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Markets to Watch
Wheat Strategies
The wheat market has been a featured mover to the upside of late. Traders who have concentrated on the genuinely bearish world and US supply fundamentals are licking their wounds and wondering why the rally is still going strong. The reasons for this are simple. For starters, trend-following funds still have a large net short position in Chicago wheat at a time when the world's investors are looking to park some capital into commodity markets. Trend following funds were net short 35,144 contracts as of November 9th.
The psychological shift that is underway among these funds, and investors in general potentially huge and long term, and they are looking for commodity markets that have lagged in recent months. Wheat is one of them. In fact, after adjusting for inflation since 1980, wheat is priced very cheap. If we were buying nearby wheat futures with 1980 dollars, today's price would be under $2.25. Of course, prices can be inflated as well as deflated. Let's take a look at wheat prices from the opposite direction. The midpoint of nearby wheat futures during the 20 years from 1970 to 1990 was roughly $3.00 per bushel. If we again start at 1980 and inflate that $3.00 price into 2009 dollars, that would compute to a price of about $6.89 1/4 per bushel. A $4.00 price in 1980 computes to $9.19 1/4 in 2009. This is a simplistic way of looking at commodity prices, and there are many factors to take into account in terms of the impact of inflation on a given commodity. While we are not suggesting a price objective of $9.19 1/4 for the nearby wheat contract any time soon, these are the sort of broad historical parameters that some money managers and investors may be looking at given the potential for an inflationary upswing.
It is also worth noting that wheat is not without some minor silver linings for bulls on the fundamental side. US acreage is expected to be down for all winter wheat this year, with soft red down due to poor planting conditions and the late harvest in corn and soybeans. This could result in a loss of acreage for soft red wheat of 1.5 to just under 2.0 million acres. The upper end of that range would result in the lowest plantings total since 2005. Other factors could be supportive, such as the continuation of the El Nino in the Pacific which could cause the Australian wheat crop to deteriorate. In addition, India saw a reduced wheat crop this year, and if they experience any further problems with wheat into 2010, this could result in Indian imports, which would be very supportive. Finally, there may be pest problems with some of this year's Black Sea wheat crop, and this could shift some Egyptian demand to France and possibly the US. This is not to suggest that there is a strong fundamental case for a rally because there is not. However, if investors want to own more commodities and fewer dollars, wheat is a reasonable place to put some money. Given the fact that trend-following funds are still short, an objective of 730 3/4 in the nearby wheat futures by mid-to-late 2010 seems reasonable.
If you'd like to receive daily information on the wheat market, click here.
Suggested Trading Strategies:
- Buy July wheat at 581 with an objective of 642. Risk to close under 571.
- Buy 2 units of the December wheat 670/750 bull call spread at 23 cents each with objectives of 34 and 47. Risk 6 cents from entry.
If you'd like to further discuss these strategies to determine the best execution strategy for you, contact us.
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Industry News
2009 Commodity Laggards Expected to Perform In the Coming Quarters
In retrospect, 2009 was a very impressive year for the commodity markets. For most of 2009 commodities were seen as "the" place to be, with many analysts touting them as a new and potentially sustainable investment class. Indeed, certain commodities forged very impressive rallies in the face of highly uncertain economic conditions, with the Continuous Commodity Index forging a gain of more than 30% from the end of 2008 to the October 2009 highs. If one also takes into consideration the low to high rally in crude oil prices of 74% and the 94% run up in sugar prices, it would seem like certain commodities are well on their way to pricing in a recovery.
With the sharp, surprising run-up in equity prices of 67% in 2009, there are a number of analysts who view the equity markets as pricing in positive growth for 2010. While the outlook for the economy remains very suspect as of this writing and many might consider the commodity markets as overstating the recovery potential, it is possible that a bit of historical perspective will lead one to the conclusion that many commodity prices still have significant upward price potential ahead.
In our opinion, a large portion of the commodity price gains that were forged in 2009 were simply a rejection of severely deflated pricing. In some cases markets fell to (and even below) the cost of production and did so off of sentiment that suggested demand was going to fall to depression type levels and not recover for years.
But as the situation was so extreme (interest rates approaching zero, widely accepted expectations for a continuous deflationary spiral and, for a while, little or no hope of an end to the crisis) the conditions that had sent prices to extreme lows in 2008 and early 2009 may not be repeated very soon. It could be very difficult for markets like natural gas, crude oil, sugar, cotton orange juice, copper, coffee and corn to return to the lows they have forged over the last 18 months. And while markets like cocoa, soybeans, soybean oil, cotton and wheat may seem to lack the fundamentals that would allow for a strong upside extension, against a backdrop of a falling Dollar, fairly consistent global demand growth and ongoing investment flows toward commodities, even those "weak horses" can catch some spillover support.
One could say that 2009 was a year to "close your eyes and buy everything physical." In contrast, 2010 looks like a year to be more selective. To be sure the direction of most commodity prices will still be largely a function of the direction of the economy, but while we have to assume that the US will slowly claw its way out of the sub-prime disaster, we have to be aware that there will likely be periodic setbacks.
However, never in history has the US Federal Reserve been so forced into a position of erring to the side of inflation. Adding into the equation what appears to be a long term devaluation of the Dollar and unprecedented quantitative easing by the most of the world's central banks, one is presented with a spectacular, classic inflationary setup for commodities.
While the commodity appreciation potential is being recognized by the "funds" who have poured in copious amounts of money to commodities, there could be some form of showdown in 2010 between commodity speculators and the regulators. However, in the wake of the move toward proposed position limits in certain commodities, it would appear that inflows to commodities from the funds have actually accelerated. In 2009 moves to restrict index trader activity in some markets forced them to rebalance their positions, which meant that while they may have liquidated positions in some markets they turned around and bought into some other markets. For example, they may have been forced to liquidate some longs in Chicago wheat, but they simply replaced those with longs in Kansas City wheat.
In the event that regulators make a move to significantly lower position limits in 2010, there could be a temporary, aggressive liquidation in some commodity markets. In most cases one might expect those commodity markets with massive long spec positions to see a concentrated liquidation event. Therefore traders should be aware of which commodity markets have tight fundamental setups and be prepared to get long or add to their long positions in the wake of any compacted washout brought about by regulatory changes. Telling the world they can't own commodities probably increases the interest in them two-fold!
In the near term, the maintenance of ultra low rates in the face of a gradual recovery in the global economy should increase the odds of inflation. In fact, we see the 2009 commodity laggards to be the stellar performers in the coming quarters. Therefore, traders should be looking to invest in orange juice, natural gas, silver and sugar on any near term, broad-based corrective action.
Keep a pulse on the industry and access more industry news.
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Trade all positions in futures on a performance basis.
The position must give a profit by the end of the third day after the position is taken, or else get out.
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