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Trade much more conservatively during exceptional market conditions.
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Today's Featured Article
The USDA October Crop Report will be out the morning of October 10th. This is a very important estimate of the size of the corn and bean crops that could easily move the market sharply in either direction. Unlike the August and September crop reports, the October report could have a relatively long-lasting influence on the market as it tends to be much more definitive as to the real size of the crops. Many traders will be hesitant to be heavily involved in the market in the days leading up to this extremely important report.
Heavy June rains in much of the Midwest necessitated replanting in many areas, putting corn and beans well behind their normal development pace. This made the August and September crop reports less reliable indicators of the size of these crops than in a normal year. According to the weekly crop progress report of September 29th only 9% of both the corn and bean crops had been harvested versus 21% average for both. Reports vary widely as to early yields for corn and beans, heightening the potential for a major surprise in the October numbers.
In September, the USDA estimated the corn crop at 12.072 billion bushels with a yield of 152.3 bushels per acre. They estimated the bean crop at 2.934 billion bushels with a 40 bushel per acre yield.
Index fund results
Index funds have enjoyed superior returns compared with the equity markets the last two years through June of this year. During this time, the main stock market indexes, including the Dow Jones Industrials, the S&P 500 and the NASDAQ, have been unchanged to lower overall. Commodity index funds, in contrast, which buy and hold a broad range of commodities and are always long, have made as much as 40% a year during this same time period. This last quarter, however, which ended September 30th, has been extremely negative. The five largest index funds are down an average of 25% for the quarter, putting them down 2.4% for the first nine months of the year, despite strong returns the first
six months of the year. All five of the largest funds lost money during the third quarter and only one now shows a profit for the last nine months, up 8.2%. It is estimated index fund assets have declined by $50 billion from their summer peak to roughly $150 billion today. The first three days of the fourth quarter don't portend well for the index funds with most commodities continuing to fall sharply as financial turmoil continues to roil both equity and commodity markets.
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It might as well be ancient history
Remember all the public and Congressional outrage about the big run up in energy and food prices last summer? How many blamed speculators, especially index funds, for the rally to all-time highs in these markets? How some Senators proposed severe restrictions on index and pension fund participation in commodity markets? In response, the CFTC issued two studies, in July and September, both of which said speculators were not to blame, that it was much more likely the culprit was supply/demand in balances due to unprecedented growth in Asian economies, especially China and India. It's just my opinion but if index funds are blamed for the big price run-ups, shouldn't they now be thanked for
the huge price declines? I am referring mainly to the energy and grain markets. Index funds are in an untenable position, caught between the proverbial rock and a hard place.
Financial turmoil - An ebbing tide lowers all boats
The financial upheaval of the last month in the equity and credit markets has spilled over into the commodity markets, pulling them all lower. Contraction in the credit markets, if wide-spread and prolonged, will slow or even lower economic growth, lessening demand for all commodities, grains included. People won't quit eating but they will cut back on expensive foods such as meat. Livestock are inefficient converters of grain into meat. It takes seven pounds of grain to produce one pound of chicken meat. A person could eat one pound of chicken at a single meal but not seven pounds of grain. Less demand for meat means less feed demand for wheat, corn, and soybean meal. Less demand
equals lower prices.
If you cannot view the above chart,
go here.
If you cannot view the above chart, go here.
If US financial troubles spread to other countries, which has already happened to a limited extent in Europe, US grain export demand would also suffer, imposing a bearish effect on grain prices. The threat of reduced domestic and foreign demand for US grain alongside growing financial turmoil the week of September 29th-October 3rd caused grain prices to crater along with a correspondingly sharp fall in equity prices that week. Even the passage of the $700 billion bail-out bill by the US Senate on October 1st and the US House on October 3rd failed to halt these markets' steep decline. As long as credit and equity markets remain troubled, grains and other commodities are likely to suffer
as well. Longer term, inflationary pressure from the unprecedented large bail-out bill should eventually drive commodity prices higher, including grains. The key questions to consider are a) How long is long term; and b) How much more room is there to the downside in the meantime?
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Convergence, or lack thereof, in wheat
Usually, as a futures contract nears expiration, the cash and futures markets come together, or converge. This has not been the case during the last several delivery months in wheat. Cash prices in many Midwestern locations have traded as much as $2 under the futures price as it expired. Responding to hedgers' complaints, the CME Group, owner of the Chicago Board of Trade, and the CFTC, have investigated this problem. The CME Group has proposed several remedies for the lack of convergence. These include more delivery points; higher storage rates from July to November and tighter Vomitoxin standards. (Vomitoxin is a fungus that makes wheat unsuitable for consumption except in
extraordinarily small concentrations.) Some hedgers are still complaining, saying these measures don't go far enough. They propose more draconian steps, such as forced load out. This would mean a speculator who takes delivery of wheat during December, for example, would not be able to leave it in a deliverable location until March, when he would then redeliver it. Since speculators ordinarily have no intention of taking wheat out of a deliverable location, if they do take delivery under this proposal they would be forced to redeliver it that same delivery month, not the next one. To do this they must have a short position in the futures market, meaning they would need to sell December
wheat and, in so doing, push December wheat lower, toward convergence with the cash market.
Historically, speculators have taken delivery of a commodity such as wheat and held it until the next delivery month when carrying charges warranted. Carrying charges refer to the amount of interest it costs to buy and hold a contract until it is redelivered, usually stated in cents per month. Speculative traders often take delivery when the difference between the spot delivery month and a deferred delivery month is greater than the interest it costs to hold or "carry" the contract for that period of time. For example, in late November, December wheat might be trading at $8/bushel while March is $8.20/bushel. A speculator would buy December and sell March at this 20 cent spread. He
would then take delivery of December wheat some time during the delivery period in the first half of December, holding the wheat in deliverable position until the beginning of March when he would redeliver it. If his cost to carry the wheat is 5 cents/month, he would be left with a 5 cent profit after paying the 15 cent cost to hold the wheat for 3 months, from early December to early March.
The CFTC has yet to approve the proposed CME Group changes for the wheat contract. Traders will be watching how this situation is resolved over coming months as it could have a significant impact on the mechanics of the wheat market.
There is a lot going on in the grain markets and this should make for dramatic price moves over coming weeks and months, presenting multiple trading opportunities.
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About the Author
Vic Lespinasse
has been analyzing the commodities markets through a career spanning 35 years of the industry's most explosive growth and dynamic change. From his unique vantage point on the trading floor, Vic has gained deep insights into the markets, forging key relationships and developing expert strategies in fundamental and technical analysis. While a full member of the Chicago Board of Trade from 1974 to the present, Vic broadened his experience and contacts into the business as a floor analyst for Clayton, Dean Witter, AG Edwards, and international grain trader, Louis Dreyfus.
Vic is recognized as an authoritative commentator on commodities with literally hundreds of appearances on all major television networks and radio stations. His observations on the markets have been quoted by numerous newspapers including the Wall Street Journal. | |
Special Message from Our Author
Get on the CBOT Floor with a Veteran Grain Analyst
Vic Lespinasse of GrainAnalyst.com takes you INTO THE TRADING PITS with on-going reports all day. Direct from the CBOT floor to your email or mobile device! Vic Lespinasse has been analyzing commodities for 35 years and is recognized as an authoritative commentator on the markets with literally hundreds of appearances on all major television networks and radio stations. GrainAnalyst.com is a division of Cytrade Financial, L.L.C.
Sign up today! | |
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