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Sell the Rally in Natural Gas

The recent bout of record breaking low temperatures has led to an obvious increase in the demand for natural gas and pushed delivery prices up to $4.40 per million metric British thermal units (mmbtu). These are the highest prices we’ve seen since the heat wave and drought from the summer of 2011. In fact, the Energy Information Administration reported the largest natural gas draw for the week of December 13th since they began tracking it in 1994. Furthermore, many analysts expect to break this record yet again with this week’s report. However, in spite of the recent strength in the market, I believe that there are several structural reasons why this rally won’t last and that the pricing of forward natural gas will head lower from here.

Continue reading Sell the Rally in Natural Gas

Trading’s Gut Check

Actively participating in the markets comes with the understanding that the trader’s gut will be checked frequently and deeply. The primary cause of this is the trader’s degree of certainty in an uncertain world. It’s been proven over and over again that once an individual feels that they have enough information to make a decision, they will. Additional information provided after the fact typically raises the degree of certainty that the correct decision was made, rather than raising the degree of accuracy. So, I sit in front of the Federal Reserve Board’s announcement this afternoon involved up to my eyeballs in the US Dollar, Euro currency, 10-year Treasury Notes and the Russell 2000 stock index.

Each one of these positions is the result of mechanical trading programs that I’ve developed, tested and traded. Therefore, there are no arbitrary decisions or adjustments to be made. This leaves me in front of the screens sitting on pins and needles waiting for a range of possibilities to materialize. Given my experience with the markets, I expect the outcome to be somewhere in the middle. Rarely does it turn out one sided either positively or, negatively.

Let’s review the possible outcomes and the gut wrenching turmoil that comes with sitting on several large positions as I try to close out the books for 2013. My oldest position on the books is short the Euro FX. I stand to profit if the Euro currency weakens against the US Dollar. I’m short the market near the top of its range based on my research into the Commitment of Traders Reports. I know that there’s about a 60% chance the Euro will back off these highs by about a penny and a half. However, the market’s continuing consolidation near these highs puts me in a position where I could be stopped out of the market with a loss even before the Fed announces its decision this afternoon. The market’s proximity to my stop loss order contributes greatly to my angst.

The opposing position to the Euro is my long US Dollar Index position. Again, I’m long the US Dollar Index against a basket of currencies, which is dominated by the Euro. If the Fed suggests that they will begin to taper quickly, the Dollar should rally. Pulling stimulus out of the economy will place fewer Dollars in future circulation thus, increasing the value of the Dollars already in the market. The Dollar would rally and the Euro would fall. Both of my currency positions would be profitable.

Tapering by the Fed would most likely crush my 10-year Note position. Frankly, the discretionary trader in me can create the strongest case for owning 10-year Notes and betting against taper talk. Based on my analysis of the commercial traders in the 10-year Note I fully expect any decline in Treasury prices to be short lived. Commercial traders have accumulated their largest net long position in the 10-year Note since April of 2005. Commercial traders have dominated the big moves in the Treasuries with uncanny accuracy. If they’re right about no taper talk this afternoon, Treasuries will rally substantially and I’ll profit from my position….while losing on my currency trades.

This leads to my final position. I use a pretty fancy program for developing my day trading systems. Whereas my swing-trading program is based on the fundamental data inferred from the collective positions of the markets’ participants, my day trading programs are strictly technical. Knowing that the markets will unfailingly put a man to the test, it should come as no surprise that my day trading programs now have me long two units of the Russell 2000 stock index heading into this afternoon’s announcement. Furthermore, while I have some expectations of how the currencies and Treasuries will react to the Fed’s decision, the stock market’s reaction is far less predictable. If the Fed tapers, the stock market may rally further based on the assumption of a strong economy leading to further gains. However, the collective reaction could very well be violently lower as tapering could signal the end of the free money that many believe has fueled the rally to this point.

Discretionary traders face conflicting data like this all of the time and pick and choose which markets they’re in and when they’re in them. Systematic traders follow the signals generated by their programs without question. The cruelest aspect of trading is the market’s uncanny ability to seek out a traders’ weak spot and twist agony’s knife. I’ve been actively trading for more than 20 years and the trepidation of a pending report never goes away. This is where the classic line, “Plan your trade. Trade your plan” has the most value. Remember, additional information acquired after the fact doesn’t increase the odds of being right, it simply tricks the mind into greater certainty of the existing thought pattern.

Wheat May Have Bottomed Out

The wheat market is a primary staple in human diets as well as global trade. This causes the wheat trade to be affected nearly as much by geopolitics as it is by price and weather. Therefore global trade prices have to factor in sanctions, duties and taxes as well as transportation fees. The simplest way to understand this is by looking at the surplus produced by the primary growers like Canada, Ukraine, Russia, Australia, Argentina and the European Union as well as us and then trying to determine why each one of those countries are also wheat importers. Due to the conflagrated nature of global trade negotiations, I find it easier to focus on the primary players here in the U.S. and plan my trades accordingly.

First, I screen the markets’ traders and their eagerness to participate in any market by reviewing the Commodity Futures Trading Commission’s weekly Commitment of Traders Report. This report breaks the markets’ participants into a few primary categories – index traders, non-commercial traders, commercial traders and non-reportable. Briefly, Index traders manage the long only allocation portion of the fund they represent. Non-Commercial traders tend to be the money managers within the futures industry. They trade from both the long and short side as they see fit. Commercial traders are either the producers of the commodity or, the end line users of it. Their trading is based on managing their costs from the production side and maximizing their profits on the producer side. Finally, the non-reportable category is left to small speculators, producers and end line users who are too small to qualify for a larger group.

Hedge funds fall into the non-commercial trader category and their movement finally began to be tracked by the CFTC in 2006. The last three weeks has seen the largest jump in their short position since their trading has become a matter of public record. There are three important factors at work here. First of all, most of this selling took place prior to the November 8th USDA crop report. Secondly, commercial traders in this case, the end users, have absorbed every bit of selling the speculative money has thrown at them. Finally, this dynamic shift in market participant makeup comes near major support near $6.50 per bushel in the March Chicago Board of Trade contract.

This sets the stage for a climax. Our bet is that most of the price decline has passed. Commercial traders are value players. We are looking at the end line wheat consumers locking future delivery prices in order to generate their business models for 2014. Cereal and bread producers are fully aware of what their input costs are and they clearly view this as a bargain. The non-commercial traders who’ve taken the short side of this market are typically trend followers and pay little attention to price. They’re simply riding the wave….until it crashes.

I believe their wave is about to crash. First of all, wheat hasn’t been this cheap since July of 2010. Secondly, in both June of 2010 and May of 2012 commercial and non-commercial traders squared off in a similar manner. These market imbalances strongly favor an outcome in favor of the commercial traders. In fact, most solid wheat rallies start by commercial traders putting a floor in to support prices and lock up future inputs. Conversely, every trend trader trades the trend until it’s over then, they give back a chunk of their profits on the ensuing market turnaround. Finally, open interest peaked in September and has begun a much earlier decline than normal into the December futures expiration cycle. This means the market is failing to attract new players at these depressed levels.

The daily chart shows a solid basing pattern that is holding just above major support. The December wheat futures rapidly approaching expiration means that anyone who doesn’t intend on delivering wheat of the appropriate standard to an approved collection site as well as those who aren’t fully prepared to take delivery of the contracts they’ve purchased must offset their position. Obviously, end line consumers are looking forward to their delivery of cheap wheat. Meanwhile, none of the non-commercial speculative money will be able to make any deliveries. Therefore, I believe that the buying from non-commercial short covering will begin to fuel a rally in the wheat futures market.

You can find more on our application of this strategy at COTSignals.com.

Day Trading Currencies to Avoid the News Cycle Chop

The debt ceiling debacle and government shutdown have affected our normal trading operations in several ways. I’ve been a stock index trader since the early 1990’s when I began working and trading at the Chicago Mercantile Exchange. The news cycle lasted at least 24 hours before newspapers and television morning shows would revise or alter the political landscape and issues of the day that may affect market behavior. Furthermore, the U.S. financial markets closed for business at 4:15pm and didn’t re-open until the following morning. This forced all of the market participants into a, “time out.” Finally, this allowed the markets’ participants to digest the day’s events and adjust their trading plans accordingly.

Fast forward to 2013 and the news cycle is delivered 140 characters at a time by anyone who thinks they may have something newsworthy to say. This all noise, no signal news environment is then transmitted via every conceivable electronic gadget, TV, and satellite radio to completely overwhelm the markets’ participants.

Fortunately, we live in a world where everyone is entitled to anything they want. The sellers of, “want” support this by providing access to the markets nearly 24 hours a day. Furthermore, the same sellers of access to open markets, the brokerage houses and government regulators have decided that 24 hours a day isn’t enough. We’ll stay open on several bank holidays as well. Our clients won’t be able to transfer funds if they get in trouble but the odds are, it won’t be our margin call and the commissions will cover any punitive damages if there’s a joint action against the brokerage industry.

The previous sarcasm is securely based in the trading world in which I exist. There are times when the only truth in the market is the market’s last traded price. This is where the rubber meets the road and the best bids meets the best offer, the contract is sealed. The noise can be tuned out. The TV can be turned off. The strategy shifts from big picture investing and turns to technical analysis and day trading. Based on my experience, the exchange traded currency markets can be the best option due to their volume, contract size and responsiveness to technical analysis.

Successful day trading in any market requires the proper degree of volatility and contract size. These are the determining factors of whether a given market has enough Dollar based movement to be profitable. The simplest method of figuring this out is to multiply the average daily trading range over the last several days by the tick value in the market you’ve selected. The Euro Currency has an average daily range of about $.0077. That doesn’t sound like much but the Euro Currency has an exchange listed contract value of $125,000. Therefore, the average movement is $.0077 X $125,000, which is an average daily dollar movement of $962.50. Another way of looking at it is that the Euro has a tick value of $12.50 and has an average range of 77 ticks.

We’ve determined that the market has enough movement and a large enough contract size to provide opportunity to profit from its daily movement. The next step is to determine if the market has sufficient liquidity to handle our trade size without losing too much in slippage. Continuing with the Euro Currency as an example we can look at the depth of the market on nearly any popular trading platform. Market depth provides us with a live look at the number of contracts attempting to be bought or sold near the market’s current price. The Euro is currently trading around 1.35 to the Dollar. There are 50 buyers at 1.3499 and 32 sellers at 1.3500. Moving a few ticks up or down shows that there are hundreds of contracts waiting to be bought and sold within a couple of ticks of the last traded price. This is clearly enough volume to handle a day trader’s volume efficiently.

Finally, we come to technical analysis. One of the beautiful things about the currency markets is the global trade that they represent. Rarely do we see the currency swings or volatility like we see in the S&P 500. The S&P 500 futures have had 30 days in 2013 where the market moved more than 1% compared to 11 days in the Euro with a 1% move or more. Market movement is important in determining potential profits but, volatility based on news events that change throughout the day will most likely lead to more protective stops being hit as well as more false breakouts in pattern recognition and the corresponding failure of the setup.

Day trading the currency markets like the euro can be a more stable way to grind out profits when the news cycles have turned the stock indices into a yo-yo. The added depth of the currency markets as they relate to global trade brings international conglomerates to the marketplace when the swings get out of hand.

A large portion of my trading, whether day trading or, position trading is focused on following the what the major players are doing and attempting to align myself with their viewpoints. The government shutdown has halted the Commodity Futures Trading Commission’s weekly Commitment of Traders report, which allows me to track what the commercial traders are doing in all of the markets I trade. In its absence, I find the added depth and global viewpoint of the currency market’s participants a good proxy. Therefore, I will shorten my horizons until better opportunities present themselves and I’m once again provided with signal rather than noise.

Swing Trading with the Commercial Traders

Do you like buying into pullbacks and selling into counter trend rallies? Do you get that little antsy, slightly queasy feeling in the pit of your stomach wondering if it really was just a counter trend move and not a major turning point? Do you watch the markets intensely waiting for confirmation of a turn back in your predicted direction?

I’d like to share something with you that helped my trading substantially. I’ve been trading for more than 20 years now and in that time span, I’ve come up with three original ideas that work. Two of them I’ve been using for more than 15 years and the third has been a puzzle I haven’t quite been able to put together for some time.

Some of you, who know me, know that I’ve been following the Commitment of Traders reports for at least 15 years. The foremost expert in this field is Steve Briese, publisher of “Bullish Review.” His weekly publication and explanation of the different groups of traders in the markets and their corresponding tallies of accumulation and distribution are like watching the “Old Boys Network,” on TV. It is a quantifiable report on how the big money moves.

Steve’s main methodologies involve the Commitment of Traders Index, which reads like a stochastic and the second is Major & Minor Signals, which are based on a static jump or decline in the aforementioned index.  His work and research is first class and parallel his character as a person. However, for any methodology to work, it has to be something the trader is comfortable with.

There are two main reasons I’ve never been able to implement this strategy as it stands. First, the problem with any stochastic or, index is that it is artificially bound between 0 and 100. There have been many times when the Commitment of Traders Index remains pegged at either extreme for months on end. This can happen in two completely different ways. First, the index can pick up a trend and remain locked onto it for an extended period of time. This is what we saw in many of the ’08 commodity rallies. The problem here is the equity swings. As a trader, I have to manage the equity in my account. Given the volatile nature of many of the markets, account equity fluctuates wildly, even in profitable positions.

The second problem with the index is that when a market retraces, commercial hedgers are quick to lock in their production and delivery prices. Their early action in these instances leads to an index reading that is the exact opposite of the market’s direction. Once they’ve bought all their raw materials and hedged all of their forward production, they’re done trading until the market moves back the other way, again. This leads to index readings of 100 in falling markets or, 0 in rising markets.

Thanks for bearing with me through the setup for my work. If you’ve read this far, you’re obviously looking for a more tradable solution. What I track is the momentum of commercial buying and selling. This eliminates the artificial boundaries of the index and allows me to compare the degree of buying and selling to the market’s history of commercial capacity for buying and selling. It also allows me to see, on a relative basis, whether there is more or less urgency in the market as we approach critical support and resistance levels. The advantage is that it helps put me on the right side of every trader’s number one question – “Resistance or, Breakout?”

When I combine the major market participants’ actions with my own proprietary trigger, I can pick off swing highs and lows with a greater winning percentage than I ever thought possible. When the Commercial Traders’ momentum is negative and my indicator says, “sell,” I use the most recent swing high as my protective stop point. This allows me to know what my dollar risk per contract is and allocate my equity more effectively. The opposite rules hold true for the buy side. When Commercial Trader momentum is positive and the market pulls back, I wait for the trigger to indicate, “buy.” I use the most recent swing low as my protective stop price. Again, quantifying the risk is one of the main keys to any successful strategy.

The last topic to address is, obviously, when to exit. This is a purely subjective task. In my quantifiable testing, trailing a stop one bar back has worked – once the market has moved in our anticipated direction. This is not how I trade it. I have the advantage of proximity on my side. I sit in front of the screens all day and watch the markets. I take profits on an experiential basis. Sometimes I’m early. Sometimes, I’m late. That is the nature of trading. There is no free lunch. I am happy to say that the more often I find myself on the right side of the market, the easier it is to be profitable and, after all, isn’t that the end game? I hope this helps put you on the right side of the markets more often and may your future trading problems be profit-taking issues.

Trading a Falling Bond Market

Successful trading pits two diametrically opposed ideas against each other and forces the trader to assimilate them into a cogent plan of action. First of all, everything we know, we know from history. We constantly relate the market’s present status to something we’ve seen in the past whether it’s fundamental, technical or pattern based. Secondly, we’re asked to project the implications of the current market’s structure into the unseen future. This week we’re going to discuss the implications of applying historical knowledge of the interest rate complex towards the deployment of mechanical models designed to take advantage of rising rates.

There are two primary steps to this process. Our first step is through analogous research. Analogous research begins when a present situation is recognizable because it looks or, behaves similarly to a pattern or collection of fundamental data that the trader has already experienced. The simplest version is the gut instinct, “You know, this market just feels like…….” A more quantifiable version falls along the lines of, “The last time these factors were in place, the market did…..” Analog trading is the primary basis for pattern recognition. The more often a certain pattern is seen and its results are predicted the more easily they are recognized and traded in the moment.

Empirically applying analogous research to the current interest rate sector yields the conclusion that monetary policy is far more likely to tighten than ease further. Sixty years of Prime interest data yields some ideas of what we can expect if history is any precursor to the future. First of all, rates have been abnormally low for an abnormally long period of time. The last time rates were steady for this long was 1960-1967. The Federal Reserve’s Prime rate has been at 3.25% since January of 2009. More importantly, it has been in a downward trend since August of 2007. A trader’s primary concern is always the trend.

The trader’s next objective is determining a target. These require both time and prices. Over the last 60 years once interest rates begin to move, they move by 73% on average before their peak or trough is reached. Furthermore, it takes an average of 30.6 months for the move to be completed. The extremes over this period include a move as small as 14% in as little as six months to more than 200% over the course of three and a half years. Throwing out the largest and smallest moves in both time and distance leaves us with an average interest rate move of 64.5% in 28 months. I think this blows a hole in the, “bonds are less volatile,” investment theory.

Anecdotally, there have been many headlines and news releases that should be forewarning us that a change in monetary policy is coming. These include comments from Fed Chairman Ben Bernanke as well as large investment managers. Perhaps the most noteworthy of which is Pimco’s decision to start offering access to hedge funds as it moves away from the bond business. Bill Gross has arguably been the most successful bond investor of all time. He has ridden the 30-year bull market in bonds up to $2 Trillion in assets under management. When the King leaves the table it’s a good clue that the free meal is over.

The case has now been made for what to expect out of interest rates as well as the time frame in which we expect it to happen once it begins to unfold. This led me to updating previously deployed interest rate models whose effectiveness became limited due to the artificial manipulation of rates following the economic meltdown of 2008. The simplest model is based on the DCB Bond system, which was published in Futures Truth in 2000. This model basically doubled its initial investment between 1995 and September 11th, 2001. The original version of this program traded both sides of the market and has fluctuated in and out of their Top 10 Bond systems since its publication nearly 14 years ago. Meanwhile the long only version posted a new equity high last June and has been flat for the last year.

Trading program technology has advanced substantially since then. We are currently developing programs using a neural network and selective data slices from rising interest rate environments. The main benefit is that we can train it on the type of market movement we expect it to see. The downside is that due to the small windows of time that rates actually move, we only have an average of a 28-month window to use for both in and out of sample testing per episode. The end result will be something traded on a shorter timeframe and will require closer monitoring during the trading day once it is deployed. Fortunately, the tighter timeframe looks like it’s going to help keep risk in check as well. This is how we intend to use history to prepare us for the future. The only certainty in trading is that nothing lasts or, works forever. Define your criteria and trade within your expectations.

Copper Points to Slowing Economy

Copper is often referred to as, “the economist of the metals markets.” This is because of its use in all things that make the economy go round from electronics to commercial and residential construction and general infrastructure. When economic development is robust, copper prices follow suit. More importantly, because copper is a base ingredient in this mix, the price of copper typically precedes any moves in the general economy. Based on the current conditions of the copper market, we expect prices to fall and with it, overall economic activity in general.

The Federal Reserve Board announced its intentions to begin tapering off economic stimulus on June 19th. As a result, Interest rates have soared. Since the Fed’s announcement we’ve seen mortgage rates rise by nearly a full point from May’s low to multi-year highs. This is a 15% increase in two months. The effect on mortgage applications is already taking hold as we’ve seen a decline in mortgage applications of more than 7% in the last two months. This has led to a 13.4% decline in new home sales for the month of July, the biggest decline in three years. Rising interest rates are slowing the economic recovery that has been led by the housing market.

No copper scenario is complete without discussing China. China is the world’s largest copper consumer, taking around 40% of the annual mining total. Unfortunately, separating the governmentally supported information handouts from the man on the street’s first hand economic observations is a difficult task in a country where information is so heavily monitored and controlled. The major news events this week are twofold. First, a group of Chinese investors are stalling on a $3 billion copper mine investment in Afghanistan. Their reasons are many but the five-year delay they just inserted into the talks suggests that the investors aren’t comfortable with current, physical demand levels. Secondly, Chinese manufacturing data, though signaling signs of expansion last month, appears to have done so through inventory reduction more so than actual production. This was seen in the contraction of new export orders, stocks of finished goods and employment.

Funneling the macro data into something tradable leads us to further bearish scenarios.  Commercial traders were actively listening to Bernanke’s discussion signaling the end of the monthly injections of $85 billion into our economy. Commercial copper traders clearly see this as a negative as they’ve been net sellers in five of the six weeks since the announcement. Perhaps more importantly, this comes after they had accumulated a very large position around the $3 per pound level we’re currently trading at. This suggests that they were locking in future deliveries based on continued economic expansion prior to the Fed’s announcement. Their actions since clearly state their change of attitude going forward and perhaps most importantly from a trading standpoint provides the potential serious selling if they decide there is no longer a reason to own copper at $3 per pound.

Finally, moving to the technical side of the market it appears that copper’s strength over the last three weeks may have more to do with speculative short covering rather than the creation of new long positions. Copper volume reached its highest level since December of 2009 on June 28th. This coincided with the lowest prices seen since October of 2011. Expanding volume coupled with declining prices is indicative of a strengthening downward trend. This becomes even more obvious in light of the rapid decline in volume and open interest over the last three weeks as the market bounced off its lows.

We feel that the slowdown in domestic construction that has been brought about by the Fed’s actions coupled with a large and now, unnecessary commercial long position will force the copper futures market to follow its typical seasonal path and decline through the end of October. This should certainly lead to a test of the psychologically important $3 per pound level. Violating the $3 per pound level leaves only the 2010 low of $2.90 as support before bringing into question the economic crisis low of 2009 near $1.50. Remember that commodities are not corporations. The world can live without another corporation but copper’s base necessity will serve to put a floor under the market. Therefore, a violation of $3 and even $2.90 is possible however, the market will find waiting buyers at bargain prices.

Natural Gas Finding Support

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.

Calling a Top in the Equity Markets

Back in the old days when the trading pits were full of people executing trades we had a saying, “The market always finds the orders.” This is quantified by the market through the comparison of volume and open interest levels against the price levels that generated the activity. The first rule of trend trading is that growing volume and open interest supports the market’s current direction. Last week we discussed the idea that the stock market may be establishing a late summer high with probable declines into fall from a big picture outlook. This week, we get technical.

Monday, August 5th, the S&P 500 futures traded approximately 850k contracts. Only one normal trading day in the last few years has done less volume than that. Typically, we’re looking for twice that much trading on a normal day with bigger days eclipsing the 3 million contract mark and big days reaching over 6 million like we did during the August sell off in 2011. Monday’s volume more closely matched the Christmas and New Year averages around 600k. Low volume is usually accompanied by low volatility and Monday’s trading range of was the smallest since August of last year and all the way back to April of 2011 before that. Thus, even the holidays of recent years generated more market movement.

Lower volume doesn’t always mean dying trends. There are times in a market’s trend typically, following the accumulation phase when volume will decline but open interest grows as the market begins its march in small orderly steps. Unfortunately, this is not where we stand within the equity markets’ current trend. The S&P 500 futures expire quarterly. Therefore, those who wish to maintain a position going forward have to re-establish it as their current contracts approach expiration. Those who do not may simply let their contract expire. Market participation in the futures markets is measured by open interest. Theoretically, open interest has no upside limit. As long as two new people come to the market and negotiate a trade, open interest will increase by two. One new person (long) is making a bet on higher prices going forward while the other new person (short) will profit from a falling market. Open interest in the S&P 500 futures is at its lowest levels in over a year. This means that the current market price is completely uninteresting to potential market participants.

This leads to the obvious question, “If the market is uninteresting, who’s trading?” We began to answer this question last week in our discussion of margin buying and human nature’s, “catch up” instinct. Margin buying in the stock market is borrowing money from your broker who charges you interest so that you can buy more stock than the available cash value in your account will allow. There have been four all-time highs in margin buying – 10/1987, 4/2000, 9/2007 and right now. The previous peaks all led to declines of at least one third within next 12 months. Remember the leveraged nature of the housing bubble? Leverage begets leverage…until it crumbles. Commercial traders and their large bank accounts have gladly sold all that the public wishes to purchase at these levels.

Finally, we have current technical and pattern analysis that clearly believes there is more money to be made on the expectation of downward pressure on the stock market rather than continuation of the upward trend we’ve been experiencing. One of the primary tools I utilize is the analysis of divergence. The idea is to gauge the market’s momentum by measuring various calculations against each other. The results are then plotted below the chart and we simply look for a market that has made a new high or low without a momentum confirmation. The all time highs made in the S&P 500 last week have not been confirmed by any of the popular indicators and their textbook, default settings. Meanwhile, pattern analysis shows that we have just created a broken cup with handle formation. This is a normally bullish formation gone wrong due to the currently overpopulated and leveraged speculative participation rate.

Owners of equities, mutual funds and their equivalent ETF’s should seriously take note of the warning bells. If recent history has taught us anything, we should know that six years of nowhere to new highs can be an emotionally traumatic interim. I’m not suggesting dumping the family holdings whose cost basis is now next to nothing. I am suggesting that those who’d like to sleep peacefully should look into the various ways of providing downside protection for their portfolios with advisors they trust. Insanity is doing the same thing repetitively while expecting different results. This time may be different but I’m not betting on it.

This material has been prepared by a sales or trading employee or agent of Commodity & Derivative Advisors and is, or is in the nature of, a solicitation. This material is not a research report prepared by Commodity & Derivative Advisors’ Research Department. By accepting this communication, you agree that you are an experienced user of the futures markets, capable of making independent trading decisions, and agree that you are not, and will not, rely solely on this communication in making trading decisions.

The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that

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Waning Demand in Orange Juice Futures

The orange juice market has rallied by more than 16% since June 25th and is now trading near $1.45 per pound. This marks nearly a complete recovery in prices from the sell off that was triggered by the late June, Department of Agriculture’s Cold Storage Report, which showed a 2% increase in inventories. Much of the rally that had led to the $1.55 high in May was due to speculative buying based on reports of, “citrus greening.” Citrus greening has been found in all of Florida’s main growing regions and leads to smaller oranges and less juice. However, Florida’s expected decline in production will be more than offset by other global issues, which will continue to pressure the market lower from these levels.

Global orange juice demand has been declining rapidly since the European economy began to collapse. The truth of the matter is that orange juice is a luxury good. Orange juice demand actually peaked way back in 1998 with global per capita consumption at 5.87 gallons per year. This amounted to a total supply of 1.8 million gallons or, 250 million boxes of raw oranges. The downward trend in demand has been tediously steady with 2008 providing the only uptick in demand over the last 15 years. Current consumption estimates stand at 3.85 gallons per capita or, less than 75 million boxes of total production.

The effect of the global decline in world orange juice consumption has taken its toll on the world’s largest exporter, Brazil. They are responsible for about 80% of the total world output. Their effort to gain market share from the U.S. over the last decade has led to a gross imbalance in the current marketplace. This has led to an about face in their agricultural strategy as the Brazilian government is expected to cull as much as 9% of total orange juice acres and redirect their efforts towards sugar cane which has a higher profit margin.

The macro trend of declining orange juice production is not lost within the commercial traders in the marketplace. Throughout the 1990’s and even into early 2000’s commercial traders were using the orange juice futures market to guarantee their supply. This means that commercial traders were generally net long and end line producers converting raw oranges into finished products were more concerned about high prices than they were about low prices. Therefore, spikes in commercial buying frequently led to long positions between 8,000 and 12,000 contracts. Most of these commercial buying splurges were followed by gains of more than 10% in the futures market, which shows that their actions have merit within the orange juice pricing structure.The last time commercial traders owned more than 12,000 contracts was in June of 2008. Keep in mind that this was the drought year and all agricultural commodities soared. Perhaps, the penultimate accumulation of more than 12,000 contracts is more instructive from June of 2004. This is when orange juice traded down to a multi year low of $.55 per pound. Currently, the commercial position is net long a mere 1,300 contracts. This tells me that end line producers have no fear of citrus greening affecting the overall marketplace. Furthermore, this tells me that they’re not worried about locking in future production at these prices.

The macro factors we’ve discussed lead us back to the current market rally, which I believe will act as a dead cat bounce. Therefore, we intend to sell the September orange juice futures contract upon the first sign of a reversal to head lower. The current rally appears to be overdone and we expect it to culminate in a momentum divergence that will cue our first entry. This short trade also coincides with the midsummer trough before fears of late summer hurricanes and early winter frosts cause orange juice futures to begin to bottom. As always, we will be protecting our position with stop loss orders placed just above whatever the high ends up being. After all, whether we’re right or wrong isn’t as important as capital preservation. Meanwhile, continually seeking out low risk, high reward trading opportunities will take care of capital appreciation.

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.