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MoundReport.com presents:
The Commodity Year in Review & 2008
Outlook
From a sea of green to a sea of red – The pending collapse of the commodity
bull market
By Head Analyst James
Mound
The End is Coming
2007 offered a year of dollar weakness and commodity price
inflation, supported by massive volatility not seen in decades. The CRB Index of commodities rose more than
25% in less than a year. The dollar
broke down as the euro rallied for the second straight year, offering a 33
point run or almost 30% in two years.
Crude oil may not have had its largest annual percentage rise but, given
it’s already inflated price, it made a massive move
doubling in price from it’s January lows to all time highs.
A housing crash, credit fallout and a Fed led by a less
predictable leader has sparked significant economic fears. Commodity price inflation and geopolitical
concerns mark a year of green commodity price boards as the bull commodity
cycle remained in full swing. However,
2008 will be a different story.
In the coming year we will see a strong U.S. dollar and
global economic weakness force a recession in commodity prices, sparking a long
overdue price correction in many major commodity sectors. This contrarian
outlook may be a bit shocking but the average analyst, newsletter writer and
broker will likely convince you that commodity prices have more to climb and
you will look back, around this time next year, and probably wish you had
followed this report. The first bear retracement in commodities in the new Millennium is upon us
and you had best listen up.
Top 5 Bull Plays for 2008
Coffee
U.S. Dollar
Cotton
Sugar
Orange Juice
Top 5 Bear Plays for 2008
Euro Currency
Canadian Dollar
Gold
Wheat
Crude Oil
Energies
Energy prices skyrocketed in 2007 as geopolitical risk took
center stage. Inflation concerns by the
Fed, sparked by rising oil prices, did little to stop crude from closing near
all time highs to end the year. While
$100 is critical from a psychological perspective it does little to determine
the long term price outlook for this sector.
The short term technical bounce after the market’s first real attempt at
retracing appears to be the real deal, but January will mark a likely top in a
sector well overdue for a massive price correction. Recent winter weather
across the U.S.
is too little too late and not enough to make supply concerns force a further
price surge. The overall tone of this
market heading into 2008 is an overbought market that is seeing funds look
elsewhere for commodity profits.
Let’s look at three main areas affecting this sector:
1)
Geopolitical Risk – This is a
general term for a very specific problem.
Turkey’s
invasion of Iraq,
Iran’s nuclear
efforts, Israel
vs. Lebanon vs.
Syria, Pakistan’s ex-PM and current political rival gets assassinated, and on
and on and on. Can the Middle East temper this unstable
market environment? What is priced in
and what is unknown? While all the
action over the past couple of years gives the feeling of impending escalation,
the Bush Presidency, despite all its faults, has doused numerous Middle
East fires before they exploded.
Unfortunately they keep relighting the fire as well.
2)
Supply vs
Demand – While estimates and expectations suggest rising demand for oil in
2008, it is often overlooked that global supply remains steady with declining
production capacity utilization. So it
would seem as if the industry can amp of production to meet rising demand all
else withstanding.
3)
Weather – After two devastating
years of hurricanes and erratic winter weather the market has gone on to see
two years of benign hurricane activity and warm winters. If 2008 is the tiebreaker in a best of five scenario then which way will the scale tip?
Rising freight prices and implementation of alternative fuel
sources and efficient automobiles will curb demand in 2008. Commodity prices act like a rubber band. It stretches and then when it is stretched to
the limit it either breaks or snaps back.
Energy prices are stretched tight and I expect them to snap back hard
and fast in 2008.
***Chart Courtesy of Gecko Software’s
TracknTrade.
The bottom line for energies is that prices are in hysteria
mode and are driven by specs pushing them higher and a bunch of greed stopping
sellers from entering the mix. When it
falls it will fall hard and I would not be surprised if volatility peaks to
another level when the top gets set – can anyone handle a $10 day in oil? I see a couple of days like that in the near
future.
Financials
Stocks offered a mediocre showing in 2007 with single digit
returns and massive spikes in the VIX creating a volatile trading
environment. The Sharpe Ratio, a measure
for fund managers to determine the risk taken to achieve a given profit, has
dropped dramatically amongst most funds and suggests that it is becoming
riskier to earn a buck in the stock market these days. While volatility is likely to fluctuate in
2008, the market is unlikely to go very far.
This will offer an ideal environment for premium collection if done in
short term time frames and with patient leg-in entry timing.
***Chart Courtesy of Gecko Software’s
TracknTrade.
In 2008 expect to see the Fed’s unpredictable interest rate
policy continue to plague the market, worsened by the housing fallout, a weaker
export market due to a rising dollar and rising unemployment. The technical outlook for the S&P
appeared ugly heading into the new year, setting up a
bear break on Friday that confirmed dual consolidation patterns and a rounding
top on a longer term chart. The top set
in 2007 barely broke the previous highs and suggests that market psychology may
be shifting to a long term top in the market.
I expect that 2008 will offer a range of 1510 to 1300, a relatively
tight year-long range given current and anticipated volatility.
The Fed marked both 2007 and the inaugural year of Ben Bernanke’s tenure by creating a volatile environment of
unpredictable policy shifts and economic forecasting. While efforts have been made to make Fed
decisions more transparent, the end result has been more interpretation arguments
than the last 4 years of Greenspan’s tenure combined. There is little light at the end of the
tunnel in 2008 as bond prices have shown expansive volatility,
the Fed has shown no ability to create intermediate or long term expectations
for rates or the economy. All we have is
a housing crisis, a global capital problem and a slumping economy. Expect bonds to breakout of both sides of the
recent range with highs above 119 and lows below 112. When volatility diminishes ahead of a Fed
meeting, look to play near term long strangles for volatility expansion as I
expect massive price expansion and contraction throughout the year.
The dollar will ultimately be the determining factor for
2008. After a long and strong downtrend
in the dollar we will finally see the U.S. dollar regain its footing and
develop a reversal pattern bringing the dollar to 88 on the index by year
end. Currencies are often the easiest to
argue a directional view and the hardest sector to predict, simply because
there are so many global factors in play.
However, the turn in the dollar is based on a few simple reasons –
exports, tourism and China.
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While the U.S.
has sustained our economy despite a ton of problems, it did so because of a
weak dollar offering strong exports and a slew of foreign investment and
tourism. The tide will soon turn, however, as the powerhouse euro currency is creating a
major problem overseas. The euro’s incredible run, a 15% rally in under a year, has set
in motion a virtual freeze on exports and tourism dollars throughout Europe. The U.S.
faced a similar problem back in 2002 when the dollar was running above 120 and
the U.S.
implemented a weak dollar policy to improve economic growth. Despite the U.S.’s
housing problems, the E.U. actual pumped more money in than the Fed has,
suggesting a possible dilution of their currency and a long term trend
reversal.
China
is tough topic. Everyone knows that China
is offering some incredible growth opportunities, an independent currency that
is very strong, and is experiencing an influx of foreign investment. However, China’s
economists are no slouches – they may not know how to relate to the public
through some of the more bizarre PR issues I have ever seen - but they know how
implement proper monetary policy. Part
of proper monetary policy is slowing growth to a point in which infrastructure,
demand for raw commodities and general inflation is kept to a minimum. Double digit annual growth flies in the face
of this type of monetary policy. While
it is important for the Yuan to remain strong and stable, it has diverged so
much from the U.S. dollar that it is causing unsustainable growth. The Yuan will retrace in 2008, and global
demand for commodities will diminish because of it.
The Canadian dollar has seen an unbelievable run due to
rising raw material prices (commodities make up approximately half of Canada’s
exports). Spec interest in the currency
spiked it to 1.10 on the U.S. dollar and created the largest move in under a
year in the currency’s history – over 30% since February! Look for the Canadian, and the Aussie dollar
to see significant retracements in 2008 as tops in
energy and metal prices, as well as a strong dollar, force specs to flock for
the exits.
***Chart Courtesy of Gecko Software’s
TracknTrade.
Grains
An historic year in grains came despite a massive corn crop,
as acreage shifts, weather issues and global demand spikes helped to bring
grains to relative contract highs.
Wheat’s devastating frosts and acreage shift helped to boost that grain
to extreme all time highs and a global thirst for under planted soybeans surged
that market to double digits and beyond.
Corn, a trailer by comparison, has still seen prices more than double
the 2006 lows. Rice, a sleeper in the
group, has sustained one of the biggest continuous rallies in commodity history
as it has risen over 400% in just over 5 years (more than doubling since
2005). While grains have long term
bullish fundamentals I expect 2008 to bring a massive price correction.
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Soybeans have seen a drop in planted acreage and a rise in
global demand, with a build up to a China
demand that will likely bring ‘beans in the teens’ before it is all said and
done. Spiking demand for bean oil has
been met with disproportionate supply of this key derivative. This is a great bull market, but it has just
about stretched the rubber band as tight as it is going to go. Expect a top between current prices and $14,
with a likely top in the low $13 area.
***Chart Courtesy of Gecko Software’s
TracknTrade.
Wheat is so overbought it makes the incredibly bullish
fundamentals behind this rally seem less intriguing. Two seasons and a secondary acreage shifts
will turn wheat back to the $6 area in 2008.
Corn is supported by rising ethanol demand, sparked by the
Bush Administration’s impressive PR and subsidization program. Can the oversupply be offset by the demand
boost and long term bullish fundamental prospects? If wheat and beans sustain such high prices
then the substitutive demand for corn will help to support prices. But if, and when, beans and wheat fall then
watch out! Corn could see $3 prices in
2008, but not before testing a critical $5 area.
Rice has been one of the best bull plays I have ever seen,
as supply issues in China
and global demand increases have allowed rice to hit historical highs. This may be the one grain that could make an
extended run, with the potential for another 30-40% move up in 2008. However, this thin market is in risky
territory after breaking through the critical price resistance seen from
previous spike highs in the past two decades.
The bottom line is if you are going to play the upside, tread lightly.
Meats
Cattle prices remained channeled for much of 2007 as sustained
high prices built in the rising feed costs as opposed to an over supply run to
slaughter that many expected. Global export issues also helped to create a foggy fundamental
picture and is likely to continue into 2008. While prices appear to be unable to set fresh
highs, it is difficult to time a major price correction given the market’s
resiliency of buying dips and general lack of volatility. Given the frequency of Mad Cow it is likely
that 2008 will see a news catalyst to a major drop in underlying prices. Look to develop straight long term put
spreads in anticipation of 30% price correction in 2008.
Hogs have had a tumultuous year despite staying within a
wide price range. Rising demand has been
hit hard with supply shocks and caused a choppy intermediate term trading
environment. The market is unlikely to
test extreme highs or extreme lows in 2008 and offers a good opportunity to buy
reasonable price dips in the 50s and sell tops in the upper 70s.
Metals
Gold prices ended 2007 at 28 year highs and a seventh
consecutive annual gain. The market has
been supported by spiking commodity prices and a weak U.S. dollar, which prices
gold on a global level. Because of the
weak U.S. dollar the rising gold price appears less inflated to foreign buyers. This year will be quite a different story as
gold will suffer from the perfect storm of retracing commodity prices, reduced
inflation fears and a strong U.S. dollar.
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The one supporting argument for gold is a potential flight
to quality if the stock market tumbles harder than expected and bonds remain at
low payoff levels. Silver is technically
very strong and may diverge from gold, but ultimately is a strong sell in 2008. Platinum is on an historic run, showing a
more than 30% runup in under a year. Look for a top to be set in platinum in
January as the inventory deficiencies and South African supply problems are
likely built into the market. Copper has
shown its general inability to retest the $4 highs and should falter due to a China
slowdown.
***Chart Courtesy of Gecko Software’s
TracknTrade.
Softs
Coffee remained on a solid weekly and monthly trend line
support as rising demand combined with drought problems in Brazil
to continue coffee’s steady climb in 2007.
Vietnam
may have had a blockbuster crop in 2007, but the monsoon rains and general
quality issues make much of the crop useless.
Brazil’s
drought almost annihilated the 2008 coffee season, the bigger supply season of
the country’s bi-annual cycle. Saved at
the last moment, the crop was still hit hard enough by the drought to likely
reduce the overall yield of the world’s biggest coffee producer. Mexico’s
growing region was hurt by hurricanes and Kenya’s
crop is virtually non-existent. Years
ago coffee production was consolidated to mainly South America. Since coffee has expanded its growing areas,
it has diversified its supply risk and caused a once volatile commodity to
become more tempered and predictable. In
2008 we may experience the first real global supply deficiency since the new
Millennium and coffee may once again become a market of extreme
volatility. Look for coffee to break
above $2 this year and offer bulls a lot to celebrate. Bull call spreads and straight long term out
of the money calls are recommended.
Cocoa
experienced a bull run in 2007, supported by devastating crop infestations and
disease and an Ivory Coast
meltdown. The Ivory
Coast produces the bulk of the world’s cocoa
and, when combined with Ghana’s
supply, essentially controls world cocoa prices. In 2007, the Ivory
Coast continued to have an unstable
political climate and little suggests that it will change in 2008. Peace treaties, disarmaments and French
intervention seem to be short lived efforts in a country wrought with violence,
improper wealth distribution and too many fighting factions. Throw in hedge fund interest, global
increases in demand and an ugly supply situation and you have the potential for
further gains in 2008.
Orange juice has been on a wild ride for years as the
hurricanes of 2004/05 and canker fungus and citrus greening have devastated the
Florida OJ crop. An acreage shift in California
has also helped to diminish the U.S. OJ supply, which once provided more than
1/3 of the world’s supply of the vitamin-C rich treat. Technically, the market hit an historic top
at $2.10 and has since had a perfect Fib retracement
that offers price support going into 2008.
This past week’s Florida
frost had a sell the news affect that begs bulls to buy the dip ahead of a
potential late winter weather season and critical hurricane season ahead. Brazil
has balanced the supply problems with their own bumper crop, but the upcoming
year may see a bull surprise in regards to Brazils’
next crop as citrus greening is wreaking havoc throughout much of the growing
region.
***Chart Courtesy of Gecko Software’s
TracknTrade.
Cotton finally got out of the doldrums as a Delta region
acreage shift to profitable corn planting left supply in cotton a bit low. Horrendous weather in Pakistan
and India
didn’t help matters either. The cycle of
oversupply is likely over and 2008 should offer a solid rally in a market that
is overdue for a cycle shift to the bull side.
Throw in a breakout to the upside of a long term consolidation pattern
and the volatility over the next several months may offer call buyers a solid
premium spike.
Sugar ended the year finally turning a corner back to the
upside. Many fundamentalists may wonder
why as one of the worst oversupply situations in any commodity in history will
likely plague this market for the next couple of years. However, the enforcement of a ruling that
stops the European Union from unloading half of the world’s oversupply of sugar
on the open market may just save this market from further collapse. Moreover, the rise in corn prices may bring
sugar ethanol to the forefront of the energy crisis as it still offers a
cheaper method for ethanol production than corn. The U.S.’s
ban on importation of Brazilian based sugar ethanol ends in mid-2009, but
recent efforts by the Brazilian government to push for an early termination of
the ban may ultimately pay off. Sugar
call premium was dirt cheap for the last half of 2007, as readers of our
Weekend Commodities Review are well aware.
Now premium is a bit pricier, but value can still be found in deep out
of the money long term plays. With volatility
starting to pick up these calls may not be out of the money for very long.
Last, but not least, is the often forgotten lumber
market. Because of the lack of liquidity
this is normally a market to avoid.
However, the market has clear long term cycle lows and cycle highs and
we are fast approaching a great value buy.
Look at 200-220 area for a great value entry to ride this up to 320 in
the upcoming year as the worst of the building freeze is over even if the
foreclosure situation still has the worst in front of it.
*Disclaimer: There is risk of
loss in all commodities trading. Please consult a James Mound Trading Group
Broker before you trade for the first time. Losses can exceed your account size
and/or margin requirements. Commodities trading can be extremely risky and is
not for everyone. Some option strategies have unlimited risk. Educate yourself
on the risks and rewards of such investing prior to trading. James Mound
Trading Group, or anyone associated with JMTG or moundreport.com, do not guarantee
profits or pre-determined loss points, and are not held monetarily responsible
for the trading losses of others (clients or otherwise). Past results are by no
means indicative of potential future returns. Information provided is compiled
by sources believed to be reliable. JMTG or its principals assume no
responsibility for any errors or omissions as the information may not be
complete or events may have been cancelled or rescheduled. Any copy, reprint,
broadcast or distribution of this report of any kind is prohibited without the
express written consent of James Mound Trading Group LLC. Total cost, or
cost/credit of trade (as referred to in the trade above), includes the
cost/credit of entry, commissions and fees. Typical commission is an approximate
mean of commission rates amongst JMTG customers, but can be more or less
depending upon the individual account/customer, services rendered, account
size, trading volume, etc. Options do not necessarily move in lock step with
the underlying futures movement. Commissions at JMTG range from $3 to $27.50
per side depending upon the market traded and specific commission rate charged
to the client. Fees range from $2.88 to $7.50 per side depending upon the
market traded.
