Feed: Commodity Trading - Future and Present - AggScore: 54.6
Stabilization in the Cocoa Market
The cocoa market spent much of 2011 struggling with leadership issues in the Ivory Coast, which is responsible for approximately 35% of the world’s production. The political turmoil forced end line users to guarantee their supply regardless of the price so the stores would stay full of M&M’s and Hershey bars. Opposite the political instability was a bounty of Mother Nature’s 2011 production, which was the highest on record. This led to the largest carry over stocks on record as well as end line users hoarding their purchases to protect their production supply. The resolution of the Ivory Coast’s political issues sent the market tumbling by more than a third in the 4th quarter as the market’s attention shifted to the excess supply.
The political shift in the Ivory Coast from dictator to a freely elected President with the full support of the United Nations is opening up the gates of First World farming technology as well as foreign direct investment. This combination will increase Ivorian cocoa yields dramatically as their farmers adopt new technology to replace the decades old traditional farming methods that have decreased their production to less than 40% of what some experts believe is their optimum level.
We’ve reviewed the turbulent past and pointed a finger towards a more productive future but we trade in the present. The present in the Ivory Coast is a state of flux. There are great hopes in the new democracy for farming reforms that will increase the standard of living for more than 700,000 cocoa farmers. The outside world is also placing a great deal of pressure on the new government to adopt certain price controls to stabilize prices at the ports. Meanwhile, the crop that is currently coming to harvest is caught somewhere in the middle of weather uncertainty.
Weather concerns early this year have impacted the crop substantially. Many are suggesting that last year’s excess production will be quickly consumed as this crop is expected to be at least 10% less than last year’s. Furthermore, western agronomy practices and foreign investment have not yet had time to take hold and mitigate the damage caused by a late la nina dry season. Finally, the new government is still finding its footing in implementing its reforms. The recent implementation of a daily cocoa auction system is the latest result of the government’s disjointed approach to their chief export. The auctions are supposed to feature daily sales of cocoa at the ports to establish a fixed price that includes transportation from the field to the port. The producers were unhappy with the floor prices and therefore boycotted the auction leaving the government organizers to entertain the corporate buyers for the afternoon at the auction site.
This recent exportation hiccup along with the diminishing size of this year’s crop has provided enough concern to get the market up about 5% off of the January lows. The consolidation pattern that’s been forming over the last three weeks may prove to be the key to the near term direction of this market. A move back above dollarsignr2,350 per ton would most likely force a large speculative short position to begin taking profits. This buying could provide significant fuel to the emerging rally, as the speculative short position is one of the largest on record in this market.
The Ivory Coast is developing a modern government and agricultural infrastructure very rapidly. This process will help ensure consistent, high quality supply in the same way that the U.S. provides so much of the world’s grains. Therefore, a rally through the end of the 2nd quarter may be the final hurrah for one of the most volatile commodity markets.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Strong as a Bull
The cattle market is a very inelastic market due to the breeding characteristics that control supply. The gestation period for cattle is approximately 40 weeks. Obviously, cows can be brought to market or, held back for breeding. This results in a cattle farmers deciding whether the current market price justifies the instant gratification of cashing out and bringing cattle to market or holding them back for breeding to satisfy future demand. Last year, the cattle market set an all time high just over dollarsignr131. I believe we will breach that level to set new highs again in 2012.
Last year’s all time highs were based on growing global demand and this year shows little in the way of slowing down. Normally, the solid global foundation of growing demand would see breeding herds built up to satisfy the coming years’ needs. However, last year’s drought in the major cattle producing regions of the southern plains forced farmers to bring cattle to market and feedlots as grazing land evaporated and feed prices skyrocketed. The result was a decline in U.S. herd sizes in the face of growing demand. This sets the stage for even higher live cattle prices in 2012.
Meat has been measured in per capita supply as long as the USDA has been reporting numbers. This year, it’s expected to be just over 54 pounds. This is down 10% from two years ago and it’s quite possible that we end up at our lowest rate in over 50 years. It took some digging as the USDA data only goes back to 1971 but the next historical level of 54 .5 set in 1953, ties right in with the USDA’s expectations. More details include a breeding herd that has declined in size in 13 out of the last 15 years as well as increasing global demand due to trade agreements with South Korea, Columbia and Panama. Finally, there is growing speculation that Japan will end their embargo on U.S. beef, which has been in place since the 2006 mad cow development.
There are two wild cards that may affect demand this year. The first is a global slowdown in the overall economy. The newfound taste for U.S. beef in developing markets is still in its infancy. Therefore, if their purchasing power declines, locally sourced beef substitutes are still readily available. The second issue is the development of the European bailout. If Greece decides to leave the European Union and revert to the Drachma we will see a flood of money into the U.S. Dollar. This would create a huge pricing issue as U.S. beef would suddenly become very expensive on the open market and may provide the justification for ranchers to pull their animals off of feedlots and place them back into the breeding population.
This leads us to, “How high is high?” April live cattle futures are currently trading around dollarsignr128.50 while the June contract is trading at a dollarsignr.60 discount. The April contract appears ready to take out the October and November highs just shy of dollarsignr130. This would provide a technical trigger of an inverted head and shoulders pattern, which provides us with a measured objective around dollarsignr136. This also ties in well with fundamental analysis by the Hightower Report, which expects a high around dollarsignr135. Finally, Jim Hilker’s statistical analysis as head of Michigan State’s Department of Agricultural Economics projects a high end just shy of dollarsignr137. In the face of the news driven markets we’ve been forced to trade, it’s nice to return to the old fashioned simplicity of the laws of supply and demand.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Goldman Fights the Fed
It’s been an interesting week in the interest rate sector. Three major developments have come into play. We’ve had the Federal Reserve Open Market Committee (FOMC) meeting; Goldman Sachs made a major recommendation and the gap between Commercial trader positions versus large trader positions have increased to the widest levels since the economic collapse of 2008.
The week started with my download of the Commitment of Trader data. Commercial traders have moved to a four-year high in their short position total while large traders appear to have taken the other side of this trade. Short positions in the interest rate sector profit when the price of the treasury issue declines. When treasury prices decline, yields rise. Commercial traders are taking the action necessary to profit from a move away from our historically low interest rates.
On Monday, Goldman Sachs came out with a sell recommendation in U.S. Treasuries. This clearly puts them in line with the opinion of the commercial trader. Francesco Garzarelli, Chief Interest Rate Strategist at Goldman argued that U.S. 10-year note yields would not be able to remain below 2% much longer. Goldman rarely comes out with outright trades in the futures market, which makes the plain language this strategy was laid out in all the more notable. Quoting Goldman’s trade, “Sell March 10 year futures contracts at 130.00 and risk them to 132.00 with a profit target of 126.00.” In English, they are selling 10-year treasuries about where they are now (130.00) and risking dollarsignr2,000 per contract to make dollarsignr4,000.
Part of the interest in Goldman’s recommendation is that it came out ahead of the FOMC meeting. The Fed left interest rates unchanged with the same target rate for Fed Funds of 0 to .25%. They generally believe that the U.S. labor market is improving and that inflation has moderated. Due to the early stages of our recovery and the expected European recession combined with slowdowns in India and China they plan to extend the exceptionally low rates through the late 2014. The final point to note is that going forward the Fed has instituted a new policy of a publicly stated inflation target. This is a first for the U.S. and puts them inline with other countries like England, Brazil, Canada, Australia and many others. This is also a publicly supported policy by the International Monetary Fund.
The current policy places the Federal Reserve Board at odds with the head trader at Goldman as well as the collective knowledge and resources of the traders representing the commercial trader category in the Commitment of Trader Reports. This is the interesting part of the story. One of the primary axioms of trading is, “Don’t fight the Fed.” Successful trading is all about money management and taking ego out of the equation. No one has more resources than the Fed and taking the other side of their trade can only be viewed as an ego fueled proposition.
I believe that any market shocks will send rates lower and prices higher. Eurozone crisis, Greek default, Middle East tensions and collapsing stock market would each, individually send yields lower on a flight to safety. We are on the precipice of these things happening in combinations. Therefore, I will be siding with the Fed and expecting rates to, not only remain low, but also plan on any surprise moves accelerating the markets’ move that direction as well.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Fossil Fuel Fracking
The three-way balancing act between the environment, job growth and energy self sufficiency are all going to play out in earnest here in Ohio during the coming elections. The primary reason for the growing interest in our State is the fossil fuel production capabilities of the shale fields throughout Ohio, with a special emphasis on the Utica shale deposits east of Columbus. The process of fracking, which drills down on average, 4,000 feet in Ohio and just as far horizontally, pumps the well full of chemically treated, “slick water” to crack the shale deposits, displace the gas and force it to the surface. This has dramatically lowered the cost of production and is ushering in significant economic prosperity.
There are always unintended consequences when theoretical models face real world application in high volume. There were more than 400 fracking wells drilled in Ohio in 2010. The Bakken shale reserves in North Dakota employ more than 6,000 wells to produce twice as much natural gas while also producing enough oil to place them at number 10 on the OPEC production list ahead of Ecuador. The production of natural gas and oil through the fracking process is not limited to the United States. Qatar, Russia and Iran contain about 70% of the overseas, undeveloped supply. This is why environmentalists are sounding such an alarm. Here in the U.S., fracking, while regulated by the EPA, is blamed for everything from contaminated drinking water to the recent earthquake, measuring 4.0 on the Richter scale outside of Youngstown. In fact, the EPA just approved a 100% green replacement for the biocide, “slick water” industry standard. How many Russian state subsidized fossil fuel producers do you think are lining up to purchase SteriFrac to protect the environment?
The economic prosperity that fossil fuel production is bringing to our area cannot be ignored. Ohio is making waves on the international energy production scene due to the volume and quality of its reserves. France’s largest oil company, Total SA, just purchased the rights to drill 619,000 acres of the Utica Shale Field for a total of dollarsignr2.32 billion dollars. This shale field is expected to produce not only natural gas but also enough crude oil to put Ohio in the top five U.S. producers. The production boom is expected to bring more than 200,000 jobs to Ohio by 2015 and provide an annual income of more than dollarsignr12 billion to Ohioans. These numbers can be extrapolated to include the Bakken fields as well as the Eagle Ford field in Texas, which is expected to drill more than 3,000 wells in 2012 alone.
The last issue to address is energy independence. The most promising estimate comes from London’s Daily Telegraph, citing British Petroleum research, stating that the U.S. could become entirely energy independent by 2030. More realistic research points to the U.S. Energy Information Administration, which recently stated that we pay dollarsignr4 in natural gas for the equivalent energy as dollarsignr25 worth of oil. This is up from less than a 4 to 1 ratio just 18 months ago. The price gap between domestic and overseas natural gas is nearly as wide. Most of Europe pays upwards of dollarsignr16 per mmbtu (million metric British thermal units) compared to dollarsignr4 per mmbtu here in the U.S. This price differential makes exporting liquefied natural gas (LNG) a growing business opportunity while the world catches up.
Comparing the cost of electricity to the cost of gasoline clearly explains the efficiency of natural gas. Forty percent of our electricity comes from natural gas. Massachusetts’s Institute of Technology published a paper this summer showing that the price of electricity has remained stable as gas prices have sky rocketed. Barring the extraction of shale gas, they expect the price of oil to increase five fold over the next 20 years. Meanwhile, allowing the use of shale oil would only see crude double in price while electricity will climb by a mere 5-10% in the same timeframe.
The issues we’ve addressed are merely the broadest points of a discussion that requires much further debate on all fronts. The simple facts are that we have a global production advantage that we haven’t seen in at least a generation. However, as a natural resource, we must respect the ground from which it flows and treat it accordingly. Finally, all fossil fuels have a finite supply. We must not allow cheap access to a new source to stall the development money and efforts flowing into renewable energy sources.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Precious Metals Ready to Soar
The turn of the calendar leads to reflections and predictions for the coming year. Economists and investment advisors typically use this as an opportunity for shock and awe to gain media attention and increase their capital base through the selling of fear and greed. Fortunately, there are some fairly impartial and anonymous surveys that take place within our industry and this year, there appears to be some merit as well as some action supporting the general thesis of higher precious metal prices through 2012.
We all know about the European Union fears and general deficit issues both domestically and abroad. We’ve written about it extensively and the general actions and conclusions suggest that much of the debt that has been taken on will be repaid with freshly minted currency and each currency unit printed will be worth slightly less than the preceding one. The global race to devalue domestic currencies to repay sovereign debt has renewed the purchases of precious metals as a store of monetary value.
A recent Bloomberg survey of 143 analysts forecasts an average gain of 27% in precious metals for 2012. The Professional Numismatists Guild (PNG) survey is far more bullish. Numismatists are coin collectors who trade the bulk metal as bullion. The average of their range of predictions forecasts a 2012 ending price of dollarsignr48 per ounce for silver and dollarsignr1,976 for gold.
Market internals heading into the New Year are also supportive of higher prices in the near term. The Commitment of Traders (COT) report shows some significant imbalances and actions being taken in both the gold and silver futures markets. The quantifiable actions of the reported positions and the adjustments they’ve made to start the year carry far more weight than the conjecture of the talking heads on TV. Commercial traders have set a new bull record in silver futures and central bank purchases of gold have soared.
Commercial trader purchases of silver futures totaled 32,950,000 ounces since mid-December. Meanwhile, the recently published report by the World Gold Council shows that the world’s central banks have been buying gold hand over fist. Their gold purchases totaled 148.4 metric tons, which equals 5.234 million ounces of gold. This is more than the combined annual production of the world’s top five gold mining companies. Total purchases of commercial traders and central banks equals a mind-boggling investment of dollarsignr8.37 billion dollars worth of gold by central banks and just shy of dollarsignr100 million worth of silver by commercial traders.
These purchases reflect diversification away from the U.S. Dollar and U.S. Treasuries and tie in directly with the shift towards precious metals in 2012 as a hard store of value. The political wild cards in play make it nearly impossible to trade such volatile markets on an annual time horizon. However, some statistical analysis backs up the projected near-term strength. Returning to the COT report, we can see that both large and small traders have taken the short side of both the gold and silver trades. The recent and decisive shift towards a bullish stance by the commercial hedgers has most likely, set the springs on a bear trap as projections point to higher gold and silver prices by approximately 5% by the end of January. This would certainly be enough to force small traders out of their positions and most large traders, as well. Their short covering may provide the lift to get these markets off the ground and out of the sideways channels they’ve been trading in since mid-September.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Selling Fear in Crude Oil
We last wrote about the crude oil market in early November. At that time, we stated that the market internals did not justify the relatively high prices we were trading at and further added that we believed the dollarsignr100 per barrel resistance would hold and provide a ceiling to any attempted rally. The market declined nearly 10% by the middle of December and now, here we are again back up to dollarsignr100 per barrel.
As we mentioned previously, there’s a distinct fear bias in the crude oil futures market that always pumps a premium into prices. This fear bias has recently been fueled by several events in Iran. First of all Iranian students stormed the British embassy in Tehran as retaliation for new economic sanctions imposed upon them by Britain. The U.S. and Canada also followed Britain’s lead. Secondly, the European Union imposed economic sanctions on an additional 180 companies and individuals, prohibiting them from conducting commerce with European Union members. Finally, Iran has threatened to close the shipping lanes of the Straits of Hormuz if economic sanctions are placed on their crude oil exports.
Political games aside, the fundamental issues in the crude oil market can be seen in slackening demand as well as the weakening internal market structure. Global gross domestic product is sure to slow in 2012. The U.S. is just beginning to gain some traction and many economists feel that the best case U.S. outlook will see job growth keep up with population growth. This will leave us at historically high levels of unemployment as stabilizing the workforce will not lead to wage inflation.
The problems in Europe have yet to be dealt with. Recent, credible comments point to a European Union, “minus one small country.” The European Central Bank continues to fight battles rather than implementing a strategy to win the war. The most recent example was their action on December 21st in which they lent more than dollarsignr600 billion to 523 banks at an interest rate of 1%. The protection of private and corporate bank bad debt at the expense of settling sovereign debt issues is penny wise and pound foolish. Their inaction will lead to a European recession in 2012 and dampen their crude oil demand going forward.
The weakness in the EU has already begun to manifest itself in the BRIC markets. Brazil, Russia, India, and China are all slowing at a rapid pace. Their domestic stock markets have declined by an average of nearly 20% for 2011. The International Monetary Fund expects that these countries will grow by 6.1% on average in 2012. While this is more than enough to be jealous of, it still represents a decline of more than 35% from their recent high growth rates. The projected economic slowdown in BRIC countries can also be seen in other metrics including, valuations, mutual fund outflows and the implementation of easing policies as they attempt to engineer a soft landing for their slowing economies.
Finally, these expectations can be seen in the declining internals of the crude oil market. Technically, strong trends pick up new followers as they gain momentum. We noted in early November that crude oil had been losing market participants on each attempt to push through dollarsignr100 per barrel. This continues to be the case with each test of resistance between the 50 and 200 day moving averages. In fact, the crude oil market now shows the fewest market participants since August of 2010. The market internals also show that commercial traders have been steady sellers at dollarsignr100 per barrel and are willing to wait for a re-test of the dollarsignr90 area to reassess their view of end line demand going forward. Therefore, we expect the crude oil market to fall rather quickly once Iran backs off its threats of blockading the shipping lanes out of the Persian Gulf.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Politics, Deficits and Disaster
The payroll tax cut issues that are locking up Congress possess the power to create both cultural and economic divides at a critical point in American history. The senate has overwhelmingly passed a version that would extend the payroll tax cuts by two months. This vote was bi-partisan and cleared by an 89-10 vote. The Republican led House of Representatives opted to bypass a vote all together on the issue. Speaker of the House John Boehner, a Republican and fellow Ohioan is asserting that a two-month extension is not acceptable and will not call a vote on anything less than a full year extension.
Politically, I believe the strategy is to force a compromise on the bill from the Senate and to allow the Republican Party an opportunity to gain some momentum in the coming elections on the jobs issue. Hopefully, job creation will be one of the main issues addressed during the election discourse. Additionally, the Senate has already adjourned and returned home for the Holidays. This may be used by the House to let the tax cuts expire and blame it on the Senate for taking personal time at the expense of their constituents. The Democratic Party’s response would most likely lay the blame of grandstanding at Boehner’s feet and using this to apply political leverage rather than helping the American people while he had the chance. The cultural split has the potential to ruin bi-partisan communication just at the time when our economy will need it the most.
Economically, there is substantial disagreement as to whether payroll tax cuts or direct government spending will provide the greatest bang for the buck to taxpayers and the economy as a whole. The primary key is the term, “multiplier.” This is the how much a policy’s contributions are maximized or minimized in the general economy. Basically, it’s the bang for the buck measurement. The payroll tax cut is designed to trim the individual’s contribution to social security by 2%. This saved 160 million average American workers about dollarsignr1,000. The current plan will extend this benefit by another two months saving the average worker about dollarsignr83 for 2012.
Averages can be misleading. The percentage paid into social security is capped a little above gross income of dollarsignr100k for 2011. The percentage basis calculation and cap provides less benefit to lower earning workers because their entire income is subject to social security taxation. The Urban-Brookings Tax Policy Center’s work shows that the net benefit to more than 65% of Americans was actually dollarsignr178. Basic math using their results as the effect of spending dollarsignr78 billion (65% of dollarsignr120 billion) provides an effective stimulus of roughly dollarsignr28.5 billion or, a net multiplier of NEGATIVE .66. Simply stated, the payroll tax cuts provided 1/3 the benefit they cost to produce to nearly 2/3 of the work force.
The expiring program cost the government, and eventually us, about dollarsignr120 billion. Therefore, the net multiplier is about 1.3. Taking dollarsignr83 per worker out of the economy doesn’t seem like a very big deal. However, by many estimates this equals about .8% of GDP, which may be half of 2011’s U.S. production. Due to the tenuous state of our economy and the expected economic decline by the European Union in 2012, the expiration of this plan could very well be enough to throw us into recession in the second quarter when the proposed tax cuts expire in March.
The debate over the effectiveness of government spending versus cutting taxes is heating up. Pessimists assume that the payroll tax cut designed to generate new hiring is really just churning the economic engine. Companies release dispensable workers and hire new ones at a cheaper tax rate. This creates some obvious unintended consequences such as new unemployment claims, benefit issues and finally, no real economic gains.
Optimists of the program suggest that payroll tax savings will spur new hiring, which will become permanent hiring as the economy improves. The basis of this academic research is that private businesses are much more efficient and responsive to allocating capital and predicting forward demand than the federal government. In fact, a study cited by Dr. Gregory Mankiw of Harvard University in his recent article on Crisis Economics suggests that the net multiple may be as high as 4 to 1.
The government faces some very tough decisions in the months ahead. The very real concerns over the growth of our own debt must be balanced against the need to nurse the recovery along. Washington deserves to hear our voices as we express our own opinions on the amount of debt we’re willing to carry versus the benefit we’ll receive from its creation. The most important thing is that we force them to recognize the very real issues at hand and not allow them to sit by idly as our economy pushes towards our own unsustainable European outcome.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
The American Consumer is Throwing in the Towel
The November Unemployment Report showed a decline in the unemployment rate to 8.6% as well as 140,000 jobs added in the private sector, which was partially offset by a decline in government payrolls of 20,000. Sounds good at first blush, private payrolls are adding jobs and the size of the government is declining. While it is encouraging, there are two major problems with accepting this at face value. First, employment is up, but not enough relative to where we should be more than two years into the economic recovery(?). Secondly, consumer spending indicates desperate behavior that is further weakening the underpinnings of this recovery.
We’ve discussed before that the economy needs to add approximately 125,000 jobs per month just to keep up with population growth. This month’s net number of 120,000 still leaves more people unemployed in the long run. The reason the official unemployment rate dropped to 8.6% is primarily due to the 317,000 people who haven’t actively looked for a job in the last four weeks and have therefore, fallen off of the unemployment report. Had those people sought employment, the continuing claims number would have been negative by nearly 200,000 and created a significantly different headline picture.
I question the impact of this recovery and have concerns about its ability to continue to gain traction due to the historical perspective of the jobs situation and our population’s spending habits. The Federal Reserve Economic Database is accessible by anyone. Looking at their employment graphs we can see that since 2007, the number of people not in the workforce has grown by more than 10 million. Conversely, when we look at the total employment level in the United States it shows that we are at the same level of employment as we were eight years ago. This ties in well with the thesis that American businesses and American workers are more productive than ever. This has led to healthy corporate profits while the domestic demographic spread continues to widen.
The American public on the other hand, is a bit of a concern. CNBC released a survey detailing the economic expectations of the American population versus our expected spending habits this holiday season. Retail sales have surged to all time highs, surpassing even 2007’s high, which was fueled by credit. This year, CNBC’s survey is expecting holiday spending to be 22% higher at the individual level. This would represent a 4.6% gain in total holiday spending over 2010. This makes no sense when 61% of American’s polled believe that the economy is in poor condition with equally dismal expectations for 2012. This is the worst reading in the five-year history of a poll that includes the euphoric ’07 highs as well as the desperate ’08 lows.
My fear for 2012 is not the Mayan end of the world. My fear is that Americans are dipping into the minimal savings they’ve built up in the last two years on one last party of a holiday season. According to CNBC, 74% of this year’s holiday purchases will be made with cash. This will leave most people skating on thin ice. The idea that we are spending more while expecting less just doesn’t jibe with the narrow cushion we stereotypically hold. When we combine this with the fragility of the European Union situation and its ability to quickly throw us back in recession, I’m afraid that this holiday’s spending habits may simply be the average American giving up and throwing ourselves a party while we still can.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Excess Liquidity Treats the Symptom but Prolongs the Disease
The crisis in Europe is coming to a head. This can be measured by the overnight index swap (OIS) rate, which measures the floating risk between the central bank overnight rate and the swap or, insurance rate. The wider the spread is, the more concern there is regarding the borrower’s ability to repay the short-term loan.
This week we have also seen credit default swaps among the largest European banks move to new highs and yields on Spanish and Italian bonds have hit new highs above the previous July high water mark. Finally, risk is starting to spread as German, Japanese and Chinese credit default swap prices have run to the highest levels since the credit crisis of late 2008.
Meanwhile, the ongoing standoff between an economically strong Germany versus a crumbling Eurozone periphery has once again been prolonged. The joint action of the U.S. Federal Reserve bank along with the European Central Bank as well as those of Britain, Japan, Switzerland and Canada to ensure Dollar liquidity to European banks facing a credit crunch has simply provided market relief rather than issuing any type of resolution.
The Eurozone’s economic death spiral is beginning to affect other economies as well. China lowered its lending reserve requirement in an attempt to kick-start domestic demand in their economy and avoid a hard landing as their second largest market, the European Union is quickly heading into recession. The European Union is also responsible for the absorption of approximately 20% of our exports. Therefore, it is very likely that the severity of their recession will determine the likelihood of a recession here in the U.S., which I expect around the second quarter of 2012.
We’ve seen a huge shift in the global economic outlook between this summer and today. This summer’s revolutionary fires of democracy did not release the pent up demand for goods and services on the free market that was expected. North Africa, the Mediterranean and the Golden Crescent are still struggling to establish stability and develop a unified voice in the world’s financial markets.
The change in economic outlook is perhaps best viewed through the lens of international interest rate policies. This past June there were 18 global economies that either raised rates or were in the process of raising rates. More than 20% of them have completely reversed their position with more expected to follow by year’s end.
European banks are believed to own as much as dollarsignr3 trillion in bad debt and be leveraged by as much as 40 to 1. Currently, this debt is carried on their books at face value. Even a small haircut would completely wipe out their lending reserves.
The joint venture by the central banks to guarantee liquidity is one more attempt to treat the symptom rather than the disease. The real disease is deflation. That’s right, deflation. The added liquidity that is fueling the rallies will not contribute to inflation until the economies of Europe, China and the U.S. can work through the excesses of the 2000’s. There is simply too much capacity in labor, production and capital to be absorbed by economies with declining employment.
The reality is that we’re going to see Dollars, Euros and Yen printed at alarming rates, as the only way to pay back the sovereign debts will be to print more currency. The repatriated currencies will be rolled into government debt, which will artificially suppress interest rates while artificially inflating other asset classes like food, energy and individual stocks. We will continue to race each other to the presses until we work through these excesses and then, lookout. Global inflation will hit like the late 70’s were just a warm-up.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Fixing MF Global's Mess
The official cutoff date for the MF Global bankruptcy has been set at October 31, 2011. It’s been one month since customers have had free access to all of the working capital that is supposed to be untouchably held by the exchanges. As of this writing, the best case scenario has been…..well, I guess there really hasn’t been a, “best case scenario.”
Customers who were trading through MF Global and had open trades on Oct. 31 had 60% of the maintenance margin plus their open trades transferred by the Trustee, James W Giddens to one of six qualified Futures Commission Merchants (FCM’s). The practical outcome of this was that a customer with dollarsignr1 million dollars in their account and one contract of corn found themselves on margin call with a new broker chosen for them by the exchange. The customer would have to pony up another dollarsignr600 to meet the margin call because they were unable to tap the dollarsignr997,643 in margin reserves held in their segregated funds account with MF Global.
U.S. Bankruptcy Judge Martin Glenn approved the distribution of 60% of the assets from accounts that held only cash as of 10/31 on Thursday, the 17th of November. However, no date has been set for the distribution of these funds. Furthermore, it provides no more relief to those customers who were actively trading their accounts and needed access to the segregated funds they placed with the exchanges as good faith collateral for their trading positions. This process has left the most active traders as the least capitalized.
The exchange’s bylaws are written so that a shortfall in segregated funds on the part of one firm must be made up proportionately by the other member FCM’s. This has created a co-operative understanding among the member firms for more than 100 years. It has also led to complacency. This would never have happened had the members of the exchanges had the opportunity to audit each other in the same manner that all of the offices and individuals are audited each and every year.
Frankly, chasing down the last dime of revenue has become the joint pursuit of the exchanges and the FCM’s since 9/11. The clearest example of this is the continuation and expansion of trading days during bank holidays. Prior to 9/11, the exchanges and the banks had the same holiday structure. This ensured that the funds would be available in case a trader or member firm needed to add cash to meet margin calls. Post 9/11, we’ve decoupled from the banks and trade more calendar days per year than ever. This is a game of, “hot potato.” Every firm hopes it’s not their customer that needs to wire funds on a bank holiday. This has proven to be a sound strategy as the firms and the exchanges have generated many more days’ worth of revenue….so far.
There are 10 federal holidays per year. The markets lost four days of business due to the tragic events of September 11th. Using our current business calendar, we’ll regain three lost business days this year, just like last year. Here we are ten years down the line and we’ve recouped nearly 30 business days compared to the four we’ve lost. It would take a margin call seven times the revenue of one business day to undermine the success of working the bank holidays over the last ten years.
The purpose of this is to place the responsibility for making John Q. Trader whole directly on the shoulders of the FCM’s and exchanges. The idea that they can continue to look for ways to squeeze extra revenues out of a system that doesn’t place its customers first is personally revolting. There are so many simple solutions to a problem that should’ve never arisen. Excusing common sense for a second and placing the primary focus back on exchange driven profit centers we can easily implement a safety policy for the exchanges, the FCM’s and the customers.
The average three-month volume at the Chicago Mercantile Exchange through last month was 14.6 million trades per day. Exchange and clearing fees currently total around dollarsignr1.20 for each buy and sell. Raising the clearing costs by a nickel per side would increase clearing costs by less than 5% and raise nearly dollarsignr730,000 per business day. The current MF Global customers should be made whole, NOW. The revenue generated by this tax would offset the MF Global losses in six months. The battle lines for the lawsuits won’t even be drawn by that time.
My greatest fear in this entire situation is the audacity exhibited by exchanges and the FCM’s in becoming so big that they’ve forgotten their customer base. This business was founded on the meatpacking houses of Chicago and the grain elevators up and down the Mississippi river. It has come along way from the blackboard trading my father remembers on Franklin Street. I just hope the age of electronic clearing and corporate profits haven’t killed the goose that laid the golden egg.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Mechanical Trading System Durability
Futures Truth magazine is the de facto industry standard for the mechanical trading system vetting process. They’ve been publishing and independently testing trading systems since 1985 and currently track and publish the results of more than 700 trading systems. Their magazine is not one that I subscribe to however, as a former contributor as both an author and mechanical trading system developer; I still receive the random copy from time to time.
Obviously, the reception of their most recent issue fueled a round of intellectual inquiry into the age-old question, “Will a properly designed and tested mechanical trading system withstand the test of time and the evolution of the markets it trades?” I believe the answer is an unequivocal, “sort of.” The answer really has two parts. All things being equal, a properly designed system will continue to perform in a statistically characteristic manner in the future just as it has in the past. Unfortunately, when it comes to market evolution, all things are rarely equal.
My first published trading system was called, “DCB-Bond.” It debuted in January of 2000 and has been in and out of the Futures Truth Bond Market Top 10 since release. The system was ranked 16th in the most current issue and has averaged more than dollarsignr3,000 per contract in annual profits for the last five years. This trading program was designed to capture medium term trends and trades about once a month.
All things being equal, searching for medium term trends in the bond market is still an exploitable niche. The evolution of electronic trading along with the corresponding shift in trading from the pits of Chicago to the computer screens hasn’t affected the basic strategy the system uses. While the dynamic nature of the mathematical equations it uses as triggers allow it to adapt to the ever-changing nature of the market’s volatility.
Unfortunately, the evolution of electronic trading has dramatically affected the performance of a suite of short term trading systems I developed that was published in December of 2005. Historically, markets only traded during their open outcry market sessions. For example, the grain markets only traded from 10:30a.m. through 2:15p.m., Monday through Friday. Therefore, overnight market developments or weekend surprises would build up pressure that couldn’t be released until the market actually opened for the next trading session.
The build up of pressure frequently caused the markets to open at a price significantly different from the previous day’s closing price. The suite of systems that I had developed was designed to capitalize on this market behavior. The program was able to predict with a high degree of accuracy when a market would generate a build up of pressure and open in a predicted direction at a significantly different price than the previous day’s close. The advent of 24 hour access to the markets has eliminated this build up of pressure and undermined the effectiveness of my, “first profitable open” exit technique.
Mechanical trading programs offer many advantages such as the ability to quantify risk, diversify a portfolio and provide access to markets one might not normally trade. The downfalls of mechanical systems are faith in the system, discipline and how to determine whether a system is still viable or has, “blown up.” The key to the successful utilization of any trading system is understanding how and why it works. Therefore, when the fundamental premise of the system is no longer valid and all things are no longer equal it can be taken offline prior to an inevitable drawdown.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Crude Oil is Running Out of Steam
Many of you may have noticed that gasoline prices have moderated since the Labor Day Holiday rally. This is typical seasonal behavior, however I think there may be more room to the downside rather than a rush back to the highs in time for Christmas travel. One thing is for certain; commercial traders’ actions clearly reflect their negative bias in the crude oil market.
Commercial traders sold nearly 22% of the positions they picked up on the market’s decline to dollarsignr75 per barrel in early October. This type of selling extends beyond simple profit taking. They are clearly placing bets that resistance around dollarsignr100 per barrel will hold. This is the exact opposite view that commodity fund managers and the retail money they allocate have of the crude oil market.
Steve Briese has devoted 20 plus years to tracking the Commitment of Traders Reports and he noticed an anomaly in this week’s reporting. His analysis was based on adding in the long only positions of Commodity Index Traders. These are the fund managers who maintain the balance of positions for commodity based exchange traded funds as well as the Jim Rogers type funds, which invest directly in the futures markets. Adding their long only positions to the crude oil market shows that commercial traders have actually set a new net short record position. Commercial traders have sold more forward production at these prices than ever.
Clearly we have come to a tipping point. Retail investors through their purchases of commodity fund shares have swallowed up the 47,000 contracts that commercial traders have sold. In spite of the size of these positions changing hands, we’ve seen the total number of outstanding contracts decline by nearly 20% since the peak in May. This decline in open interest while the market is climbing is strongly viewed as a technically weak move.
Finally, I’ll throw in a wild card; declining retail interest in the futures markets. Every market has a directional wild card bias. The crude oil market has a built in fear bias to the upside based on potential supply disruptions. This may be the first time I’ve really considered a negative bias in public sentiment in this market. This is based solely on the MF Global implosion and the heinous nature of their commingling of segregated funds.
MF Global customers’ trading account cash was supposed to be 100% separate from MF Global’s operating cash. That is the purpose of segregated funds. Customer funds are always protected regardless of the brokerage firm they clear through. John Corzine, who once held the trust of the entire state of New Jersey, has broken the trust in this principal and possibly, the retail investors’ faith in the futures markets. The withdrawal of retail market participants in the futures markets will force the long only Commodity Index Funds to liquidate positions to maintain the proper portfolio allocations as retail customers make redemption requests. Given the record speculative long interest, we could see a sell off in the crude oil market similar to the 2008 correction of more than 50% or, at least a re-test of the dollarsignr75 October lows.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
Customer Safety Comes First
Barry Lind and my father, Jack Waldock founded Lind-Waldock in 1965. One of the primary compliance categories in opening a new futures account is, “know your customer.” For 35 years the business was based on genuinely, “knowing their customers.” Their belief in doing business the old school way allowed them to provide superior order execution on behalf of individual traders as well as providing them with top-level research. This process helped them to break down the barrier of institutional preferential treatment.
Refco bought Lind-Waldock in 2000 primarily for Lind-Waldock’s clean compliance record and presence in the retail market. Refco went public in 2005 and also went bankrupt in 2005 due to the accounting improprieties of Phil Bennett, their CEO. Man Financial bought the Lind-Waldock portion of Refco’s operations in the ensuing bankruptcy. Man financial went public in 2007. They retired the Lind-Waldock name in August of this year and operated under the MF Global name and have now gone bankrupt as well.
Now that the history lesson is over, lets talk about the recent developments. The primary issue at hand hinges on the sanctity of the term, “segregated funds.” Cash in a customer’s futures trading account is held in segregated funds. This money is completely separate from the clearing firm’s operating cash and is not to be mixed in with the clearing firm’s assets in any way shape or form. This is guaranteed by the various exchanges as margin collateral and is a collective covenant of all Futures Commission Merchants (FCM’s) that are members of a given exchange.
MF Global and their CEO, former New Jersey Governor John Corzine are accused of using customers' segregated funds equity to guarantee bets he made on European sovereign debt as he attempted to transition from the historical business of providing trade execution services and retail customer trade assistance to investment banking, proprietary trading and the greedy pursuit of becoming the next Goldman Sachs, his former firm. These actions are in violation of all of our governing bodies – NFA, CFTC, FINRA, etc.
The losses incurred as a result of his pursuit to be a big shot has left a dollarsignr700 million dollar shortfall in MF Global’s books. Dipping into segregated funds has created an accounting nightmare as customers close their accounts and transfer to solvent brokers. The segregated funds covenant of the FCM’s with the exchanges is to guarantee the customers’ equity. This is the peace of mind that trading on an exchange versus cash markets is supposed to bring.
The dollarsignr700 million dollar shortfall should be covered, whether through the joint efforts of the FCM members of the exchanges or, the exchanges themselves. To put this in perspective, the top 10 FCM’s have a combined equity of more than dollarsignr1 trillion dollars and the Chicago Mercantile Exchange is valued at more than dollarsignr17 billion. Therefore the dollarsignr700 million is a manageable number as a portion of this capital pool.
Customers must be made whole in order to maintain the integrity of the exchanges and instill the confidence in the investing public. The longer this thing is drawn out, the more likely this erosion of confidence in the governing bodies will devolve into retail investor panic. The remaining FCM’s as well as the exchanges must do everything in their power to prevent an easily covered black eye of a monetary issue from becoming a public perception issue more akin to a terminal disease.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.
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