Tag Archives: soybeans

Food Inflation is Here to Stay

Inflation is measured many ways. Government reports will talk about core inflation, inflation excluding food and energy, consumer price index, producer price index and so on. These measurements all exist in the academic world. Talking heads argue about it on TV. Real inflation, inflation that is felt throughout the world, is food inflation. Food inflation is here, it’s real and it’s here to stay.

The Food and Agriculture Organization in Rome tracks a basket of 55 commodities to measure global food prices. This month, it topped the June ’08 high due to regional production issues. Many domestic commodity markets are substantially below their ’08 highs. Remember $8 corn and $16 dollar soybeans? Lets not forget the input cost of $140 crude oil. The only reason prices didn’t sky rocket even more in 2008 is because the world was still reeling from economic meltdown. Savings rates were increasing and spending was declining. This kept fundamental demand in check. The 2008 rally was fueled by poorly timed commodity index fund buying coupled with rising fuel and fertilizer costs.

The commodity index funds were created to capitalize on the growing appetites of emerging markets. As foreign markets mature, their tastes will include a more western diet, which is heavily based on grain and meat consumption. For example, total United States meat consumption is approximately 250 pounds per person per year. China’s total meat consumption has nearly doubled in the last 10 years and is now around 100 pounds per person per year. This is still less than half of our consumption. Their population, which is four times larger than our own, could double their consumption again and still be below the average American’s.

The example above also translates into the grain markets. Think of soybeans in terms of vegetable oils and think of corn to feed the livestock. The USDA released their annual crop production report this week as well as their supply and demand reports. The United States planted and harvested more acreage than last year in corn and beans. The bean harvest was the second highest on record and rice did set a new record. Historically, these numbers would be seen as very bearish for the markets since they point to greater supply. However, looking deeper, we can see that ending stocks are near all time lows, which indicates exceptionally strong demand given the generous supply for 2010.

Food prices are beginning to soar. Just as decent nutrition is the most basic of luxuries in a developing economy, so is it the most primal of necessities. We are already seeing riots in many third world countries over the price of sugar and grains. Developing nations are faced with a two-headed monster of rising food costs in the open market as well as food that is moving to the black market. President Clinton’s primary focus in Rwanda was to safely transport food aid past the warlords and to the people. Algeria, Haiti, Bangladesh, Senegal and Indonesia have all experienced civil unrest due to rising food prices just in the last week. It is much more difficult to contract one’s appetite than it is to expand it. Any planting issues in the U.S. this spring would douse the global embers of unrest with gasoline.

The United States is responsible for nearly 40% of the world’s soybean production and approximately 70% of its corn. These are the staples that feed the world’s people and its livestock. Our crops yield five times the global average. The U.S. will export our agricultural intellectual property as Brazil, Russia and the Ukraine expect to grow their output by 30% over the next ten years. Fertilizer, seed companies and biogenetic engineering will become the next wave of global financial players as mother Earth prepares to deal with the strain of a swelling and hungry population.

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.

Managing Volatility with Options

Last week we discussed the growing volatility in many of the best trending markets of the year. We noted that the uptick in volatility had to do with three primary sources. China’s attempt to cap inflation and put the breaks on their over heating economy, Irish bank solvency issues and the nervous anticipation surrounding Spain and Portugal and finally, money managers who were late to arrive are trying to capture year end performance and match their benchmarks. We can now add some certainty to last week’s assumptions. China did raise their rates. The European Union is actively striking a deal with Irish banks as well as taking an official look at Spain and Portugal and finally, money is flowing into stock index futures.

 

We can see through the Commitment of Traders data that commodity trader index funds are flowing into the stock index futures. This group has added approximately 50,000 contracts on last week’s minor correction and contributed greatly to the market’s ability to close virtually, unchanged for the week. Money managers will frequently use the added leverage of futures when chasing performance on the long side of the market or when hedging the risk of their portfolio when a downturn is expected. The fact that this buying pressure has been more than offset by commercial short selling only increases the uncertainty at these levels as the market’s largest players fight it out with ever growing conviction.

The same pattern is playing out in several sectors as these forces work their way through the markets. We’ve seen soybeans rally nearly 36% this year and silver was up 67%. The commodity market’s biggest winner for 2010 was cotton. Cotton was up more than 125% until news began leaking out of Asia that the textile industry was slowing down. These markets have all contracted considerably over the last two weeks as questions persist about the health of the global economic system and the stability of international trading relationships are re-examined.

 

Taking a look at any of these charts quickly makes clear two things. First, the trend is most definitely higher. Two, the pullbacks in these markets, when calculated on a dollar basis, are large enough to test even the strongest of commodity bulls. Commodity markets are leveraged instruments whose contract sizes were determined many, many years ago when prices were much lower. Consequently, the dollar value of the same percentage swings is much greater at these elevated prices. For example, a five percent swing in cotton at this time last year translated to a $1,671 swing in your account balance. Today, that same five percent swing is worth nearly $3,000.

 

The question that I’ve been asked most frequently over the last two weeks is, “How can I trim the dollar value risks of my commodity account while maintaining a comfortable diversification in case the stock market craps out in the face of a Euro Zone meltdown and a constricted China?”

 

My first response is that some commodities offer multiple contracts in various sizes. There are currently four listed contracts for gold. These range from the full size, 100-ounce contract down to a micro contract of 10 ounces. If this doesn’t work for your market of interest, I suggest using options to construct a hedge on an existing position or limit the risk when initiating a new one. Many people hear the word, “options” and their eyes glaze over as their memory drifts back to trigonometry and exponential curves. A better way to think of options involves using the insurance industry as an example.

 

Insurance is used to transfer risk. Buying the policy limits the potential of loss for a fixed cost up front. The seller of insurance collects a fixed fee up front while assuming the liability of the risk associated with the policy. This means that there are two ways trade options. Buying an option provides you with full protection for a flat fee. However, like most insurance policies, you may never have a covered incident to collect on. The premium you’ve paid in for the coverage you’ve selected will expire just like any other policy. The alternative is to be the seller of the option. You will collect the premium up front and if there is no collectible claim during the period, you keep the all of the premium when the contract expires.

 

I’d like to introduce one technical term for options trading and provide one example of how this all fits together. Insurance agents have actuaries. Actuaries are the number crunchers that provide them with the expected payout on any given policy. They’re the ones that make car insurance more expensive for a 16-year-old boy than for his 40-year-old mother. In options trading, the actuary is called, “delta.” Delta determines the probability that that option will be, “in the money,” at expiration. If an option is in the money, then it would be a collectible insurance incident. Delta is a probability and is bound by the 0% to 100% probability scale.

 

Given the large imbalance of positions in the stock market, options can be used based on the degree of protection one wishes to purchase. An option with a delta of 15 means that the market believes there is a 15% chance that the it will qualify as a covered incident on the policy issued. This option can be used to provide 15% protection to an existing position or, cut the contract size of the given market by 15%. Either way, the option can be combined with a futures position to limit the volatility of the account’s balance. Given the magnitude of the global issues being discussed and the elevated levels that many markets are still trading at, limiting the volatility of the account’s cash balance seems like a worthwhile endeavor.

 

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.

Counter Trend Moves…What’s Next?

This week’s commodity trading featured many strong counter trend moves. Many of the markets saw swift turnarounds in trends that have been established for weeks and months. The 64 million dollar question is; “What’s Next?”Here is what I’ve defined as established trend and counter trend moves.The following markets are share the following traits:

1) They are all near their respective 13 week highs or, lows. The market began within spitting distance of its  recent extreme.

2) Their weekly sentiment readings are > 70 or < 30, respectively. Each market has a large, one sided public following.

3) They’ve experienced a large 5 day counter trend move. All week the market has moved conter to the public’s expectations.

4) Thursday’s ranges were larger than average. The market has moved far enough to force traders into action.

These criterea do a reasonable job of establishing a market direction and bias. Now, what can we learn from this. Is the counter trend move done? Does the longer term trend hold? Are the market’s topping or, bottoming out? Based on the following statistice, we can see that not all of the markets react in the same way.

Here is what to look for in a general sampling for the coming week. We can expect, in order of predicted strength, the following markets to bounce from the week’s declines.PlatinumNatural GasCrude OilSoybeans

Sugar looks like it will continue to decline, reaching a projected low of 1111 approximately 7-8 weeks from now.

The S&P 500 shows the strongest statistical bias. According this week’s events, we can expect the S&P to continue its rally over the coming month, peaking around 1312.

Govt. Legislation in Free Markets

By David Goldman, CNNMoney.com
staff writer

NEW YORK (CNNMoney.com) — Some of the Democratic lawmakers leading the campaign to crack down on oil traders appeared Wednesday
before the House Committee on Agriculture to explain their proposals.

A dozen or so bills have been introduced on the subject of oil speculators,
and Democratic leaders in the House have promised to address the issue by
tackling what they call “excessive” speculation.

But some Congressmen are skeptical that the legislation will do any good –
and could even cost consumers more by driving up the price of other commodities
such as corn and soybeans.

“Given that charges against speculators have historically been more wrong
than right, it is important that we have the facts, data and analysis that
demonstrate the validity of this contention before we take action,” said
committee chairman Collin Peterson, D-Minn. “Any legislative remedy that seeks
to remove speculative interests from futures markets could result in more
volatile markets, as the role of speculators has always been vital for price
discovery and liquidity.”

The slew of speculation-tackling bills that have not yet faced a vote address
a variety of issues.

Some have bipartisan support, such as one increasing the Commodity Futures
Trading Commission’s (CFTC) budget, and some are more contentious, such as
limiting over-the-counter trades to producers and boosting traders’ margin
requirements.

If applied to all commodity traders, some lawmakers say the propositions may
have unintended consequences on other markets.

“Increasing margin requirements, for example, would be very problematic, as
volatility in the futures prices of the grains … has already made it tough for
elevators in farm country to meet margin calls,” Peterson said. “Such
instability can have serious effects on the prices we pay at the
supermarket.”

Legislation necessary to combat high oil prices

But other lawmakers are convinced that curbing excessive speculation by
expanding the role of CFTC will help reduce oil and fuel prices for
consumers.

“While some have advocated for doing nothing and others believe that we
should simply bar index investors and others from the energy commodity markets
altogether, I believe what we really need is a level playing field that is
transparent and accountable,” said Rep. Jim Matheson, D-Utah. “Our goal should
be to make sure that the regulator – the CFTC – has the ability to ensure undue
manipulation isn’t taking place in the markets.”

Though many lawmakers are still unconvinced that speculation plays a role in
higher gas prices due to a lack of concrete evidence, other Congressmen say the
circumstantial evidence is enough reason to act.

“In light of the dramatically increased speculative inflows into the energy
futures markets … coinciding with a staggering 1,000% jump in the price of a
barrel of oil, I believe the burden is on those who would argue for maintaining
the status quo,” said Rep. Chris Van Hollen, D-Md.

“Proponents of maintaining current law must definitively demonstrate that the
exceptions we have thus far permitted to persist in the Commodities Exchange Act
do in fact support the primary functions of price discovery and offsetting price
risk necessary for a healthy energy futures marketplace,” Van Hollen added.

Speculation debate continues

Since 2003, the volume of investment funds in commodity markets – especially
oil – has risen from about $15 billion to $260 billion, according to the
International Energy Agency (IEA), an influential oil-policy group.

But the IEA released a report last week arguing that the increase in
oil-market speculation is not driving up crude prices.

“There is little evidence that large investment flows into the futures market
are causing an imbalance between supply and demand, and are therefore
contributing to high oil prices,” the report said.

But the study far from ends the debate.

“A growing chorus of congressional testimony and market commentary from a
wide range of credible and authoritative sources has concluded that the run-up
in today’s price of oil cannot be explained by the forces of supply and demand
alone,” said Van Hollen.

Even analysts who concede that the laws of supply and demand are the main
contributors to record oil prices say that speculation can make price swings
more volatile.

The House Agriculture panel has planned hearings Thursday and Friday to
further discuss the issue of amending the Commodity Exchange Act. To top of page

Competitive goods at the margin

As petroleum prices climb, alternative energy sources become more useful. So it is with biodiesel and soybeans. Look at the correlation during yesterday’s sell off and today’s rally.

Now, look at the 25 day correlation chart between the two markets.