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The
Weekend Commodities Review
By Head Analyst
James Mound
For the Week Ending
October 19th,
2008
General Market Commentary
Historic volatility and fund liquidation has forced an
epic selloff that, simply put, has gone too far too
fast. In the beginning of 2008, marked
by my 2007
Year in Review and 2008 Forecast, I called for a monumental pullback in
commodity prices during a dollar rally in 2008. I may have been a little early to the party
but nevertheless this industry wide price plunge is the culmination of years
of commodity price inflation coming to a head. The S&P 500 has seen one of the largest
one year drawdowns in history. Crude oil is down over 50% in under 4 months.
Cotton has come down from 90 to sub-50 prices in the same time
frame. Silver is down to about $9 from
$20 price highs seen just a few months ago!
Do not get caught up by the fact that you did not ride this all the
way down.
Traders have been looking for value entries into
commodities for a couple of years but now everyone is so panicked by the ‘global
recession’ that they are afraid to jump in.
So you must ask yourself a simple question – is the commodity bull
market over? The answer is simply…no. Prices do not move in a straight line,
despite the last couple of years illustrating a reasonable counter
argument. For the most part there are
price retracements along the way. The likelihood of general commodity prices
testing the relative highs set throughout 2008 some time next week or next
month is not that good. However, there
is value to be bought, and there is cash on the side waiting to buy it. The dollar rally has likely seen the main
part of its 2008 rally and should offer a chance for the euro to bounce
before year’s end, thereby igniting a commodity price rally – one that could
be epic in its own right.
However, with all this volatility is there a way to get
in on the value without losing everything you have if your timing is
off? For the options trader the answer
is a resounding yes!
There are outrageous premium collection opportunities out
there for the risk takers, and there are numerous value plays for upside
rallies in key markets using long option strategies for the risk averse. The question is not whether this is a great
time to participate in commodities, but rather how and whether you have the
backbone to jump in when so many are running for the exits.
Instead of my normal Weekend Review format I think it is
best to just readers a little peak into what my brokerage customers and subscribers
to my Mound Trade Signals get
on a regular basis (of course I will leave the strike prices and entry prices
out – that I will save for my customers).
Let’s just focus on trade concepts this week and we can get back to
fluff next week.
Energies
For much of 2007 and 2008 I have argued that there is
probably about $50 or so in hype premium in crude oil, which has effectively evaporated
with this recent plunge. The market
should quickly test $100 and I believe there is money to be made on the
upside with short term bull call spreads.
The skew in crude has flipped to the put side and selling a put spread
to pay for that call strategy is a great way to go. Natural gas should go along for the ride
and has a lot of ground to make up, but is best traded with straight calls.
Financials
Premium collectors in the
S&P are in mega-panic. This has
inflated all option premium to epic levels. If you have the intestinal fortitude, sell
premium over multiple time frames in this market and collect the excessive
option premium being offered on second standard deviation options. Look at November strangles and March ratio
credit spreads.
**Chart courtesy of Gecko Software's TracknTrade
Bonds are all over the map and the downtrend could easily
continue as the liquidation going on in that market takes it by storm. Avoid.
The dollar has reached my 2008 target and even pressed it
a bit. The euro is likely to rebound
and straight calls are the way to go. The
Canadian has spiked in volatility to an historic level that is unlikely to
continue. Leg into a short strangle,
out in December options.
Grains
The beat down in grains seems
like too much too fast, but these markets are falling from a very high cliff.
While the gut says to jump in and buy up some bull call spreads, I can’t help
but think there are better plays out there than trying to time a harvest time
turnaround in this sector. Rice
plunged as anticipated and may have some more downside, despite lacking a
clear way to take advantage of it.
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Metals
The market to watch here is silver, but the options
market is very expensive. Sell a put
to pay for a call and make a synthetic long stab at this market that is way
too oversold. Gold should make a move
as well and I like selling a tight near the money put spread to pay for a
wider bull call spread as a way to jump on this market.
Softs
The cocoa train has left the
building and is heading south for the winter.
There is more downside here, and the put premium spike is no where
near pricing in what I see as the potential downside for this market. Wait for a bounce and then jump on some
straight puts for a move down to the 1500 area. Coffee is a the value buy of the decade and
long futures are the best way to capture that value, but straight calls and
bull call spreads aren’t bad either.
OJ is way past my 105 downside target but remains a long term value
and a short term rally play. Look at some March calls and wait for the
volatility spike (ever since the 2004 hurricanes everyone forgets winter
brings frost risk). Cotton is ready to
run higher and I am a buyer down here with straight calls, despite Friday’s
volatility spike. There is more to
come in this market. Sugar is choppy
and not worthy of a play at the moment. Lumber remains a value buy with calls long
term.
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