More Rain in the Cocoa Zone

So the cocoa zone in west Africa got another dose of rain a few days ago. This is pretty unusual for this time of year, and augurs for a heavy mid-crop in Ghana and the Ivory Coast. Bearish!

Having said this, I still don't see a big downside here. The end-users, of which I used to be one, realize the value here are are willing to extend coverage. I also think that we are near an inflection point in grindings.
I'm looking for another spot to buy again.

The Bottom in Cocoa?

I think it is. It's always hard to catch falling knives, but in this case I think the risk/reward is there.

- Cocoa is cheap on a long run basis. The forward 10-year graphs that I run have it about doubling in the next 10 years. That's not a basis for a trade, but it's a good start. Note: I no longer publish these.

- We are beginning to get some bullish info out of Africa. The rain event in early Feb was unusual and quite bearish. Since then however, dryness has continued. Also, Reuters has an article about how cocoa is being left on the trees to rot (overly dramatic, but with a grain of truth). The official Ghana cocoa agency reduced its 2016/17 crop estimate by 50K tonnes. I doubt that this is accurate, but it shows that the producers are starting to do things to move prices up.

- Commitments of traders is VERY one sided. There have been very few times in the past ten years where the specs have gone short cocoa; all have ended with bull markets. We are at record short now.

I believe the last leg down was due to defaults by some medium size cocoa middlemen. I have no knowledge of, but wouldn't discount the possibility of, a western trading company being in trouble as well. This new selling added to the decline. This is probably over, or nearly so.

I bought a half position via options in CCK two days ago. If we can get some further upside action, I will double up.

Trades Today

I took off about 30% of my Impala Platinum. It's had a nice run. If it comes off I'll buy it back, if not - too bad.
Going to add some Cameco (CCJ). I'm still bullish on uranium, but it's going to be a long slow climb. So only buy the dips.

Someone commented in the last post about the correlation between platinum and gold. I simply used the correlation of the daily returns of GLD and PPLT. In fact, if you strip out the overall commodity correlation, the true relationship is even lower.

More on Platinum Group Metals

I wrote an article for Seeking Alpha on the platinum group, here. The net is that all the supply/demand stats are pretty bullish, especially for palladium. I'm going to write another giving my picks to buy, but the short of it is I'm long Impala Platinum (IMPUY). It has about 25% of its revenue from palladium at current prices, and has a strong leverage to commodity prices. I started buying at $3.09 and finished at $3.33.
The interesting question here is the future of the internal combustion engine. If virtually all cars will continue to use it, we will need a lot more investment in platinum-group capacity. OTOH, if there is a massive switch to electric, we won't need it. So far electric cars are still a fringe market, but who knows? It probably depends on the future price of oil, which I am pretty neutral on.
One more interesting thing: the correlation between gold and platinum has dropped a lot. Back in 2010, the correlation was about 80%. Now it's only 54%.

It's all About EM Demand, China and India

With all the sturm und drang of the US political season, it is excusable that investors are looking less to emerging markets (EM). However for commodities traders and investors, that is not possible. The fact is that almost all the growth in commodity supply and demand comes from EM. And right now EM is in serious trouble.

This article will focus on commodity demand. Over the medium term, there's not much that can happen to supply. Putting in a new world class mine or plantation province takes many years. These were cut back sharply starting in 2013, and will not revive for quite a while. So over the shorter term commodity prices will be set by demand.

Here's a table of the World Steel Association's forecast for steel demand in 10⁶  tonnes:

	2016	2017	Change
Developed Markets	406	410	4
Emerging Markets	436	457	21

So EM is the growth driver for steel. The numbers are similar for virtually all industrial commodities. DM economies expand in the commodity-light service sectors. EM economies expand by building things.

The two biggest EM economies are China and India. Both of these are having problems, for different reasons:

China is experiencing massive financial outflows. It's impossible to get exact numbers, but Barclays thinks it was $207 billion in the third quarter. Data from the Federal Reserve TICC report shows that China and Belgium (China holds treasuries in Belgium for some reason) liquidated $184 billion in treasuries during Oct alone. So the outflow may be speeding up.

Analysts have varying reasons for the massive movement out of China. Rising US interest rates, the falling Yuan and a clampdown on corruption in China are mentioned. But my view is that this is wealthy people in China seeing the end of the Chinese growth model. China is going through the same process that Japan went through in the 80s. The export-led growth is maxed out, but China still has a huge savings rate. So the capital is seeking a better and safer home. Trump is speeding this up, since he will certainly reduce China's exports to the US. But it would happen anyway.

The Chinese leadership realizes this and is steering the economy toward services. Long term this is the right path, but the process will be bumpy. Basically, a lot of heavy industry will have to be shut down. Services are much less capital-intensive than manufacturing, so the returns on capital will be lower. Also, services are far less commodity-intensive, so that demand will be muted.

So China will not have a need for incoming capital. It has also massively expanded its higher educational system, so it probably won't have much of a need for foreign technology either. History tells us that if a nation doesn't need foreign assets for growth, it doesn't let foreign companies make much money. So my advice is to avoid Chinese stocks as an asset class. This is also negative for US companies that have major operations in China (GM, WYNN, YUM).

India is a somewhat different story. It is at an earlier stage of the growth cycle. Exports and construction have a large place to play in future growth. Because of the rule of law and English language, it also has a major stake in service exports, a particularly good sector. The problem here is self-generated. Like many EM countries, much business is done in cash. This is done to avoid taxes as well as distrust of the financial system. India wants to change this. So the government has called in all large denomination bills. But business culture doesn't change overnight. So a lot of business has ground to a halt. In time this will dissipate, and India will resume its growth.

The Hike

The Fed raised rates by a quarter point yesterday. This was as expected, but the tone of the statement and the press conference was rather hawkish. So everything sold off, including most commodities. Here's my take...

The big number to me was the forecast for growth, at about 2%. If this is true, then the Trump optimism is worth zero. That's the same crappy growth we got during Obama's eight years. It's also a big step down from previous Fed forecasts. Many people may not know that the Fed has been forecasting a return to 3+% growth for about six years. They have been wrong of course. This year they finally threw in the towel, probably at the exact wrong time. I believe 3% is likely.

Any rise in interest rates is bad for commodities, especially monetary-tied ones like gold. But if the rise is due to a stronger economy, that's actually a good thing. The big risk is what happens to emerging markets, where most of the demand growth comes from. A protectionist US would be a great negative. We have to see how Trump policy evolves. However, the people he has picked for his economic advisors are all pretty savvy, and undoubtedly understand what is at stake. So I bet they will tread lightly. In all, I'm still pretty bullish, especially on equities. The major risk here is that many commodities are not longer cheap, so you don't have that long term value working in your favor. But a lot of the companies I hold can do quite well with current prices.

I bought back the South 32 shares I sold last week.

Uranium

Uranium is close to breaking out. Here's a graph of U.TO, a Canadian fund that only holds uranium as assets:

So it filled a gap. Might have to chop around for awhile before it moves higher. I'm keeping my whole position.

Here's a graph of CCJ, the leading western uranium company:

I took some off this morning. Again, at important chart levels.