A lot of action in the Cocoa Market so far this year. Many people have been asking me how to play it. If you don’t want to trade futures or options, you can always trade NIB iPath Dow Jones-UBS Cocoa Subindex Total Return ETN.
Battle Pits Cocoa Speculators against Chocolate Makers
On the morning of July 15, 2010, Nauck realized he was being attacked.
It was 8:30 a.m. on a cloudless, beautiful day. Nauck was sitting at his desk made of polished Oregon pine on the fifth floor of an old factory building with a view of the church spires in Bremen’s market square. Nauck was going through his mail. The quarterly figures were looking good, the company had just hired 62 temporary employees and the economy was picking up steam. As he was going through his morning routine of checking prices and stocks online and glancing at a few websites, Nauck saw something that startled him.
The price of cocoa was dramatically high. In just two days, it had risen by 132 British pounds (€148, or $220), and it was still rising. During the course of that trading day, the cocoa price in London would climb to £2,732 per metric ton, a 33-year high. It made Nauck fear for his livelihood, his workers and his factory — in short, for everything he was about.
Nauck is the majority shareholder and managing director of Hachez, one of Germany’s 90 chocolate makers. The company was founded in Bremen in 1890 by Joseph Emile Hachez, and Nauck’s grandfather was already a co-owner in the 1920s. In 1990, when the company was in trouble, Nauck took out millions in loans and bought shares in Hachez. As the company’s new managing director, he updated its product line to suit modern tastes.
Anthony Ward, the man behind the attack on Nauck, is sitting in an office in London. The fund manager and trader has been given the nickname “Choc Finger,” a play on the James Bond villain Goldfinger. In the industry, though, it is meant as a term of admiration.
Anyone who understands the basic rules of Ward’s game, commodity speculation, can also understand why the global economy is plunging from one crisis to the next.
Ward doesn’t like journalists, and he hardly ever grants interviews. Instead, he employs two public relations agencies, whose publicists can say a lot without saying anything.
A broad-shouldered man in his early 50s, Ward grew up in an upper-class family with a long line of merchants. His grandfather reportedly supplied the British Navy with rum. His office is in a black-painted townhouse in Mayfair, London’s most exclusive neighborhood.
“When it comes to money,” says a man who worked with Ward for years, “he focuses on this goal alone.”
Cornering the Cocoa Market
Ward had long spoken of his ambition to corner the world cocoa market, and he had already attempted to do it twice before, in 1996 and 2002. He embarked on his third attempt on July 15, 2010.
Ward’s plan could work because the global economy has become more and more complex. The price of cocoa has been rising — seemingly unstoppably — for the last five years. But this is only part of the global boom in commodities. Over the last year, the price of wheat has risen by $4.83 per bushel, to $9.03. In the same period, the price of a metric ton of corn has gone up from $3.46 to more than $7.00.
Commodities speculation fuels inflation in India, drives up the price of tortillas in Mexico, causes famines and fuels political unrest. Speculators act as accelerants — and the smaller the market, the easier their game.
Cocoa makes up one of the world’s smallest commodities markets. Indeed, the annual harvest amounts to only 3.5 million tons, with more than half coming from Ivory Coast and its eastern neighbor, Ghana. The average price per metric ton is £2,000, meaning that it takes only £7 billion to buy a year’s harvest.
The cocoa market’s simplicity makes it particularly vulnerable to speculative attacks and attractive for the billions of roving dollars and euros. Depending on the estimate, speculation in the commodities markets alone entails somewhere between $400 billion and $800 billion. Ten years ago, it was only about $5 billion.
Experts say the money comes from three sources: from private wealth investors or, in other words, the world’s super-rich; from banks trading for their own accounts and at their own risk; and, finally, from pension funds in the West investing the retirement savings of millions.
The cocoa business is actually very straightforward. During the harvest, traders buy cocoa beans directly from farmers in places like Ghana and Ivory Coast and, later, they resell them to chocolate makers in Europe. Since traders can’t know when manufacturers will buy their cocoa, there is an exchange, where traders and others can buy and sell goods at any time. Still, the downside for traders is that the price that the exchange offers is generally lower than the price that chocolate companies pay.
To make cocoa scarce, Ward had to manipulate how the cocoa business works. He had to lure traders away from the chocolate factories and convince them to sell their cocoa on the exchange, instead, because it was only there that he could buy large quantities of cocoa in an ambush-like maneuver.
Chocolates may not come easy on the pocket as cocoa prices surge ahead in the domestic market due to global supply constraints.
India imports more than half of its requirement of cocoa every year with demand increasing at a rate of 8% per annum. “With supply from Ivory Coast disrupted due to political problems, availability is low in most of the markets,” traders said.
Indian cocoa prices are now at a premium of more than 12-15% compared to the global markets. Dry beans at the farm gate are above R175 per kg while wet beans are selling at around R55 per kg in Kerala. “There is a scramble for cocoa and the supply is tight. Farmers are getting good returns for their crop,” Shiny George of Indian Organic Farmers Company.
Ivory Coast produces nearly 40% of the world’s raw cocoa, valued at about $3.8 billion. Interestingly, the wholesale price of cocoa has been surging ahead and doubled in the previous four years as global demand increased, particularly in India and China.
No one is taking the cacao or cocoa plant for granted these days. Chocoholics and chocolate manufacturers everywhere are anxious about the political turmoil in the Ivory Coast, the West African nation that produces nearly 40 percent of the world’s raw cocoa, valued at about $3.8 billion.
“Cocoa prices should come down by another $100, but not more, as there is a logistics nightmare waiting for the supply chain on the ground — banking, storage, trucking, workers, cash. No one will return until the guns are silenced.” – Luis Rangel, ICAP Futures
Alassane Quattara, the winner of the Ivory Coast’s November presidential election, suspended all cocoa and coffee exports for 30 days to cut off funds to incumbent President Laurent Gbago, who refused to leave office after a run-off election and who threatened to take over the purchase and export of cocoa.
While 68 companies are licensed to export cocoa from the Ivory Coast this season, the market is dominated by major international firms, such as Cargill, Archer Daniels Midland and Barry Callebaut AG. Among them, they bought 630,371 tons of cocoa during the 2009-10 season, more than half of the tonnage registered.
Cargill Inc.’s Ivory Coast unit honored the ban and suspended purchases. ADM told Dow Jones it was evaluating the situation, as did Barry Callebaut, adding it had sufficient cocoa stocks to cover its processing needs.
Even before the ban, the wholesale price of cocoa doubled in the previous four years as global demand increased, particularly in Asia. Uncertainty of supplies — and British commodity trader Anthony Ward’s attempt at cornering the cocoa market last year — led to cocoa powder prices holding at historical highs in 2010, and it appears volatility will continue to put pressure on prices.
Jim Rogers breaks down commodities from an old interview.
Jim Rogers : Missing out on Commodities?
Matthew Bradbard’s daily commodity round up:
Brace for the Fed as we expect it to be a market mover. Indecision in the oil market as prices close virtually unchanged today. If we fail to make a new contract high in the next few sessions we should resume the set back we’ve been forecasting, in June that would be a trade over $114.05. A settlement below the 20 day MA should confirm a move lower but before either scenario happens we’re just guessing, that level is $108.90 in June WTI. We suggest the sidelines in natural gas willing to be a seller on a spike higher. We cut losses for clients that still held bear put spreads in the June ES; it resulted in a loss of approximately $400/per position including fees.
0:20 It’s a one-sided directive in Europe. The ECB’s only job is to control inflation.
0:55 The big question is whether the U.S. dollar should be the reserve currency; it no longer is, it shares that role with the euro, other currencies, and commodities. But it’s not just gold being used as a substitute, but oil too, which is putting upward pressure on the market.
1:55 The euro is under “some cloud.” It is “quite inappropriate” for the ECB to raise rates right now.
2:30 China, and its inflation problem, is a serious concern. It stimulated its economy, but is now trying to reign in its rate of growth. It is putting restraints on the banking system, but now a shadow banking system is rising. Big banks may not be willing to lend, but the shadow banking system is growing out of control. Real risk of wage and price inflation. Real estate price spike has led to a wage price spike. The Chinese government should have let its currency inflate, but because they didn’t, they now face wage inflation.
4:40 China was the main beneficiary of globalization, and the big winner in the financial crisis.
6:00 State capitalism may have worked better in China lately, but it’s a mistake for others, like Brazil, to follow suit now.
“Two different directives govern the European Central bank and the U.S. Federal Reserve. In the case of Europe, it’s a one-sided directive. Their only job is to prevent inflation, and in the case of the U.S., it is more balanced, to maintain employment and financial stability.”
On whether the U.S. dollar is still a safe asset:
“There’s a big question whether the U.S. dollar should be the main reserve currency and in fact it no longer is because it maybe accounts for two-thirds of the monetary reserves. The euro is an alternative and there’s a lot of diversification into other currencies and even more into commodities. Not only gold, but actually oil is now an asset class for investors. That has put some upward pressure on the commodities.”
On whether the sovereign debt crisis has diminished euro’s chances of becoming a reserve currency:
“The euro is under a cloud, but that is exactly because there are some inflationary pressures from the price of commodities, particularly now oil and also food prices have risen. That is what has induced the European Central Bank to raise interest rates at a time which is, in my opinion, quite inappropriate…It is not appropriate in current circumstances when you have a number of countries that are suffering from too much debt and high interest rates that they have to pay.”
On China’s economy:
“China has really stimulated its economy full force very successfully and now it is trying to rein in the rate of growth, and is exercising very strong constraints on the banking system. But because of that constraint, and because of the big demand for money, a shadow banking system has arisen and is growing very rapidly. So while the big banks under direct central control are in fact refusing to lend, there is a shadow banking system that is growing out of control. There is a real danger there of wage price inflation because prices have gone up, particularly real estate prices have gone up because there was a real estate boom.”
“Therefore, wage demands have risen, and we now have 20%, 30% wage increases. The Chinese government has made a mistake not allowing its currency to appreciate, which would have controlled the price of inflation. Instead of that, we now have this wage pressure, which is a little bit out of their control.”
Violence continues as former president refuses to concede defeat
What began as the week when Laurent Gbagbo would finally concede defeat ended with the Ivory Coast strongman defying the world from his bunker in Abidjan. After watching his area of control shrink to only a few pockets of the lagoon city, his forces pushed back dramatically overnight on Friday with an assault on the French ambassador’s residence.
AFP reported yesterday that Abidjan’s Golf Hotel, headquarters of the internationally recognised President-elect, Alassane Ouattara, had come under attack. The UN evacuated 17 British citizens from the high commissioner’s residence, which is close to the Gbagbo compound.
The heavy weapons that had supposedly been destroyed in joint UN and French air strikes re-emerged as Gbagbo loyalists retook some ground. Arrayed against the 65-year-old loser of November’s election are the combined might of the French Operation Licorne (Unicorn) force, UN peacekeepers and Mr Ouattara’s ragtag army.
The violent standoff has created its own tale of two cities: each day the commercial capital seems poised to return to normal but at night the shooting starts and everything becomes uncertain.
It is not a war with a single frontline. The complications of Abidjan’s lagoon is matched by the complex of alliances that rule its neighbourhoods. In the south of the city, the long queues for food outside the only working supermarket show the struggle to return to normality.
I had a feeling Laurent Gbagbo wasn’t going to roll over.
Gbagbo forces advance again in Ivory Coast
And as if silver bulls needed some more good news, here is a report from the Morgan Stanley metals desk…
I was told on Wednesday that big buying went thru on Tuesday in may atm silver calls which should make the market short gamma.
A short gamma position will become shorter as the price of the underlying asset increases. As the market rallies, you are effectively selling more and more of the underlying asset as the delta becomes more negative.
So what that means is that the SELLER of the calls, probably bought Physical to delta hedge themselves neutral. As this market jumps just about 1-2% daily (this week alone +6.5%) they would need to now re hedge to bring themselves back to neutral by BUYING more Physical as SILVER goes higher, essentially driving the market Higher still and so the chase goes theoretically moving the market higher causing them to buy more to hedge and moving the market higher, thus buying into rallies.
Now they could BUY puts also to create positive Gamma as well to offset some of that pain they are not bound to the Physical for their hedge. Lots of what if’s but that’s the idea.
On the other side if Silver were to gap lower, this would not help either as they would need to SELL Physical into a falling market to re-hedge themselves.
Great in a slow steady market, nightmare in a volatile
Jim Rogers: Buy the rmb [renminbi, the Chinese currency].
Bill Bonner: We are in a period much like the period following WWI, in which the great debts and losses of the war had to be reckoned with. It is an era of great risk. The U.S. faces many of the same challenges faced by Germany and England after WWI. Like England, it has huge debts. It is a waning imperial power. And it has the world’s reserve currency. And like Germany, it is attempting to fix its problems by printing more money. This is not a good time to be long either U.S. stocks or U.S. bonds.
Peter Schiff: Don’t be suckered into the idea that recovery is just around the corner. The current climate is like living in a hurricane or earthquake zone; it’s important to stay vigilant because you never know when disaster will strike. Physical gold is the financial equivalent of a flashlight, first-aid kit, and store of canned goods. It’s a basic way to protect yourself from any eventuality. From there, if you’re looking for returns, there are plenty of foreign markets with strong fundamentals, as well as commodities that feed those markets.
Investing in the U.S. is now driven largely by force of habit. It’s a habit you should resolve to break.
Jeffrey Christian: Do not invest based on what you believe, but on what you know. Gold is a market, like other markets. It rises and falls. You probably want to stay long gold on a long-term basis, but may want to cull the weaker gold assets from your portfolio in the first quarter, and put some hedges in place to protect a long-term core long gold position against the potential of significant price weakness over the next two years or so. Such a period of weakness would be an excellent time to add to one’s gold assets.
John Williams: As an economist, I look for the U.S. dollar ultimately to lose virtually all of its current purchasing power. Accordingly, for those living in a U.S. dollar-denominated world, it would make sense to move to preserve wealth and assets over the long-term. Physical gold is a primary hedge (as is silver). Holding some stronger currencies outside the U.S. dollar, as well as having some assets outside the United States, also may make sense.
Steve Henningsen: Dramamine (for volatile markets), a stash of cash (for potential investment opportunities), and move some of your assets offshore if you haven’t already.
Frank Trotter: My advice is first to look at the other side of your balance sheet – the liability and risk equation – before seeking out absolute gains. What are your goals, what resources do you already have to meet those goals, and what events (health, income stream, upheavals) might impact these risks? Place some assets to hedge these risks directly, then look to diversify globally into markets with higher growth potential than we see here at home, and that may balance your global purchasing power risk. Almost like a religion, we have had the phrase “Stocks are the only legitimate hedge against inflation” beaten into our heads. I say, look at assets that define inflation like commodities and currencies and evaluate where these fit into your risk portfolio.
Krassimir Petrov: Last year I recommended silver, and I would stick to silver again, despite the phenomenal run in 2010. Then it gets tricky. I usually don’t recommend diversification, but now I would again recommend a broad portfolio of commodities. Investing in 2011 should be easy: stay out of real estate, out of bonds, out of fiat currencies, and out of stocks; stay fully invested in commodities, overweight gold and silver.
What to watch in 2011: stay focused on the sovereign debt crisis and bond yields. Spiking yields will trigger the next stage of the crisis.
Bob Hoye: Once past the early part of 2011, the best returns are likely to be obtained from the junior gold exploration sector.
Here is Jim Rogers breaking down the economic impact of Japan disaster:
“normally when something like this happens it leads to a chance to buy things , all man made or natural disasters in the past meant that you could buy something, now I am not buying anything I am just watching at the moment , this is horrible and we do not know how it all gonna wind up, I would thing buying commodities would be better than buying stocks but I might buy both”, says Jim Rogers
Crude oil prices have been rising. Do you see supply constraints on mounting pressure from West Asia or speculation?
Of course, it’s supply constraints. Libya has closed down some of its oil production, while Egypt is having problems with its production. There are turmoils in many countries and this is causing supply problems.
These may be temporary problems, but the world, in the mean time, is losing some of its inventory. So, if there is calm and peace tomorrow, we may have oil go down for a while, but the basic problem that the world is running out of known oil reserves continues.
What is your medium-term outlook on crude oil?
Crude oil will continue to go higher, though there can be intermittent corrections. The price of oil is going to continue to rise for years to come.
The dollar index has fallen almost 6 per cent in the past three months. Do you feel that the dollar is losing its appeal as the reserve currency?
Yes, it is an ongoing process. The correction has been severe. But, that is going to happen with the US dollar, as it continues to lose its status as the reserve currency. It is a terribly flawed currency.
Are you investing in other currencies? Which is your favourite and why?
The renmibi is my favourite currency. China has a gigantic balance of trade surplus, and it is the largest creditor nation in the world.
It has a lot of things going for it. Clearly, a currency that can and will go up is the renmibi.
The Chinese are trying to hold it down now, rightly or wrongly. And, I think it is a mistake to try to hold it down. But, the renmibi is the currency that has to appreciate a lot in the next few years.
The bull run has just begun in agricultural commodities. How long do you see that lasting?
I am very bullish on agricultural commodities, probably more than other class of commodities. My favourite agri-commodity is rice.
What is your outlook for gold and silver?
I own both gold and silver and I am neither selling nor buying these two precious metals at current levels.
This week, there are supposedly going to be mass demonstrations/protests in Saudi Arabia. If this happens, gold and silver prices will surge and I will then buy. So, I am not buying gold and silver right now, but I am certainly not selling.
After the recent correction, how are you viewing the Indian equities?
I am just watching. I have sold/short emerging markets and emerging market (EM) ETFs.
EMs have been one of the most exploited sectors of the market in the last two-three years. I have sold/short emerging market and I am not buying any markets anywhere except commodities.
When comparing other asset classes we do not think that commodities are superior, though we do like the non-correlation to other asset classes. The performance of most commodities is independent to the performance in the stock market, bond market or real estate market. The U.S. stock market has just clawed back to levels seen before the financial crises, while the jury is still out on whether the housing markets have bottomed yet? With yields at near record lows in the Treasury complex we doubt a sizeable allocation here is the answer for investors either. Because we are clearly in a bull market in commodities, with a number of them reaching record if not multi-decade highs, we suggest getting on board. Many investors I speak to feel they have missed the boat. I disagree, while I feel the train has left the station we think there is much more upside in the quarters and years to come. Additionally most commodity investors are not long only so there will be opportunities to speculate on price depreciation as well.
Find below a brief overview broken down by sector as to what we feel 2011 has to offer commodity investors.
Agriculture: If the first month of trading in the grain market is any indication of what is to come, expect your grocery bill to increase this year. Since the October USDA crop report we’ve seen a bullish sentiment in the grain complex. Ending stocks in corn have been reduced to their lowest level since 1996/1997 pushing the stocks to usage ratio to under 7%; the second lowest in history. The increased usage from China and abroad should mean exports ramp up in the United States again this year. Weather is the wildcard currently in the South American crop and then in the United States in the spring and summer. It is not just the United States that is dealing with tight stocks as the world stocks/usage ratio is just 14.5%, the second tightest setup since 1973. Ethanol usage is perhaps even a bigger wildcard as the demand outlook is unclear. My belief is that corn prices still need to move higher to curb demand and to attract more acreage.
Wheat was the first major agricultural market to surge to record highs in 2008/2009 but of late the price action has taken a back seat to soybeans and corn. The end result was because prices reached such extremes, we’ve seen production increases globally that have tempered prices. Wheat will continue to react to movement in the dollar and on growing concerns of food inflation. The two biggest countries that could affect movements in wheat are Egypt and India. Egypt, being one of the largest wheat exporters, has been forced to build reserves because of the drought in the Black Sea region. While India has harvested a bumper crop in 2010, they still maintained a ban on wheat exports. The underlying quandary abroad is increased food insecurity. United States farmers have done a good job of taking advantage of higher pricing as ending stocks in 2010/2011 are projected to be the second highest in history. Assuming normal weather we believe the wheat market will see increased supplies and we could see prices trade back near the $6 range.
Like many commodities China has been the driving force in the soybean market. For many producers they can say 2010/2011 will be their most profitable years ever. You have not seen a more significant jump in acreage because the margins at the moment are even better for corn. Case in point is the soybean/corn ratio, which at 2.1 is near the lower end of the 30-year range. Given the current fears of a possible drought in South America and a late start to plantings, coupled with the surge in demand from China, we think 2011 will be another bullish year in the soybean complex, albeit particularly volatile. Demand is undeniable but there may have been too much weather premium built into the market, so on ideal weather expect that premium to be stripped out of the market. As it stands now the world’s balance sheets are showing a production surplus but the recent reductions are far from bearish. There may be more upside in the months to come but with record net longs in place we think there is more potential downside surprise than upside in the immediate future.
Softs: Volatility was the name of the game in sugar in 2010, as prices more than doubled reaching multi-decade highs by Q4. As we enter 2011, if we see continued weather issues in Brazil it could set the stage for an additional price surge as we’ve been unable to truly rebuild supplies with growing demand after the previous deficit. World sugar stocks remain near 17-year lows and the stocks/usage ratio is dangerously narrow. Weather was the problem last year with a drought in Brazil, the Black Sea region and Russia contributing as well were floods in Europe and Thailand. Major weather events shifted what was expected to be a 4-6 million tonne build to potentially no surplus or another deficit. China’s output is expected to recover but the problem may be that their usage may grow at a faster pace. It’s feasible that China could become a major importer in 2011. In our view, it would not take much to see the tight supply imbalance to make sugar a good candidate to buy and hold after we get a 10-15% correction in the next few months.
For the first part of 2010, coffee traded sideways and then from June on, prices appreciated 70% lifting coffee to over $2/lb. for the first time in nearly 15 years. Beginning stocks were tight to begin with and much like sugar, adverse weather in South America helped propel prices higher. We go into 2011 with coffee too pricey and it would take a healthy correction for us to get interested in longs. In fact, aggressive traders could gain bearish exposure to play a 10-20% depreciation in Q1 and Q2. The fundamental picture is mixed with very tight ending stocks, but we should have ample supply as across the globe is expected to have record production.
Cotton futures surged to all-time highs in 2010 and currently look poised to challenge those levels once again. Exports have continued to increase in the face of the market making new highs, so until we see that let up expect the trend line near $1.30 to act as solid support. Because high prices to date have yet to ration out demand, we will likely see fresh highs. If demand continues to expand into 2011 this could pose a major problem even with the domestic crop getting off to a good start because if the Asian demand is growing at a faster pace we still need to rebuild US stocks. Cotton will need to capture 2-3 million additional acres in 2011 but the challenge is other crops i.e. corn and soybeans may be more profitable. We do however feel that in time, likely several months when we start to experience a slowdown, a trade back under $1 is not out of the question. The fact that the December 2011 is trading at a 37% discount to the front month is an indication that these levels are not sustainable.
OJ was sideways for the first part of 2010 before trending higher from mid-year trading to $1.80; levels not seen since early 2007. We start 2011 with a positive outlook on OJ but like coffee we expect to experience a correction early this year that could drag prices closer to $1.50. A drought in Brazil could take some supply off the world market. That may be able to be offset by larger crops domestically in California and Florida. The problem with that scenario is OJ prices may be more susceptible to price spikes on a freeze in the United States or increased hurricane activity. We would be a buyer between $1.40/1.50 and a seller closer to $2.00.
An attempt at cornering the cocoa market last year was the major headline as grindings in Europe and North America were showing their first gains in over a year. Those actions caused a price spike on both the LIFFE and ICE exchanges during Q2. Once delivery had passed prices quickly turned around dropping 15-20% depending on the contract month. From there we’ve seen a rebound lifting prices back to the upper end of the trading range. The forecast in 2011 is for cocoa supplies to exceed demand, reversing a 2010 production deficit. Major cocoa producers including Ghana, the Ivory Coast and African nations are all expected to have production increases year over year. We expect that if the economy globally remains stable and we experience a resumption of the downtrend in the US dollar we can see prices approach $3500/3600 by Q3.
Metals: A record high in 2010 and the 10th positive year in a row…yes folks gold. This market has attracted gold bugs, safe haven investors, those looking to diversify and perhaps the most influential the ETF crowd. Gold undeniably has become the quintessential flight to quality instrument. From currency issues to the sovereign debt debacle, even uncertainty in the Treasury market, gold remains a popular diversification play in most investors’ portfolios. We suspect we could get a major shake out in gold sometime in Q1 or Q2, somewhere in the neighborhood of 5-8%. In fact it may already be underway. Central banks are far from the best market timers and because they recently shifted from being net sellers of gold to being net buyers, the timing would be appropriate. We continue to suggest being net buyers on setbacks but typically will trade options against futures or incorporate a strategy with both gold and silver for our clients. We do not see a trade below $1250/ounce this year and on the upside we suspect we could approach $1500/ounce.
Gold made the headlines but silver had performance that far outpaced gold last year and we suspect that to be the case in 2011 as well. Prices have retraced off a 30-year high above $31/ounce, and just in a few short weeks we’ve traded nearly 13% off those levels. In January alone, we’ve witnessed a 50% Fibonacci retracement taking prices near $27/ounce for the first time in two months. We view solid support approaching the 100 day MA at $25.50. Silver has been far more volatile (i.e. risky to trade) than gold in the years past but those with the stomach are advised to scale into longs on set backs, as we have a target of $40/ounce by late 2011 or early 2012.
As the recovery took hold and industrial demand re-emerged, copper prices have soared gaining nearly 250% off their lows in late 2008. As there were rampant fears of a double-dip recession, a number of copper producers reduced their production and even eased back on their exploration/mining efforts. So it was a double whammy when supplies were slack and demand came back into the market. As LME copper stocks and Shanghai copper stocks declined throughout 2010 that added fuel to the fire. If we were to see a bump in copper stocks on either exchange we could easily see a trade back to $3.00/lb. which is approximately the median price for copper over the last five years. At $4.30/4.40 we feel prices are over inflated and in the weeks and months to come we anticipate a trade back near $3.45/3.60. While we rarely trade copper for clients we do follow the price action as it is one of the best barometers for gauging the health in the economy.
Energies: A day rarely passes when I don’t hear someone say oil prices are too high, but it’s all relative and I do not share that opinion. Several years ago one of my managers told me as a trader “to dispend my disbelief.” Translation: We’re in uncharted waters and prices will move substantially higher…six years later I accept that statement as truth. I get the argument that based on supply, prices should be lower but more and more oil is treated as an investment vehicle and in some instances even a currency, so fundamentals in my opinion do not play as large a role as they did in past years. Above ground world supplies are near record highs but current demand, and more importantly, future demand expectations are escalating. Refinery interruptions and violence in oil producing regions around the world have in the past and will continue to cause price volatility. 2011 will likely be a bullish year for oil once again as we assume a buy dips mentality expecting prices to see $110/115 by Q3 with solid support between $75/80. One must remember it is not always about oil either, sometimes the tail can wag the dog; as RBOB and heating oil may determine price direction in oil.
With refinery rates as low as they have been it has been an anomaly for RBOB stocks to stay at elevated levels but that has been the case now for several quarters. Ethanol production continued throughout 2010 to post record highs. This may become a larger factor in 2011 as the government has paved the way for increased usage. Weighing first the supply situation in RBOB the current US operating rate is extremely low and it would not take much to cause price instability. Domestically the demand side has shown signs of life, as travel and usage have started to bounce back. To really see demand eat into the exorbitant supply we will need to consistently consume in excess of 9.0 million bpd. That in itself could get prices moving north or continued refinery glitches. We see a range between $2.00 and $3.00/gallon in 2011.
Heating oil was range bound for much of 2010 for the most part wandering in a 50 cent range. A colder winter across much of the country has started to boost demand and will start to eat into the burdensome inventories. It will take a significant jump to put a dent though as we’re coming off record distillate stocks of nearly 176 million barrels in August 2010. The pivot point into 2011 should be if demand can exceed 4.5 million barrels per day. In recent quarters supplies have exceeded demand but exceptionally cold temperatures can change the scope in the coming months. The US refinery operating capacity is also at lower levels so fundamentally we have a bullish set up. Expect increased volatility on weather and refinery issues much like RBOB. We see a range between $2.25 and $3.25/gallon in 2011.
Natural gas was one of the worst performers in 2010 and remains one of the cheapest physical commodities. There is one reason why natural gas has remained at discounted levels relatively close to the cost of production, an overabundance of supply. New all-time highs were reached last year in regards to inventories. A bottoming process has occurred in the last several months, as the market appears to have found equilibrium. We see natural gas as more of a trading range market in 2011 and we will be trading both sides with clients; likely buying near $4 and selling above $5. For this market to gain any significant traction we would need to see either a further cut in rig production, higher oil prices forcing increased usage in natural gas as an alternative or a policy shift from Washington to encourage greater usage. Short covering may also be a potential catalyst being we have a significant short interest with speculative dollars.
Currencies: The currency market is largely guided by direction in the U.S. dollar, which in 2010 was all over the place, gaining 15% in the first half of the year and then falling 10%. The two main questions in determining the direction of the dollar in 2011 will be the impact of a quantitative easing measure taken by the Federal Reserve and if the Fed starts to raise interest rates this year. In recent years the weakness in the dollar has been a key catalyst for a surge of capital into emerging markets and commodities. We expect this scenario to resurface the second part of 2011 but to kick off the year we could see a strengthening in the greenback. Solid support is eyed around the 75.00 level and stiff resistance comes in at 84.00.
The Euro is caught in a tug of war between the perceived strength in Germany and France and troubles in Greece, Portugal and Ireland. The direction in the Euro will largely be impacted by whether the ECB will need to resume monetary easing and how the markets deal with Trichet’s exit. The same trading range that has contained prices in the last six months should maintain the restrictions between 1.2600 and 1.4200.
The Yen was supported due to safe-haven buying and implications due to the carry trade in 2010. This strength has caused severe problems in their economy predominantly with their exports. Expect a series of interventions by the BOJ in 2011 in an attempt to cap further upside. Do not expect the same near 20% appreciation in 2011 that we witnessed last year. In fact, a trade over 1.2500 is not in our forecast and we think a dollar rally could take prices back near 1.1500.
The Swiss franc also found investors interest when looking for a flight to quality taking prices to near record highs for much of 2010. As fears ease around the globe and on a continued set back in gold expect the franc to trade down to the mid .9000’s.
The new government austerity measures in the UK may ease the pain in the Pound momentarily but the quantitative easing should outweigh the positives, so we anticipate further downside. We suggest using the rally we’ve seen in the first part of January to gain bearish exposure. Stiff resistance is eyed between 1.6300 and 1.6500 and we feel we’ll get a steady slide closer to 1.5000 in the quarters to come.
Given that the dollar has such a grave impact on the price of commodities it would only make sense for the commodity-driven economies which include Australia, New Zealand and Canada and their respective currencies, to be impacted by the underlying fluctuations in commodity prices. That being said, further strength should support these three crosses so our suggestion would be for most of 2011 to trade from the long side. Additionally, in New Zealand and Australia the positive interest rate differential should serve as a supporting factor.
Financials: The U.S. equity market far exceeded my expectations last year advancing from mid-year on gaining 10-20% depending on the index tracked. It would appear there is little to no fear from the sub-prime crisis or at least the powers that be have swept these concerns under the proverbial carpet for the time being. While in some sectors we did see top-line revenue gains for the most part the bottom lines appear better because of aggressive cost cutting measures. In order for the trend higher in stocks to continue into 2011, we need to see increased positive corporate earnings, real job growth, a bottom in the real estate market and for consumer spending to truly re-emerge. Low interest rates and the quantitative easing that has taken place could aid in an extended recovery in the short run but we do not feel appropriate for an improvement longer term as we’re kicking the can down the road. All the good news, in my opinion, is factored in and if and when additional shoes drop we may see a 10-15% plus correction. We’ve been thinking this for the last two months and obviously have been premature. We do not expect to see the Dow trade above 13000 and see the upper band in the S&P at 1400 this year. As for downside in 2011, we see 10000 and 1000 respectively.
The rally in the Treasury market in 2010 was largely a reaction to the sovereign debt issues abroad and the threat of a double-dip recession. The rally that took place in the first half of the year was erased in the second half as prices ended the year only marginally higher in price and lower in yield in the long end of the curve. In the short end, prices remained at elevated levels due to the Fed’s desire to focus on the short to middle part of the curve. The sporadic back and forth between the US and China and their pace of debt purchases also contributed to volatility throughout 2010 and will likely persist into 2011. Pay very close attention this year to the monthly capital flow report. If the price of commodities continues to increase the Fed’s hand may be forced resulting in raising interest rates which would have a direct impact across the curve. Continue to monitor the monthly PPI and CPI figure for signs of inflation increasing or abating. We have a sell rallies mentality in this complex in both the short end and long end of the curve.
Livestock: The cattle market saw a major recovery during much of 2010 as improving demand in the U.S., a strong recovery in exports, lower imports and declining production all contributed to an aggressive climb higher in prices lifting cattle to record highs. After the decline in pricing in 2008/2009 cattle reached low enough levels that producers reduced their herds. To complicate the situation a surge in corn prices left the market without an incentive to encourage herd expansion. Beef production is expected to increase Q1 and Q2 of 2011 but the increase is expected to be one of the smallest in the last decade. Exports have started to pick up and as demand increases domestically we see prices trading to new record highs in the coming months.
After a rough few years of major losses in the hog industry a decline in hog supply and demand coming back on line has helped improve margins and cause a major rally in recent months. Nearby futures put in a major low in August of 2009 and have not looked back since more than doubling in value in that time frame. Margins are improving as hog producers are making money again but the surge in inputs will undoubtedly prevent a large increase in herds. Exports have also slowed so we will need to work off some production into the spring of 2011 but then we expect another surge higher. The game changer this year is how large the increase will be in US pork exports.
Conclusion: What an investor should obtain from this report is that commodities should be a portion of your portfolio; a conservative investor should have an allocation of approximately 5% and an aggressive investor is advised to have approximately 20% of their portfolio in commodity futures and options. This can be through a commodity account with a brokerage firm or an allocation to a managed futures fund. In our opinion, there will be ample opportunities across all seven sectors to be both long and short. However one must respect the trend as we see more upside to come, so get involved because investors that ignore the price action in commodities do so at their own peril.
For specific strategies contact us via e-mail http://www.mbwealth.com or telephone at (888) 920-9997 / 954-929-9898. For the most part investors reading this analysis want to be more hands on, however we suggest taking a look at our managed futures section and consider diversifying further via CTA’s with proven track records.
Risk Disclosure: The risk of loss in trading commodity futures and options can be substantial. Past performance is no guarantee of future trading results.
Maybe I have a bias since I run a Commodity brokerage and recently set up a CTA but I believe commodities are currently the best game in town. Please do not misinterpret me that does not mean commodities should be perceived as a get rich quick scheme or commodity trading is even appropriate for every investor. Trading commodity futures and options is extremely risky and not for the faint of heart. In my eyes commodity investors must posses two things, first the financial wherewithal and second the intestinal fortitude. We suggest conservative investors have 5% of their portfolio exposed to commodities and aggressive investors have no more than 20% of their portfolio exposed to commodities.
Reviewing what happened last year in commodities: Metals traded higher for much of 2010, standouts include copper and gold reaching record highs while silver appreciated nearly 85%. As did more obscure markets like pork bellies and cotton trading at record highs. Sugar and cocoa hit their highest level in three decades. And while oil is well off its 2008 peak near $145 trading at current level prices are higher than before the collapse of Lehman Brothers. It has been a good two years for commodities as a whole; the Dow Jones-UBS Commodity index was higher by 16.8% in 2010 after an appreciation of 19% in 2009. The run higher in commodities is largely due to unquenchable demand from China and other emerging markets. We see no let up on demand in the immediate future and identify further complications by the slackening growth in drilling, exploration, mining and farming. More money chasing fewer opportunities could also be a contributing factor. Capital is finding its way into this asset class via hedge funds, pension funds and institutional investing. According to Barclays Capital as much as $136 billion of new money may have found this space in the last two years.
There is no question bulls were in the driver’s seat in the metals complex in 2010. Gold continued to shine last year marking its 10th straight positive return. Economic instability and fear of inflation were contributing factors but perhaps increased investor demand may have been the major catalyst for gold performance. Platinum and palladium were along for the ride jumping on the back of a global recovery in the automobile industry. Resurgence in industrial demand helped lift copper to record highs and aided in a near 85% appreciation in silver as well.
Last year in agriculture we started out seemingly with a supply/demand balance but circumstances quickly changed. A drought in Russia sent wheat prices soaring with corn and soybeans along for the ride. Corn ended the year up gaining over 50%, soybeans just under 35% while wheat racked up a respectable 58% appreciation. Floods in Pakistan cut the cotton harvest short and Chinese imports soared resulting in record high prices in cotton. Coffee gained nearly 80% due to some weather issues in South America, so Mother Nature played her role in 2010 increasing price instability in a number of commodities. We are not out of the woods yet as dry weather in South America currently could threaten the size of the harvest once again causing price spikes in agriculture markets in 2011. A further game changer is what decision farmers make domestically when choosing what crop to plant and how much acreage to allot.
The energy complex had its moments in 2010 but for the most part the headlines in commodities were elsewhere. Robust demand globally was tempered by record-high stockpiles. The stock market and oil for most of the year were heavily correlated so large economic forces were a bigger factor in 2010 than in years past. Prices of WTI oil remained within a $30 band in 2010 ending the year higher by just 15%. According to the IEA global oil demand was at an all-time high in 2010 and expected to expand in 2011 so it would not take much to see the price spikes in oil that we’ve grown accustomed to in recent years. On the supply side a number of producers have curtailed their spending due to the financial crises and have yet to come fully back on line. The distillates (HO and RBOB) followed suit tracking oil for most of the year and that should remain the case in 2011. Natural gas was among the worst performing commodities in 2010, down 20%. Prices were weighed down by increased supplies and weak demand.
Find above the major happenings in the commodities market and below the major events that shaped 2010 as a whole:
Major happenings in 2010, in no particular order:
GM predicted they would make money in 2010, a bold prediction for a business that exited bankruptcy in the summer of 2009.
The CBO predicted that the nation’s jobless rate will not return to 5% until the middle of the decade.
Ben Bernanke won Senate confirmation for a second term as Federal Reserve chairman.
The Dow finished down 3.5% in January, its weakest month since February 2009.
The New Orleans Saints won the Super Bowl, suggesting an up year for stocks for believers of the Super Bowl Predictor theory.
European leaders refused to let Greece succumb to a credit crisis.
Iraqi elections opened to violence and fraud claims.
The Federal Reserve announced they will end their purchase of $1.25 trillion of mortgage-backed securities. One of its main supports for the economy.
The House approved a historic healthcare overhaul.
President Obama signed the healthcare overhaul into law.
Greece won support for a deal that could lead to a bailout, as leaders of the 16-nation euro zone backed an accord that the IMF would serve as a back drop should the nation’s debt intensify.
President Obama proposed more oil drilling in the Gulf of Mexico.
Q1 ended on a positive note with the Dow gaining 4.1%, in a volatile three months.
Alan Greenspan came under criticism as the former Fed chairman for his role in the financial crises.
President Obama and Russian President Dmitry Medvedev signed an arms-control pact, dubbed New Start.
World leaders pledged to secure nuclear fuel by 2014.
Ash from an eruption of a volcano in Iceland drifted across Europe causing the largest airspace shutdown in years.
The Dow closed above 11000 for the first time since September 26, 2008.
A BP operated oil rig in the Gulf of Mexico exploded and sank spewing oil for months.
Greece’s credit crises spreads to Portugal.
New York’s Time Square was evacuated as a car-bomb plot was evaded.
“Flash Crash” Dow closed down 3.2% after an apparent trading glitch sent the index down nearly 1,000 points intra-day.
President Obama picked Elena Kagan as his Supreme Court nominee.
The European Union agreed upon a $955 billion bailout plan for the euro-zone.
Goldman Sachs reported they did not have one single daily trading loss in the Q1.
David Cameron took over as Britain’s prime minister.
General motors reported its first quarterly profit in three years.
Germany banned some types of naked short-selling in an attempt to avoid “excessive price movement.”
BP came out reporting that the oil leak was far bigger than originally estimated.
The Dow dropped 7.9% in May, its weakest May since 1940.
BP began its “top kill” operation to stanch the oil flow.
The SEC signed off on new “circuit breaker” rules designed to tame volatility in individual stocks.
The UK government unveiled a shake-up of its financial regulatory system that will consolidate power within the Bank of England and dissolve the FSA.
China’s decision to make its exchange rate more flexible showed a desire by the government to set its economic diplomacy on more sustainable footing.
President Obama relieved Gen. Stanley McChrystal of his Afghanistan command.
House and Senate Democrats took a decisive step toward a historic remapping of financial regulation, reaching a legislative compromise that will put the banks and financial institutions under tighter government control.
Russian and US officials completed a spy swap.
The US issued a new ban on deep water drilling until November 30th.
Congress approved an overhaul of financial regulation, its biggest expansion of government power since the Depression.
China passed the US to become the world’s largest consumer of energy.
European banks passed a round of government stress tests.
US bank failures topped 100 for the second consecutive year.
July became the deadliest month ever for US troops in Afghanistan.
Wheat prices surged 8% after Russia announced a ban on grain exports.
Japan’s Nikkei slipped into bear market territory.
Dow fell 4.7% in August; it’s worst August in nearly a decade.
Five year anniversary of Hurricane Katrina.
Central banks around the world laid out Basel III; intended to ratchet up capital requirements.
US poverty rate hits 14.3%; a 16 year high.
Silver traded to levels not seen since 1980.
Gold closed above $1300/ounce for the first time ever.
BP’s Gulf of Mexico well was declared as permanently sealed.
The Dow had its best September since 1939; ending Q3 up 10.4%.
The White House lifted its ban on deep-water drilling in the Gulf of Mexico.
The GOP took back the House and the Democrats held the Senate.
The US military began accepting openly gay recruits for the first time ever.
The Fed announced it will buy $600 billion of Treasury’s over the next eight months in a bid, known as quantitative easing hoping to stimulate the economy.
A key gauge of US inflation date fell to its lowest level since 1957; when record keeping began??
Gold topped $1400/ounce for the first time ever.
General Motors went public.
Europe issued a $90 billion bailout of Ireland and crafted a blueprint for its rescue.
Silver traded to a 30-year high approaching $30/ounce.
The Treasury sold the last of its Citigroup common shares.
President Obama announced a tax deal that would extend the Bush cuts, reduce payroll taxes, extend jobless benefits and set the estate tax at 35%.
Moody’s warned about Spain’s ability to service its debt.
Congress approved the new tax legislation.
All the major US indices finished the year in the green; the Dow higher by 11%, the S&P ending higher by 13% and the NASDAQ jumping 17%.
Many other important events took place during the year, but a generation from now, as we read the history books we will see these as the highlights.
Find attached the 2010 high, low, open and close data for the major commodities.
Much like 2009 we expect 2010 to be more of a traders’ market as opposed to sitting in positions for extended periods. A successful trader will need to apply fundamental research and technical research by paying attention to seasonal tendencies, examining correlations commodity to commodity, monitoring the weather and most importantly being flexible with their positions. By this I mean to perhaps scale back your position size because of the volatility, trade both futures and options, and use hedging strategies. The two principal conditions to look out for this year are who wins the argument on inflation vs. no inflation and decoupling relationships between asset classes. To keep up to speed with our ideas we encourage investors to follow in our weekly commentary or daily blog.
The substantial swings we expect to see in 2010 commodity wide will force investors to be more attentive with their portfolios. Speculators, hedgers, and producers need to recognize that with this comes excellent opportunity but much more risk. While it is unlikely that we will encounter the same type of swings this year as the previous two, one will need to bring their best game to be successful at marketing, hedging, or speculating this calendar year. The good news is that more investors are trading commodities which are quickly becoming a critical component of the global economic system and a necessary asset in your portfolio.
We are looking forward to 2010 and see many opportunities that we’ll outline here. For further explanation and to keep up on an evolving basis follow our Weekly commentaries and on our blog’s Daily thought at www.mbwealth.com. Feel free to visit and give us feedback, we are always eager to see what other traders and investors are doing.
Metals: Copper is not a market you can put a position on and forget about as swings have just become too large. Prices in the last 4 years have been under $1 and over $4. Off their lows which were established in late 08’ early 09’, prices have rocketed higher by almost 270%. At this point we say prices are too high and we would expect a set back; a trade back to $2.40- 2.60 is not out of the question. The demand out of China was one of the main driving factors in 09’ and if we were to see that pace slow one would expect a correction to ensue so pay close attention to copper earmarked to China this year. Copper continues to act as a very accurate barometer on global economic sentiment and if prices are either extreme or moving higher or lower at a swift pace do not ignore the warning signs. Gold saw record highs last year trading over $1220/ounce but after a wash out early this year we would expect new record highs. Before we would expect that to really develop we would anticipate the masses to get out of the trade and for this trade to be far less crowded. As we hinted at last year, when the markets are leaning only one way the ensuing move is generally in the opposite direction. Though we feel gold has and will continue to serve as a store for value, we expect the move higher in 2010 largely to be driven by more investors realizing that we have inflation around the corner. The 50 day moving average comes in just below $1000/ounce and at about that level serves as a 38.2% Fibonacci retracement level so that would make sense for a back off point. The closer we get to that level or if we even get below that the level, the lower one is able to buy gold and the more bullish we are. On the upside we are expecting to see a print very close to $1400/ounce this year. Silver outperformed gold in 09’ and we expect the same outcome in this calendar year. Silver failed to get back to its highs reached in early 08’ while gold hit fresh record highs, so in my eyes silver has some catching up to do. Furthermore, the gold/silver ratio that you need to be aware of as a metals trader we view to be way too wide. This spread has decreased from the wide level we saw in late 08’ of 85:1, but at the current level the spread is still at 61:1 when historically it has been closer to 30:1. The 50 day moving average in silver comes in just above $15 and though we think a loss of 18% from the current level may be a stretch, we would maintain a buy the dips mentality in silver with a price objective on the upside of $22-24 in 2010. In both gold and silver we would suggest buying the dips we see the first part of the year because if things go as planned we may not see those levels again this year. Additionally we would suggest scaling into the trades and utilizing a combination of futures and options as we expect volatility to persist.
Financials: While there are consequences if a large institution tries to move the Equity market and it is frowned upon when Central banks intervene in the currency market, I presume that when the government manipulates the bond markets we are supposed to turn a blind eye. That is what the story was in 2009 as we feel that the government controlled the flow and moved the Treasury market higher and lower as it saw fit. What should be the driving force in this market this year, is the perceived direction of interest rates and the eventual tightening which we expect to start around mid-year. The Fed may want to leave rates low for an extended period but when countries around the globe raise their rates the US cannot let the spreads widen significantly or it will suffer dreadful consequences. If we are right on stocks moving lower the flow of money may keep prices of Treasuries afloat temporally early in the year, but we suggest a short bias in Treasuries in 2010 as we expect more downside than upside potential. We see a trading range in 30-yr bonds of 124’00 to 108’00 and in 10-yr notes of 123’00 to 110’00. More than likely most of our trade recommendations in the Treasury complex will be the short end of the curve as opposed to the long end as we will be positioning clients in long dated put options and short futures in Euro-dollars to take advantage of the coming interest rate tightening. We made a similar prediction last year and hindsight tells us we were early but we continue to think risk/reward this is one of the best trades one may see in a lifetime. Let’s get real where can interest rates go from here? The key is to scale into positions and not add any substantial size until the market proves you right. We think once the Fed starts raising rates this trade could last 2-3 years. The key will be to stay with the trade, recognize this trade is not glamorous but if rates move to 7.5%-10% in the coming years this trade should reap hefty rewards. I should have known as the S&P bottomed in March 09’ at “666” that there was an uncharacteristic move to follow. The 50% appreciation got many investors back some money that was well deserved but what we should take away from a move like no other is we may be facing a crisis like no other. This should serve as a warning much like a loud horn before a devastating crash. By no stretch of the imagination do we think we’ve seen the worst; with growing unemployment, another leg down in real estate, the lack of consumer spending, mounting US debt, the rising cost of commodities and a rise in interest rates to come we Do NOT see the light at the end of the tunnel. Early this year we could see an attempt at 1175/1200 in the S&P, 11000/11250 in the Dow and 1950/2000 in the NASDAQ but we expect a sizeable correction to follow. Are we calling for a double dip, not at this point, but our downside targets are as follows: 825/875 in the S&P and 8000/8500 in the Dow, and 1400 in the NASDAQ. This market will continue be a stock pickers market and the days of buying and holding are dead. With still so many unanswered questions it is extremely difficult to predict what the right move may be. As investors we are in unchartered waters and making up the rules as we go.
For specific strategies contact us via e-mail http://www.mbwealth.com or telephone at (888) 920-9997 / 954-929-9898. For the most part investors reading this analysis want to be more hands on, however we suggest taking a look at our managed futures section and consider diversifying further via CTA’s with proven track records.
Risk Disclosure: The risk of loss in trading commodity futures and options can be substantial. Past performance is no guarantee of future trading results.