard to find a 12-month CD over 1% here. Wednesday, 20,000 Grecians rioted in response to the latest round of austerity cuts. Finally, European Central Bank President Jean -Claude Trichet is calling for an expanded role of the bailout fund. These headlines all echo the same theme…uncertainty.

 

Uncertainty is a bigger impediment to fully functioning markets than fear or, greed. Uncertainty prevents planning and prevents action. While Europe digests their own financial crisis, we can take a look at the effects of our own actions here as well as what to expect in the coming months.

 

Throughout the late summer and into fall, many leading analysts suggested that the domestic stock market was a much better investment than the domestic bond market. This includes people like Warren Buffet, James Paulson and Alan Greenspan. Their general assertion was that the effects of the loose monetary policy put in place to provide liquidity and jump- start the economy was holding interest rates at artificially low levels.  Therefore, the risk premium, which compares investing in stocks versus bonds, had swung in favor of equities. The fourth quarter has clearly proven this to be correct with the stock market up 9% so far in Q4 while the 30yr. Treasury bond has declined more than 9.5% in price.

 

Most of this rally has been based on the unwinding of the fear and carry trades. Investors must constantly balance yield versus safety. Lately, the investment world has become virtually unmanageable to the individual investor attempting to figure out what the global leaders will put into play, how it will affect their portfolio and finally, what actions can be taken to capitalize on that analysis if it is correct. For example, it was generally accepted that the domestic stock market, metals markets and the U.S. Dollar could not simultaneously trade in the same direction yet, that has been the case of the fourth quarter. In fact, a decline in commodity prices combined with a rise in borrowing costs would put a real squeeze on the carry trades that have been placed over the last two years.

 

One solution to this puzzle is to focus on individual pieces. Sometimes, we don’t have to know what the final picture looks like. Eventually, if we keep putting the pieces in the right places, the picture will take shape. Therefore, some of the assumptions we will be working with are:

–       The U.S. is ahead of Europe in dealing with the financial crisis.

–       The U.S is still the largest safe haven economy.

–       Euro weakness will make the Dollar seem strong by comparison.

–       Developing Tiger countries are the engines driving global growth.

These ideas will continue place us on the long side of the commodity markets, while trading both sides of the Stock market and the U.S. Dollar. The markets should become less predictable and volatility should increase as the risk premium between the currency, equity and commodity trades continues to tighten. This will place many asset classes on equal footing and leave alpha to be gained only through the careful examination of the individual issues within those asset classes.

 

Out of the 36 markets that we track on a daily basis, 25 of them are facing negative commercial trader momentum. As we discussed a couple of weeks ago, some of these markets are near all time speculative limits. In fact, crude oil just set a new record for speculative long positions this week. This means that professional money managers are putting money to work buying crude oil while the people who produce it are selling all they can. The ability to follow the money flowing through the individual commodities provides a degree of certainty. This allows us to take action, using bottom up, micro economic analysis while the people at the top are still trying to figure it out on a macro economic basis.

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.

Fear & Greed vs. Panic

Several years ago I designed a day trading system for the stock indexes based on the following assumptions:1) Bulls favor an orderly, steady march higher.          This can be seen in               a. Smaller daily ranges as the market climbs.               b. Declining volatility. (less daily variance).               c. Declining put/call ratio. (less desire to purchase downside insurance)

As this story builds, complacency shifts to greed. Bulls are less likely to buy put options for fear of giving up top end growth. The television’s pundits tell us why “This bull is different.” John Doe investor feels secure enough to enter individual positions directly. The rising tide of the market begins to float all issues.

2) Bears are waiting for Achilles to bare his heal. Wide ranges and exceptional volatility create mass confusion.          This can be seen in               a) Large daily ranges as the swings from positive to severely negative.               b) Expanding volatility. (large daily variance) Think, back to back 300 point Dow ranges ending roughly                              unchanged.               c) Rising put/call ratio. (strong willingness to protect what equity is left)

As this story deteriorates, open interest in put options begins to rise. Investors try to protect their equity through the purchase of put options as the market declines. These purchases are made in an increasingly volatile market and are marked up with heavy premiums (Louisiana hurricane insurance). Ultimately, panic sets in and we get some kind of flush where equities are dumped, investors head to the sidelines and put options are purchased in a rush.  This creates the common “spike” bottom. A single day’s events can create the reversal necessary to set the bull/bear cycle in motion again.

For more on the development of this program see here.http://www.commodityandderivativeadv.com/andyftp/dcb%20dt%20article%20for%20web.doc

The interest in today’s article comes from the wide range of data now available to us. I’ve spent some time analyzing the option data governed by the Options Price Reporting Authority (OPRA). Finally, I can track open interest on index options as well as volume. I was interested to find out which component was more important; volume or, open interest. Is daily activity a better predictor of market direction or, am I better off tracking the number of participants?

Volume simply tells me how many contracts were traded that day. I’ve used short term exponential averages to track the general flow of activity for years. I’ve never been able to quantify the number of players involved in creating the volume. Tracking open interest would allow me to determine the degree of greed or fear in the market. The higher the option open interest, the greater the anticipation of big event.

Would this data be a better predictor than volume? As it turned out, the volume generated by panic, combined with the direction of the market’s volatility was still the single one, two indicator of future short-term stock market direction. The correlation between open interest and market direction was random, at best.

Frequently, very frequently, the process of analysis bears very little tangible proof. Seemingly logical and fundamental truths of market behavior produce no better than random results when subjected to the rigors of quantifiable testing methodologies. Thus, a robust system in place for several years has withstood another attempt at, “improvement.”

A Quick Memory Test

Q:Last week, crude oil fell $20 per barrel. According to the Department of Energy’s “First Purchase Price,” when was the last time crude traded at $20 per barrel??????

A:March of 2002! I certainly thought it was pre-911.

Click on the link for the full DOE price series.

8-3 doe.asp.xls