In the last post I gave the argument for the possible upside in corn and soybeans. Let's talk about tactics.
Which to concentrate on? Nov beans are 2.36 times Dec corn. That's within the average range. However other things currently make corn more attractive to farmers. Input prices, particularly fertilizer, are way down, and corn uses a lot more of these. The USDA is forecasting a two million acreage increase in corn and for soybean acres to be down marginally (some analysts disagree with that). So I tend to favor beans. However, corn is usually more susceptible to poor weather, so you can really take your pick.
The option volatilities really do make the trade feasible. Nov bean ATM vols are running at about 15% versus the 17% range for most of the past year. OTM vols are of course higher (10 calls are 17.5%) but still quite cheap. Very far OTM calls are even higher. I wouldn't do a spread trade tho. If and when a crop problem occurs, all vols and trading costs will go up. This will make it costly to take profits.
If you want to do corn, Dec ATM calls are about 21%. That's within the range of the past six months.
I am buying a half position of ZSX100C at the current market and another half at 10. Beans are under pressure because of the favorable conditions in South America. This is providing a good entry point.
Monday, February 29, 2016
Sunday, February 28, 2016
Is it Time to buy New Crop Calls in the Ags?
Last week an old friend called me with the idea of positioning long for the US growing season. Here are my thoughts. This is a pure risk/reward type of trade (i.e. with less than a 50% probability of success, but with a big payout if it works.).
Corn, wheat and the bean complex are all down a lot. This is fundamentally based; the world has had good to great crops for two years. Stocks levels are high. The speculative money has left commodities, and is actually somewhat short. It's hard to see US acreage down much, so we may get another bin buster this fall.
However....
We may not. We are currently in a extremely high ENSO period. The US NOAA is forecasting that these el Nino conditions will dissipate this summer and may well bring on a la Nina event in the fall. Here is a list of years since 1950 in which the ENSO has fallen by at least 1.0 from FEBMAR to AUGSEP, along with corn yields relative to trend:
Corn, wheat and the bean complex are all down a lot. This is fundamentally based; the world has had good to great crops for two years. Stocks levels are high. The speculative money has left commodities, and is actually somewhat short. It's hard to see US acreage down much, so we may get another bin buster this fall.
However....
We may not. We are currently in a extremely high ENSO period. The US NOAA is forecasting that these el Nino conditions will dissipate this summer and may well bring on a la Nina event in the fall. Here is a list of years since 1950 in which the ENSO has fallen by at least 1.0 from FEBMAR to AUGSEP, along with corn yields relative to trend:
| ENSO Change | Corn Yield | |
| 1954 | -1.346 | -10.6% |
| 1958 | -1.152 | -0.9% |
| 1964 | -1.012 | -10.8% |
| 1970 | -1.473 | -12.3% |
| 1973 | -2.558 | 4.6% |
| 1978 | -1.35 | 7.2% |
| 1983 | -2.543 | -22.9% |
| 1988 | -1.949 | -24.7% |
| 1995 | -1.296 | -9.3% |
| 1998 | -3.315 | 1.8% |
| 2010 | -3.339 | -0.7% |
So the average of the 11 years is (7)%. The average for soybeans since 1960 is (4)%. Probably more important for this trade, the crop was bad over half the time.
So this smells like a pretty decent option position to me. Let's look at the specifics of the options market.
MORE TO COME
Friday, February 19, 2016
How are the Blog Positions Doing
I started this blog in October of 2015. About a month later, I started making actual recommendations. In all cases, I actually put my own money in these recommendations. Here's a little more detail about how I invest.
- I only look at notional position size. Leverage does not appeal to me. This means that I normally trade smaller commodity positions than most people. I do the same on the short side.
- All my equity trades are alpha-based. Basically I look at the trade vs. the ETF SPY. I do have another account in which I have some broad-based mutual funds, but that is not the point of this blog. BTW, I have held one mutual fund for over 30 years!
So let's evaluate the trades I have on here:
Long Southern Peru Copper, short copper metal. Put on Nov 13, 2015. This has done decently:
SCCO -3.5%
SPY -7.6%
Copper -1.2% >> net gain of 5%
Long Dean Foods. Put on Dec 12, 2015. This has been my big winner:
DF +19.9%
SPY -5.1% >> net gain of 25% wahoo!
Long Alcoa Preferred. Put on Oct 26, 2015:
AApreferred -5.2% (incl pref div)
SPY -6.3% >> net gain of 1%
Long Dec 2018 Crude (WTI)
I have traded this position quite a bit, but the original was put on on Dec 7, 2015 at $53. So it has a loss of -12.5%.
I also have on a cocoa options position. This is rather complicated, and I'm not going into all the details. It's basically short gamma, neutral delta.
I hope to have most of these on for much longer. I also plan to buy Nickel either using the metal or Norilsk. More in the next post.
- I only look at notional position size. Leverage does not appeal to me. This means that I normally trade smaller commodity positions than most people. I do the same on the short side.
- All my equity trades are alpha-based. Basically I look at the trade vs. the ETF SPY. I do have another account in which I have some broad-based mutual funds, but that is not the point of this blog. BTW, I have held one mutual fund for over 30 years!
So let's evaluate the trades I have on here:
Long Southern Peru Copper, short copper metal. Put on Nov 13, 2015. This has done decently:
SCCO -3.5%
SPY -7.6%
Copper -1.2% >> net gain of 5%
Long Dean Foods. Put on Dec 12, 2015. This has been my big winner:
DF +19.9%
SPY -5.1% >> net gain of 25% wahoo!
Long Alcoa Preferred. Put on Oct 26, 2015:
AApreferred -5.2% (incl pref div)
SPY -6.3% >> net gain of 1%
Long Dec 2018 Crude (WTI)
I have traded this position quite a bit, but the original was put on on Dec 7, 2015 at $53. So it has a loss of -12.5%.
I also have on a cocoa options position. This is rather complicated, and I'm not going into all the details. It's basically short gamma, neutral delta.
I hope to have most of these on for much longer. I also plan to buy Nickel either using the metal or Norilsk. More in the next post.
Monday, February 8, 2016
Round Trip for Emerging Markets
With all the sturm and drang about emerging markets these days, you would think they might be at all time lows. You would be close to being right. The largest emerging market ETF (EEM) started trading in 2003. Not coincidentally, that was the beginning of a major bull for EM. It's all been reversed:
So we had a classic bubble. A major asset class almost tripled on a relative basis and then did a round trip.
Are we at value? It's always hard to catch a falling knife, and my sense is there is no risk/reward in this trade. Remember, we haven't had much in the way of actual defaults in EM yet (or in DM for that matter). So far it's just been the slowing of growth and possible financial trouble. Wait till some of these guys actually default (I mean you Venezuela et. al.).
Are we at value? It's always hard to catch a falling knife, and my sense is there is no risk/reward in this trade. Remember, we haven't had much in the way of actual defaults in EM yet (or in DM for that matter). So far it's just been the slowing of growth and possible financial trouble. Wait till some of these guys actually default (I mean you Venezuela et. al.).
Saturday, February 6, 2016
Just for fun I wrote a stock options valuation calculator using the Shiny package in the R language. I really just wanted to see how Shiny worked, but the result turned out to be quite useful. Check it out here.
Note: Shiny isn't the most compact code, so the page will take a few seconds to load, but once it loads it runs great. Email me or comment below if you have any thoughts or ideas for improvements.
Note: Shiny isn't the most compact code, so the page will take a few seconds to load, but once it loads it runs great. Email me or comment below if you have any thoughts or ideas for improvements.
Thursday, January 28, 2016
Cocoa
The cocoa market has a soft spot in my heart. It was the first commodity I ever concentrated on, and I have continued to follow it all these years. My first real job in commodities was as cocoa analyst for MARS Inc., the privately help candy company. BTW, MARS was a truly excellent company and probably still is. The big reason for this was (is?) guidance from a really smart family that takes a multi-generational outlook. I doubt if they will ever IPO, but if they do, I'm in.
Anyway, there are a few structural issues in cocoa that make it somewhat unique:
- Cocoa is a tree and it takes 6 -8 years from the time prices provide incentive for an increase in plantings until you start getting substantial production from the new trees. Say one to two years for the plantings to occur and another five or so for the trees to mature. Once the tree has matured cash costs for harvesting are very low. So cocoa can and does have multi-year cycles, like oil.
- Cocoa fundamentals are exquisitely researched by the major participants in the industry. The large candy companies have staffs continuously examining the trees in the major growing regions. They see even minor effects of weather or disease quickly. Some of the large trade houses also do this research, but on a smaller scale.
- Cocoa speculators are generally technical. This makes sense; it's more difficult and costly to get fundamental info than in say, corn or soybeans. So technicals are all they have. This mostly means they follow trends.
Let's start with the long run position of cocoa using the ten-years graphs. Click here for an explanation.
Interestingly, cocoa has the highest r-squared on this graph of all the commodities in my universe, over 90%! I've backtested it, and you can actually do pretty well in cocoa using this alone. The ten year outlook is still bearish. Let's go a little deeper.
I'm not going to spend any time on current year's supply/demand because as I said, the major players know far more about that than I ever could. So I'll concentrate on the longer term and then discuss tactics. This "time arbitrage" is where Commodity Strategists have their edge.
The bullish case in cocoa can be summed up like this: Demand in emerging markets will increase as their populations adopt a middle-class western diet. Meanwhile cocoa production in the traditional area of west Africa will stagnate as old farmers retire, and their sons move to the cities.
I don't find this argument persuasive. First, as I said in my post of 10/21/15, I don't believe that most EM residents will ever move to a western diet. This is even more true for cocoa since chocolate is a cold weather food. Even in the US or EU consumption strongly dips in the summer. Second, the current productivity of cocoa trees is extremely low. Most African cocoa is grown by "smallholders" who cannot or will not adapt current farming techniques. Yields per acre on commercial plantations are much higher. Also, the African farms mostly use older cocoa varieties that yield much less than newer ones (although they do have better taste). As an example of what can be done with yields on a modern plantation, see United Cocoa.
My view is that cocoa is still historically overpriced, and that there is no "this time is different" case to be made. So I want to be short. Now let's look at tactics.
As noted in the beginning, cocoa speculators are largely trend followers. I once backtested a simple strategy using the CFTC's Commitments of Traders report. The strategy simply waited until the managed money went long (short) by a certain amount. The system did the opposite. It was a net positive strategy, although the drawdowns were too large to actually trade. Here's a graph of the COT over time from barchart.com:
My backtest found that the key statistic is the position of Large Speculators (CTAs). That is the green line in the middle panel. You can see that these specs got maximum long slightly after the peak in prices in early December. You can also see that they are now largely washed out, down to about the lowest long level they have been on the chart. On this basis, now would not be a good time to initiate a short position in cocoa. In fact, now is probably a good time to cover shorts.
So is this a good time to actually go long? I wouldn't. As a Commodity Strategist, I am only playing this from the short side. Nonetheless, the combination of the spec washout and the appearance of heavy manufacture buying at this price back in early 2015, is tantalizing. If you want to do it, you could probably buy here with a 2,700 stop.
Anyway, there are a few structural issues in cocoa that make it somewhat unique:
- Cocoa is a tree and it takes 6 -8 years from the time prices provide incentive for an increase in plantings until you start getting substantial production from the new trees. Say one to two years for the plantings to occur and another five or so for the trees to mature. Once the tree has matured cash costs for harvesting are very low. So cocoa can and does have multi-year cycles, like oil.
- Cocoa fundamentals are exquisitely researched by the major participants in the industry. The large candy companies have staffs continuously examining the trees in the major growing regions. They see even minor effects of weather or disease quickly. Some of the large trade houses also do this research, but on a smaller scale.
- Cocoa speculators are generally technical. This makes sense; it's more difficult and costly to get fundamental info than in say, corn or soybeans. So technicals are all they have. This mostly means they follow trends.
Let's start with the long run position of cocoa using the ten-years graphs. Click here for an explanation.
Interestingly, cocoa has the highest r-squared on this graph of all the commodities in my universe, over 90%! I've backtested it, and you can actually do pretty well in cocoa using this alone. The ten year outlook is still bearish. Let's go a little deeper.
I'm not going to spend any time on current year's supply/demand because as I said, the major players know far more about that than I ever could. So I'll concentrate on the longer term and then discuss tactics. This "time arbitrage" is where Commodity Strategists have their edge.
The bullish case in cocoa can be summed up like this: Demand in emerging markets will increase as their populations adopt a middle-class western diet. Meanwhile cocoa production in the traditional area of west Africa will stagnate as old farmers retire, and their sons move to the cities.
I don't find this argument persuasive. First, as I said in my post of 10/21/15, I don't believe that most EM residents will ever move to a western diet. This is even more true for cocoa since chocolate is a cold weather food. Even in the US or EU consumption strongly dips in the summer. Second, the current productivity of cocoa trees is extremely low. Most African cocoa is grown by "smallholders" who cannot or will not adapt current farming techniques. Yields per acre on commercial plantations are much higher. Also, the African farms mostly use older cocoa varieties that yield much less than newer ones (although they do have better taste). As an example of what can be done with yields on a modern plantation, see United Cocoa.
My view is that cocoa is still historically overpriced, and that there is no "this time is different" case to be made. So I want to be short. Now let's look at tactics.
As noted in the beginning, cocoa speculators are largely trend followers. I once backtested a simple strategy using the CFTC's Commitments of Traders report. The strategy simply waited until the managed money went long (short) by a certain amount. The system did the opposite. It was a net positive strategy, although the drawdowns were too large to actually trade. Here's a graph of the COT over time from barchart.com:
So is this a good time to actually go long? I wouldn't. As a Commodity Strategist, I am only playing this from the short side. Nonetheless, the combination of the spec washout and the appearance of heavy manufacture buying at this price back in early 2015, is tantalizing. If you want to do it, you could probably buy here with a 2,700 stop.
Sunday, January 17, 2016
The 10-Year Forward Graphs have been updated. You can view them at the Ten Year Forward Graphs link on the right side of this page.
There aren't too many surprises. Most commodities have fallen into a general value level, and are not clear buys or shorts. A few of the industrial commodities (some metals, iron ore, uranium) still have further to fall. And there are a limited number that do seem to warrant long positions. I'll talk about a few of the last category in this post.
Crude Oil has finally become officially cheap. It has happened quite quickly, in about a month. Using the current spot prices for Brent and WTI, I expect them to double in the next ten years. But of course you cannot buy the current spot and hold it. Well actually you can, but storage and other costs will more than eat up your gains. If you want to do this trade, it's best to buy the forward futures position. Guess what? The last currently traded future, Dec 2022, is going for $48.79. So if I am right, and the price goes up to $60, you make 23%, or about 2% per year. Not good enough. So no trade there.
Shrimp is expected to go up by about 80%. You can invest in this via non-US aquacultural companies. However I would caution against it. This is one of those commodities where there really has been an "this time is different" event. Over most of the history of my price series, shrimp was a wild-caught product. I remember as a boy what an expensive delicacy a shrimp cocktail was! Now most shrimp is farm-raised, and costs are much lower. Different world. Of course you might get an outbreak of some shrimp disease that comes from the unnaturally close confinement of shrimp in the farms, but I wouldn't want to bet on it.
Wheat and Barley are somewhat undervalued, but they have the same contango structure that oil has. So same non-trade.
Aluminum and Nickel are expected to gain by 60% and 80% respectively. I think nickel is a buy. The best bet is to buy cash metal and pay the storage. If you don't want to open a commodity account there is a somewhat thinly traded ETN, symbol JJN, that will do it.
Both hardwood and softwood are cheap. These can be bought via timber companies or REITs. I would worry that electronic communication has given us a "this time is different" situation in softwood. Paper production has already fallen by a lot, and may have a lot more to go. Also, given the world's demographics, I don't see homebuilding going back to pre-recession levels. Hardwood may be a buy, since many old growth forests in S. America and tropical Asia are being cleared. I cannot think of a clean way to play this. If any of you can, let me know.
Cotton is both cheap and has a flat futures curve going out three years. The problem here is that if the supply/demand balance tightens, the years after 2018 may go into the same kind of contango that Wheat or crude has. That would eat up profits. Nonetheless, this is an interesting situation, and I will look into it further.
There aren't too many surprises. Most commodities have fallen into a general value level, and are not clear buys or shorts. A few of the industrial commodities (some metals, iron ore, uranium) still have further to fall. And there are a limited number that do seem to warrant long positions. I'll talk about a few of the last category in this post.
Crude Oil has finally become officially cheap. It has happened quite quickly, in about a month. Using the current spot prices for Brent and WTI, I expect them to double in the next ten years. But of course you cannot buy the current spot and hold it. Well actually you can, but storage and other costs will more than eat up your gains. If you want to do this trade, it's best to buy the forward futures position. Guess what? The last currently traded future, Dec 2022, is going for $48.79. So if I am right, and the price goes up to $60, you make 23%, or about 2% per year. Not good enough. So no trade there.
Shrimp is expected to go up by about 80%. You can invest in this via non-US aquacultural companies. However I would caution against it. This is one of those commodities where there really has been an "this time is different" event. Over most of the history of my price series, shrimp was a wild-caught product. I remember as a boy what an expensive delicacy a shrimp cocktail was! Now most shrimp is farm-raised, and costs are much lower. Different world. Of course you might get an outbreak of some shrimp disease that comes from the unnaturally close confinement of shrimp in the farms, but I wouldn't want to bet on it.
Wheat and Barley are somewhat undervalued, but they have the same contango structure that oil has. So same non-trade.
Aluminum and Nickel are expected to gain by 60% and 80% respectively. I think nickel is a buy. The best bet is to buy cash metal and pay the storage. If you don't want to open a commodity account there is a somewhat thinly traded ETN, symbol JJN, that will do it.
Both hardwood and softwood are cheap. These can be bought via timber companies or REITs. I would worry that electronic communication has given us a "this time is different" situation in softwood. Paper production has already fallen by a lot, and may have a lot more to go. Also, given the world's demographics, I don't see homebuilding going back to pre-recession levels. Hardwood may be a buy, since many old growth forests in S. America and tropical Asia are being cleared. I cannot think of a clean way to play this. If any of you can, let me know.
Cotton is both cheap and has a flat futures curve going out three years. The problem here is that if the supply/demand balance tightens, the years after 2018 may go into the same kind of contango that Wheat or crude has. That would eat up profits. Nonetheless, this is an interesting situation, and I will look into it further.
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