Matthew Bradbard: 2011 Commodities Outlook
Matthew Bradbard: 2011 Commodities Outlook
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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.
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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.
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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.
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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.
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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.
Jim Rogers Top Bets for 2011 01_03_2011
