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The
Weekend Commodities Review
By Head Analyst
James Mound
For the Week Ending
March 30th, 2008
General Comments
After a holiday weekend off, the WCR report has a lot to
catch up on. After all, we just experienced
the volatile week in commodities in my career and followed it up with a pause
and recoup period that is about to come to a quick end. So we really have two questions that need
to be addressed:
1)
What caused the
collapse?
As I anticipated in the my
2008 Outlook, the commodity boom is in for a significant price retracement this year, and it started just prior to Good
Friday (which was a Great Friday for myself and my loyal readers, and a
not-so-good Friday for most everyone else).
The driving force behind the plunge could be attributed to a number of
factors, but the primary catalyst was a fund selling exit of some major
commodity sectors. Yes, the Fed
meeting sparked a dollar rally; and yes, Bear Stearns shook up a lot of fund
assets; however the Monday plunge that started it all was
sparked by a global recession fear.
Normally a recessionary environment is actually bullish commodities
since many other investment realms push money into tangible investments and
commodities typically allow for an uncorrelated play. However commodity prices are at such severe
highs that the industry will see a demand drop as economies around the world
suffer difficult times and are exposed to price inflation. Markets like cocoa, sugar, gasoline and
coffee owe a lot of its demand to ‘wants’, while markets like corn and rice
fall more into the ‘need’ category.
This is an important issue that will change the demand structure of
several markets in the coming years if we are in fact exposed to a prolonged
global recession. Moreover, if the
market is going to adjust to this trend then this selloff
we just experienced is just the tip of the iceberg.
2)
Is it over?
Many fund managers were posting
profits in excess of 25% in just the first two months of ’08, let alone the
strong year just ended. Taking profits
in an overbought inflated environment just makes sense for a fund manager who
is rolling in the dough from some serious profit based incentive fees. Throw in increased margins and volatility
in almost every commodity sector and you have good reason to run for the
exits. To top it all off, a long overdue
pop in the dollar is going to really damage commodity prices in the near term
as most commodities are priced globally in U.S. dollars. This has a reverse inflationary effect on
commodity futures prices as it will reduce global demand if price levels are
sustained.
When you stretch a rubber band
as taught as these markets have been stretched to the upside, the snap back
can be fast and furious. We got a
taste test but by no means is this going to just be
a blip on the screen of a bull commodity market. We are on the way down, maybe 30-40% more
in some markets, and this past week’s bounce gives us bears a chance to get
back in. Net to you, the trader, this
means the perfect storm has come together and the rest of 2008 is going to
offer some serious price volatility.
For an options specialist like myself this an exciting time. Volatility breeds opportunity, and options
are an excellent vehicle during volatile times such as these.
Energies
Volatility spikes in crude oil are all over the map lately
as the market tops at $110 but rebounds as last week’s inventory report
offered a bull shocker. A one day $10
crude oil plunge is right around the corner so play long term deep OTM
straight puts. Natural gas is offering
some support as we amp for hurricane season and a short term put play here is
recommended.
Financials
The stock market remains choppy but is a solid short as
it tests a resistance bad between 1350 and 1380. Target a retest of the lows by Memorial
Day. Bonds are still stuck in a range
and are a great premium collection opportunity as it holds between 125 and
112. The dollar is getting volatile as
it tries to hold the lows, a price expansion indicator with some key turning
point signs pointing to a major trend reversal. Get long the dollar by buying euro currency
and Canadian dollar puts. The yen is
exposed to a carry trade support despite this export based country’s need for
a dilution in their currency, so I would avoid this market until the Fed
stops cutting rates.
Grains
The grains are a blank slate heading into the monster prospective
plantings report due out Monday morning.
The market is susceptible to a massive selloff
regardless of the report’s data as reports like this one often act a catalyst
for a trend reversal. We all know the
grain sector is exposed to high demand and no carryover inventory. We all know that any issues in this year’s
planting, growing and harvest seasons could devastate the global supply
picture. But that’s just it…we all
know. Prices are at or near all time
highs in all the grains. The premium
is already in their. Get this report
out the way and what will the market have to support prices? The selloff from
the other week is a good indication of not only how easily this market can
turn, but also how volatile it will be when it does. If the market rallies on the report then
jump on some long term puts and watch the volatility spike when the sector
turns.
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Meats
Cattle broke
key nearby support and is a sell along with the grains, however it is
testing a longer term support that would need a break below 85.60 to give
confirmation. Buy puts if we see a
Monday bounce. Hogs are range bound
and not a market worthy of a play.
**Chart
courtesy of Gecko Software's TracknTrade
Metals
Gold and silver’s volatility from
the top was reminiscent of when gold broke 430 resistance only to immediately
reverse (proportionately speaking).
Now that event ultimately gave gold bugs and investors a great entry
point to a much longer term sustained rally, while this recent top is likely
setting up a longer term trend reversal in a market sector that has had one
of the biggest 6 month bull runs in history.
This sector appears more exposed to a crash than any other sector.
Softs
Coffee appears to be establishing
a value support following it’s more than 20% retracement
from the recent highs. I am cautious
but see some long strangle or call buying opportunities here as the market
breaches critical weekly trend line support but holds the longer term monthly
support. I could see coffee testing
120 but just as easily testing the highs at 170 – sounds like the risk-reward
to play the rally is well worth it to me.
Cocoa
is congesting into a pennant after setting its top just under 3000. Short bounces. OJ is ugly on a chart but an
excellent value buy here for a long term play through hurricane season. Cotton is choppy and avoidable until the
smoke clears from the USDA report.
Sugar remains choppy after retracing from a strong price surge – not
worth the premium for option plays and not worth the risk to sell premium
either.
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