The Brexit vote caused a spike in volatility by creating an instant, “risk off” trade. The ensuing sell-off appears to have created a buying opportunity in unleaded gas futures that should continue to be supported by growing domestic demand through the summer vacation season.
We published this short sale in RBOB unleaded gasoline Monday night for COT Signals subscribers and followed it up with commentary for Equities.com on Tuesday morning. You can read, “Are Rising Gas Prices a Trading Opportunity?” at Equities.com. You can see the effects of commercial traders buying and selling RBOB unleaded gas and the summertime peak gas price on the chart we posted at COT Signals.
This trading setup is a classic Commitment of Traders Sell signal and shows why we use the CFTC Commitment of Trader reports as the primary basis for screening our trading opportunities. Follow the links to see how we do it or better yet, call us and ask us how.
They say that the most important read for a comedian is timing. The comedy in trading is that the market typically delivers its own punch line at the expense of the trader’s timing. Twenty years of trading has proven one thing right over and over again; traders aren’t meant to get it right. The markets constantly change and a pattern that has been developing for months may be no good on the day the trader pulls the trigger. When the trader is right, they’re lucky to price either the entry or the exit well. Typically, there’s meat left on both sides of that bone. Therefore, the psychological positive reinforcement must come from the bottom line, rather than the lines on the charts. With this in mind, let’s look at some trading opportunities on the horizon and how to prepare for them.
Starting with a seasonal top, unleaded gas should be rapidly approaching its seasonal high. The build in prices tends to peak just past Memorial Day. Whether this is a gasoline producer conspiracy or, purely supply and demand, there’s no argument about when it hurts the most. The unleaded gasoline market has put in a very tradeable top in eight out of the last 10 years during the Memorial Day – June 15 window of opportunity.
Moving to agricultural commodities takes us to the typical weather patterns and their effects on crops. It’s important to understand that the historical seasonal patterns are based on the most probable outcome of a full data set. Therefore, extreme weather events like drought and flood will only register as one year’s data. Thus the historic spikes we’ve seen don’t have nearly the impact when compared to 10 or 20 year’s worth of data. This is why sample size is so important when providing the general guidelines for what’s expected to happen.
Once we get past Memorial Day, we’ll begin looking for a bottom in the live cattle market before June 10th. Fundamentally, the cattle market should be well supported. There simply aren’t many cattle out there. The breeding herd has been on a gradual decline for years. This year is no exception with the 2013 herd coming at the lowest level in 61 years. The tiny herd size provides the market with two different ways to rally. First of all, if corn prices remain low, we’ll see cattle affordably held back for breeding. Secondly, if corn prices rise, we’ll see the herd size continue to dwindle. Either scenario takes steaks off the summer grill.
Fortunately, you’ll be able to finance that new grill using the falling interest rates that typically begin between Memorial Day and the third week of June. Even though some of the newer interest rate contracts may not have the history of cattle, corn or, gold at least interest rate futures all tend to trend in the same direction. The typical pattern is for interest rates peak in the early summer and decline through the rest of the year and into lay-away season.
The final classic summer seasonal trade is to sell soybeans once the planting fears have begun to pass. The soybean market always has support through the planting season. In fact it’s not uncommon for soybean futures to set their high price for the year in May or June. Once the crop is safely in the ground, the market breathes a collective sigh of relief. Given normal growing conditions, the decline in prices really picks up after pollination in July.
The summer markets appear to have gotten off to predictable starts. I think the one, notable exception is the strength in the stock market, which we believe has about run its course. In fact the Russell 2000 – S&P 500 spread trade we mentioned last week appears to have finally turned in our expected direction. The most important concept in these trades is being aware of the seasonal tendencies of different markets as they approach. Mark them down on your calendar. It will take half an hour to do the entire year’s worth for the markets you actually trade. This way you’ll always know if you’re near a market’s inflection point and in trading, predicting inflection points is how we measure our timing.
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.
Uncovering Value in the Commodity Markets
The electronic meltdown in the stock market also cued a selloff in many commodity markets. Typically, markets move in their own individual rhythms. However, when fear dispossesses logic and panic takes over, it becomes a case of sell first and ask questions later. As the stock market selloff accelerated and we watched the media reports of the riots in Greece, survival became the primary concern. Now that the dust has settled, it’s time to appraise the current state of the markets. I believe the shock to the system uncovered some fruitful trading opportunities.
First, let’s examine the context of the markets prior to the selloff. In the currency markets, the Australian and Canadian Dollar as well as the Japanese Yen had been consolidating near the upper end of their ranges. All three had been holding their own since the U.S. Dollar’s rally has come, primarily, at the expense of the Euro, Swiss Franc and British Pound. The same pattern appears in the metals and energies as gold, silver and platinum as well as heating oil, unleaded and crude had also had been consolidating near their highs.
Secondly, let’s consider the composition of the markets’ participants through the Commitment of Traders Report at these price levels. Commercial trader positions in the markets above were gaining momentum in the direction of their established trends with the only exception being the silver market. This means that even as the markets were moving higher, the traders we follow, commercial hedgers, anticipated higher prices yet to come. For our purpose, we track the commercial hedgers. Prior to the market shock, we presumed that we were in a value driven futures market and no one knows fair value like the people who produce it or, have to use it. In fact, it is precisely their sense of value that provides the commodity market’s rhythmic meanderings that swing traders love so much. Let’s face it, producers know when their product is overvalued and it should be sold just as well as end line users know when they should be stocking up at low prices.
Finally, in the wake of “Volatility’s Perfect Storm,” we have seen the commodity markets snap back from losses of 3% – 4% in the world currency markets to 7% – 10% in the physical commodity markets. This sharp selloff and snap back to the previous range of consolidation prices is called a “Spike and Ledge” formation in technical analysis and pattern recognition. Typically, this occurs when an outside force creates a counter trend shock to the market and scares everyone out. The fear of being in the market is replaced immediately by the fear of NOT being in the market and missing the move. The shock forces out the market’s weaker players while allowing the strong to accumulate more positions at better prices. This is why COT Signals has been kicking out buy signals since the meltdown. Following the commercial trader positions has allowed us to buy into oversold markets. Our targets for these positions can be calculated by adding the depth of the market’s decline to the top of the consolidation levels. If the market you’re following sold off 5% from its highs, a spike and ledge projected target is 5% above the market’s previous highs and a protective stop would be placed just beyond the spike.
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.
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.
Today’s price action appears to have trumped the
deflation/reflation argument that has been building over the last month. Many
of the markets have been rallying on small speculative buying as seen in the portfolio
rebalancing by the major long only funds.
Looking at the Commitment of Traders reports over the last
few weeks, we can see an increase in the net long positions of small
speculators in the following markets:
Swiss Franc, Japanese Yen, Canadian Dollar, Unleaded Gas,
Wheat, Beans, Bean Oil and Meal, Corn, 10yr. Notes, Eurodollars, Live Cattle,
Hogs, Copper, Orange Juice, Coffee, Sugar and Dow Jones futures.
The commercial hedgers have gladly stepped in to take the
short side of these trades with their numbers building as we’ve neared the
October – November resistance in many of these markets. Obviously, the interest
rate sector is the exception, although, there is strong short hedging taking
place at these levels.
There are a few major reasons for the resistance at these
levels. First, the U.S. Dollar Index has a strong bias towards setting a high
or low for the coming year in the first two weeks of January. If the Dollar’s
trend is going to be higher, the global demand for American commodities will
decline. Secondly, portfolio rebalancing by the major index funds for 2009 is
going to balance smaller gold weighting against heavier crude oil weighting.
Today’s collapse in crude oil futures is an indication that they may have filled their
need for crude. This also helps explain Gold’s inability to rally through $900
even on weak U.S. Dollar days. Lastly, the economic numbers continue to get
worse with each release. Last week’s ISM numbers were the worst since 1980.
Unemployment this Friday should continue to rise and eventually head north of
This is a very brief outline of the weakness I’m expecting
in many markets in the near term. Please call with any questions.