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Announcements
Learn about the benefits of managed futures within a well-balanced overall investment portfolio.
We recently launched a new section on our website dedicated to managed futures. Along with our model portfolios, you'll find a wealth of information about this exciting, and often overlooked, investment class.
Explore Managed Futures.
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Commodity Outlook
According to the US Fed and the Bank of England (BOE), the outlook for the economy remains highly suspect. However, it also seems as if the BOE, the US Fed and a long list of commodity markets are starting to catch a whiff of inflation. For some, the combination of ongoing slowing and rising prices fosters fears of stagflation. The central bankers who are tending toward the use of extra quantitative easing probably want to play up the prospect of deflation, as that seems to give them more room and justification for their actions. While some might suggest that historical rallies in cotton, sugar, coffee, corn, soybeans, beef, gold, silver, platinum and copper could be the result of internal fundamental supply and demand conflicts, there haven't been many times in history that such a broad-based and historically significant rally ended up being a fluke. Certainly the run-up in gold is somewhat suspect because of the speculative component that is assumed to be in place in that market, but with so many unrelated and usually uncorrelated markets rising at one time, one could come to the conclusion that commodity supplies really are tight enough to push prices up, even in the face of a suspect global economy. We have banged the drum for some time on our belief that many commodity prices are too cheap or too close to their costs of production. It is now becoming even more apparent that global demand can draw down supplies very quickly.
In markets like grains and exotic foods (the soft commodities) it is also becoming clear that even minor supply-side setbacks have become significant events. Washington and the regulators would like to suggest that prices are being inflated by speculation, but that still doesn't take into account that the cost of production for almost all commodities has risen. The speculators see that, and that is what is pulling money toward commodities. If commodity prices aren't lifted by speculation, commodity production and supply won't rise fast enough to meet surging global demand. As recently as June of this year corn prices for 2011 delivery were trading close to their cost of production. With the world supply set to contract even in the face of a record 2010 crop, it was clear that corn needed to rally aggressively or it would risk losing production area to cotton, soybeans or perhaps even wheat.
In the gold market one noted analyst recently suggested that the cost of production at some South African gold mines might be more $900 per ounce. That in by itself suggests that $1,270 gold prices are not as expensive as many would like to think.
An example of a storm brewing in the future can be seen in the milk market, where the price paid to farmers was so cheap throughout 2008 and 2009 that the US dairy industry saw a massive contraction. Since the demand for milk continues to increase globally, the contraction in the US dairy herd will probably means that prices in the coming year will have to explode. Since the dreaded speculators don't usually frequent the milk market, that potential crisis will continue to fester until the required response in the market serves to reduce demand and rebuild production.
In the meantime, we think that strength in industrial and food-based commodities are justified but that a combination of a sharply weaker Dollar and promises of more easing are destined to bring about a temporary bubble in prices. However, the trend in prices over the long turn probably has to stay up to secure needed supplies. Therefore traders should adopt a long futures mentality, with the addition of periodic options protection in the face of classically overbought technical signals.
Keep a pulse on the industry and access more commodity news.
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Markets to Watch
CORN STRATEGIES
While wheat prices have done little since Putin banned Russian grain exports, a combination of stronger demand for US grains, a weaker US dollar and continued signs of lower yields for corn have sparked a surge of new buying in corn. Since August 10th December wheat has done nothing, but December corn is up $1.00 per bushel (+24.5%) and November soybeans are up 66 cents (+6.5%). World feedgrain demand is very strong, and a tighter supply and higher prices could be a factor to support gains in other related markets such as livestock. The surge of growth in China, India, Brazil and other developing countries along with more and more demand for better diets would suggest increasing demand for meat and feedgrains, especially if the US dollar continues to weaken.
While many traders are already talking about the price level at which corn demand will be dented, it seems unlikely that livestock producers in the US will look to liquidate breeding stock. Hog and cattle herds are already depleted from the recession, and poultry producers are just beginning to rebuild their supplies. With hog and cattle prices pushing to new contract highs last week, there is even speculation that we need to see increased, not decreased, supply ahead. In addition, the cheaper US dollar plus a trend toward global growth opens the door for increasing exports of US meat.
A decline in corn production from the August to the September USDA reports is sometimes seen as an indication that weather was not conducive to strong crop yield. In light of the decline in this year's reports, there is suddenly an uneasy feeling from the trade that the October report will show a further drop in yield and a further drop in production.
A casual look at the data does not really bear this out. In the 20 years out of the last 39 in which September production declined from the August report, October production declined from the September estimate in only 10 of those years. It actually increased in the other 10. The average decline for the down years was 109.6 million bushels.
However, one of the primary reasons traders are concerned this year is the tendency for yield to drop significantly when temperatures are higher than normal during the month of August, especially nighttime temps. These conditions can cause an early end to the growing season, as crops mature quicker than normal. This problem may be compounded this year by the heavy rainfall in the Corn Belt during June and July. The abnormally wet weather leaves the corn plants with less fertilizer for growth later in the season.
Some traders view the August USDA report as a reading on plant population, the September report as a reading on the number of kernels per ear and the October report as a reading on the weight of the kernels (the filling process). In 1995, the August yield projection was 125.6 bushels per acre. The number fell to 121.1 bushels per acre for the September report that year, fell dramatically to 116.6 in October and fell again to 113.7 in November. While we are not anticipating such a dramatic decline this season, we do expect yield estimates to drop, not increase, in future reports.
Of the 10 years in which a lower production forecast in the September report was followed by an even lower forecast for the October report, in four of those years the declines were dramatic and were accompanied by above normal temperatures. August temperatures in Des Moines were significantly above average in 1983, 1993, 1995 and 2000, and those years saw the corn crop reach maturity early and production decline significantly from the September to the October reports. In 1983, production fell 131 million bushels in the October report (down 2.9% from September) and another 138 million in November. In 1993, production fell 267 million bushels (-3.7%) from September and another 459 million in November. In 1995, production declined by 291 million bushels in the October report (-3.7%) and another 167 million in November. In 2000, corn production fell 170 million bushels in the October report (-1.6%) and another 138 million in November. For these four years in which we saw higher August temperatures, the October report was down an average of 3% from September. A 3% decline in yield this year would drop the estimate to near 157.6 bushels per acre for the next report from 162.5 posted by the USDA for the September report.
Already ending stocks for the 2010/11 season have dropped to 1.116 billion bushels and the US stocks/usage ratio to 8.3%. This only the third time this ratio has been below 10% since 1973, and it is the lowest stocks/usage since 1995. If we see another 1.5% drop in yield to 160 million bushels (not the 3% projected from the study), ending stocks would slip to 916 million bushels, and the stocks/usage would come in at just 6.8%, the second tightest since our records begin in 1960.
The Commitment of Traders report, to be released after this writing, is likely to show a record net long position held by fund traders (both index and traditional trend-followers). We bring this up to illustrate that while funds have helped drive the market higher during August and September, many end users appear to be waiting for a normal seasonal decline in prices to book their needs for the coming year. This is likely the primary reason that we have not seen a significant correction during the recent run higher and why commercial buyers are likely to be active on technical corrections over the near term.
Receive daily information on Corn trading strategies.
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APRIL CATTLE
In our last issue, we warned of a possible near term high in the cattle market and pointed out the extremely overbought and record high net long position of the fund trader. A bearish Cattle on Feed report was all it took to spark a sharp break in cattle futures, and long liquidation selling from fund traders emerged to drive the market lower in the three sessions following the report.
The long liquidation from speculators is likely to be a more lasting bearish force than the 1-month jump in placements. A continued downward correction over the near term looks like a buying opportunity, as high corn values are likely to cause a sharp drop in placements of cattle into feedlots into the fall. This will tighten the outlook for available slaughter supply into the spring which could be a good foundation for another leg higher in cattle prices into the first part of 2011. A cheaper US dollar and continued expansion in the global economy are factors which could add to the potential tightness.
The USDA monthly Cattle on Feed report for September 17th was a bearish surprise for traders, who were generally expecting limited movement of cattle onto feedlots. Traders were looking for on-feed supply for September 1st to come in around 1% above last year, so the news that the on-feed supply was 2.8% higher was bearish against expectations and even above the high end of the range of estimates. Placements in August were 7.1% above last year compared to trader expectations for a slight decline. Keep in mind December corn was at 432 on August 31st when the USDA survey was taken, so the corn rally so far in September (and even a further run higher in October) should cause placements to drop.
Strong seasonal demand in the spring is the primary reason that April and June cattle trade at a premium to other months. It is also the reason that cash cattle generally push higher into the spring even though higher placements of cattle in the fall normally result in higher production in the second quarter of the year. In the recent supply/demand update, the USDA predicted 2nd quarter 2011 beef production to be 6.3 billion pounds, down 3.8% from 2010 and the lowest 2nd quarter production in six years.
The upside is normally limited for cattle in years in which we see a sharp increase in production from the 1st to the 2nd quarters. Production normally increases about 400 million pounds for the quarter, but the increase in 2011 is expected to be only 250 million pounds, the smallest increase since 2000 (see chart). If we see small placements this fall, 2nd quarter production is likely to come in even lower the current USDA estimate. High grain prices could keep spring cattle weights down, which would also cause production levels to come in below expectations.
Receive daily information on Cattle trading strategies.
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HEATING OIL
Strong distillate demand accompanied by three contra-seasonal draws in weekly
inventory levels (totaling 1.467 million barrels) could be an early sign that
the heating oil market is poised to tighten. These weekly inventory draws have
fueled a rally in heating oil crack spreads to new four month highs ($15.00 per
barrel). The contraction might have been partially the result of the Enbridge
closure, but as of September 10th, total distillate demand stood 14.5% over year
ago levels, so strong demand can't be ruled out as a contributing factor. It
seems that U.S. distillate demand around 3.50 million barrels per week equates
to an equilibrium heating oil price of $2.10, based on comparisons to past
bottoming formations.
Meanwhile, record-high U.S. distillate stocks have been accepted by the
marketplace, even at prices higher than current levels. Last fall the then
record high stock levels corresponded with a price of $1.80. Now even higher
stock levels are garnering prices of $2.10.
There are also signs that the market is tightening up outside of the U.S. In
Singapore, distillate stocks have fallen to new 11-week lows, possibly due to
North Asian markets building inventories ahead of winter. Consequently, gasoil
(another name for heating oil) spreads have gone into a backward-dated pricing
structure, which is likely to encourage the release of supplies from floating
storage. Furthermore, European distillate inventories are below year ago levels,
and data out of Germany are indicating that their heating oil sales for August
2010 were up a whopping 114.9% from year ago levels.
Against a wave of rising commodity prices in general and a somewhat dismal
outlook for the U.S. Dollar, we are on the hunt for lower priced value plays
like heating oil. It might seem off the mark to peg heating oil prices around
$2.13 as undervalued compared to the last 18 months, but if the market falls
back $2.05, the lower end of the last four months' consolidation zone, we would
consider entering a long position. We think that the potential for a slight
tightening of burdensome supplies, a pickup in distillate demand around the
world and a cheaper price would make it the best long opportunity in the energy
complex.
Receive daily information on Heating Oil trading strategies.
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BRITISH POUND
The Dollar moved sharply lower during the last two weeks as market sentiment
turned very negative towards the US currency. Historically low longer-term
yields and the market's shift towards the Japanese Yen and Swiss Franc as safe-
haven currencies have kept the Dollar on the defensive over the past several
months. There was some relief during the Bank of Japan's rounds of intervention
to weaken the Yen, but the Dollar showed little inclination towards recovering
its losses. This current selloff reached a crescendo after last week's FOMC
meeting, when the first hints of possible future US quantitative easing sent the
Dollar down to the lowest prices levels in nearly eight months. While the Swiss
Franc and the Australian Dollar saw multi-year highs, other major currencies saw
more modest gains.
The December Pound was able to move above its recent downtrend during this
period and returned back to early August price levels. What makes this strength
surprising is that the Bank of England indicated an increased probability of new
UK quantitative easing the day after the FOMC meeting. Weak economic data,
falling sentiment measures, and a near-dormant housing market have kept up the
pressure for looser UK monetary policy. Upcoming government spending cuts made
by the new coalition government are likely to limit chances for an economic
rebound. With Britain experiencing many of the same economic problems as the US,
the post-Fed meeting rally appears to be excessive. Another test of last week's
highs may be the upper limit of the December Pound's strength during the near
future.
Receive daily information on British Pound trading strategies.
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NOVEMBER RICE
Rice is one of the cheaper basic commodities from a historical perspective, and
many rice farmers in the US would add that at a recent low of less than $10 per
hundredweight it had also fallen below the cost of production. While a
relatively cheap price does not necessarily justify a major recovery rally,
there are reasons to think that rice will be a consistent gainer into late 2010
and early 2011. Rice has already started putting in what looks to be a
significant bottom at a time when traders are scouring the world for relatively
low cost assets and commodities to invest in.
Rice and wheat are the two most basic major food grains consumed by humans, with
occasional localized switching between the two based on price or a lack of
availability in one or the other. These two grains are also linked in many
traders' minds in the wake of the price shocks that took the markets to new all-
time highs 2-3 years ago. The rice-wheat ratio is one way to look at the
relationship between these markets, and it may be signaling a long term turn in
rice. The wheat rally drove the rice-wheat ratio down to near the low end of its
range for the past decade.
A look at the weekly rice-wheat ratio shows that it has a strong tendency to
turn and trend when it pushes to the low end of the ratio's historic range.
Furthermore, the last two major lows in the ratio occurred in September and
October, the current timeframe. The question becomes whether this will be
accomplished via a further break in wheat, a rally in rice, or some combination
of the two. Several factors favor a rally on the rice side of the equation,
including the emergence of scattered crop problems as well as its relatively low
price. The USDA lowered Pakistan production by 1.2 million in the September
WASDE supply/demand report. The USDA report lowered China's overall rice crop
for 2010/11 by 1.5 million tonnes.) While these losses are not likely to start a
parade of crop losses around the world, the USDA did lower overall 2010/11 world
ending stocks by almost 3 million tonnes to 94.56 million.
The situation in India is at the opposite extreme. The USDA projects 2010/11
overall rice production in India at 99.0 million tonnes, up from 89.13 million
in 2009/10. India is also dealing with a bumper wheat harvest, and the
combination of these two crops has virtually overwhelmed government storage and
led many to ask why India is not moving aggressively into the export market. The
answer is simply a fear of food inflation. Whatever benefit the country might
receive from a substantial increase in export revenue would be outweighed if
food inflation takes off and sweeps politicians out of office in the next
elections.
Basic commodity inflation is already underway on the world market. Some of this
is being tied to an emerging buy-and-hold mentality on the part of the world's
investors, along with stock building tendencies on the part of wheat importers
such as Egypt and exporters such as India and even Russia. Money is the most
liquid, fungible and transferable asset or commodity class in the world, and the
world is currently awash in it. Rice's cheapness relative to wheat in light of
recent minor losses in rice production worldwide may help to shift it onto the
list of markets, such as gold and corn, that are currently attracting the buy-
and-hold crowd. Look for the nearby rice futures contract to move to 1330 into
this fall with further gains into 2011.
Receive daily information on Rice trading strategies.
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***This report includes information from sources believed to be reliable and
accurate as of the date of this publication, but no independent verification has
been made and we do not guarantee its accuracy or completeness. Opinions
expressed are subject to change without notice. This report should not be
construed as a request to engage in any transaction involving the purchase or
sale of a futures contract and/or commodity option thereon. The risk of loss in
trading futures contracts or commodity options can be substantial, and investors
should carefully consider the inherent risks of such an investment in light of
their financial condition. Any reproduction or retransmission of this report
without the express written consent of The Hightower Report is strictly
prohibited.
Discuss Trading Strategies with Us!
If you'd like to discuss trade strategies to determine the best execution strategy for you regarding the market, contact us or call us toll free at 1.800.800.3840.
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| In This Issue |
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| Trading Tip |
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If you’re in futures simply for the thrill of gambling, you’ll probably lose because, chances are, the money does not mean as much to you as the excitement. Just knowing this about yourself may cause you to be more prudent, which could improve your trading record. Have a business-like approach to the markets.
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| Did You Know... |
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Daniels Trading offers a Spanish translation of our website? Simply click the “Español” link located on the upper right corner of every Daniels Trading webpage.
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Get the inside scoop on the rice futures!
Rice is one of the cheaper basic commodities from a historical perspective, and many rice farmers in the US would add that at a recent low of less than $10 per hundredweight it had also fallen below the cost of production.
This IMA special report addresses the following questions and more:
- What reasons lead us to believe rice will be a consistent gainer into late 2010 and early 2011?
- What factors favor a rice rally?
- How can the rice situations in China and India affect the markets?
- What evidence supports the fact that basic commodity inflation is already underway on the world market?
- Why the rice market might shift onto the list of buy-and-hold markets?
Register now to view our IMA special report - “Rice Update” now!
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Featured Video
The globalization of financial markets has made portfolio diversification and managing risk more important than ever.
Defer your trading to an experienced Commodity Trading Advisor with a documented track record.
Click here or anywhere on the video image below to launch the “Managed Futures Execution Service” video page on the Daniels Trading web site.
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Upcoming Webinars
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Kurt Pfafflin |
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dt Pro 201 - Intermediate Order Entry, DOM & Chart Execution Techniques |
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About Daniels Trading
Daniels Trading is a relationship-focused commodity futures brokerage located in the heart of Chicago's financial district. Founded in 1995, we have a history of providing effective and reliable trade executions to both individual traders and institutional investors around the globe. In addition to our focus on relationship and execution, Daniels Trading is a leader in providing ongoing education opportunities and resources for our customers.
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