CEA Portfolio Update – September 2015

Oil Downturn Finally Nearing An End…

As you know, I sent out an email on September 9^th alerting you to the buying opportunity in the UBS-Etracs MLP Infrastructure ETN $MLPI.

Here’s additional insight into why we made this trade, and how it’s performing thus far.

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No doubt about it, equity and commodity markets are still getting whipped around like a beach ball in a tornado.

As we discussed in our last monthly update, the markets fell victim to a vicious onslaught of intense volatility in late August.

Stocks fell precipitously as investors feared a hard landing in the Chinese economy.

However, things started looking a little brighter in September.  The markets managed to pull together a slight recovery the past few weeks and all the major indices are trading higher than when we last spoke.

However…

September’s upturn was still volatile and highly unpredictable.

And when you factor in today’s 179-point downturn in the Dow Jones Industrial Average, it’s abundantly clear stocks are not out of the woods just yet.

Here’s the deal…

Today’s big market drop is likely the start of another tumultuous multi-week downturn for the equity markets.  Not only is October a historically poor performing month for stocks, but investors are simply too gun shy to push the markets back to higher ground right now.

But here’s what’s really interesting…

The price of West Texas Intermediate (WTI) crude has actually performed quite well the past month.  In fact, the commodity is up 20% from the late August lows of $38 a barrel.

No doubt about it, crude has sidestepped the past month of extreme market volatility with remarkable ease.

What has changed?

Bearish investors rushed to cover their short positions in late August when they found US oil production is starting to taper off considerably.

In fact, the most recent Energy Information Administration (EIA) data reveals oil production across seven US shale basins will decline by 80,000 barrels a day from now until mid-October.

That will be the sixth consecutive month of oil production declines and a 6% drop since April.

Now don’t get me wrong- the US is still producing a lot of crude… multi-decade highs in fact.   That reality, mixed with unrelenting output from OPEC, and you understand why WTI is still trading under $50 a barrel.

But the seeds of the next bullish cycle are currently being sown…

With US producers cutting exploration activity in half since last year, it’s only a matter of time before overall production really starts to decline.  When it does, the price of oil has nowhere to go but up.

At the very least, with US production starting to turn lower, the idea of WTI dropping into the $20 a barrel range (like some uber-bearish analysts suggest) is not a likely scenario.

Of course, a bottom in crude oil pricing is a great development for the energy infrastructure space… 

As I explained in the trade alert earlier this month, shares of oil and gas pipeline companies have been unjustly sold in the recent crude decline.

Remember, pipeline and storage operators get the majority of their revenue from fee-based contracts that aren’t directly linked to crude prices.  As a result, these companies aren’t nearly as subject to the extreme revenue downturns seen in the exploration and production space right now.

Here’s another way to look at it- pipeline operators are simply an essential toll road for energy products.

Speaking of pipeline operators, our newly established position in the UBS-Etracs Alerian MLP Infrastructure Index ETN $MLPI holds some of the best in the business…

The largest holding in the fund (10.4% weighting) is Enterprise Products Partners LP $EPD, which is a $54 billion market cap company operating over 30,000 miles of crude, natural gas, and NGL pipelines in various US regions.

Next in line is $22 billion market cap Energy Transfer Partners $ETP, which owns and operates approximately over 12,600 miles of interstate pipeline.

All told, the $MLPI fund holds just over 20 energy infrastructure companies operating hundreds of thousands of miles of critical crude and natural gas pipeline/storage facilities.  

Simply purchasing $MLPI gives us a diversified bullish bet on the entire midstream oil and gas sector.

How is our position performing thus far?

As of last night’s close, $MLPI was trading at $30.17- down 3.2% from our official entry at $31.19.  There’s no question $MLPI is still subject to the bearish volatility occurring throughout the marketplace right now.

But remember, we’re holding $MLPI with a 15% risk control price ($26.52), so our position still has quite a bit of wiggle room.

The best part is, we’ll be paid handsomely to wait out the energy industry bottom.  Since $MLPI pays a juicy 5.7% dividend, we’ll sleep a little easier knowing we’ll get a dividend check every quarter! 

Now listen closely…

With the equity markets still suffering from a massive case of the jitters, I suggest we move $MLPI to a HOLD in the portfolio.  There’s no sense taking excessive risk with the markets in the condition they are.

Once volatility subsides, we’ll move $MLPI back to a buy.  That is, just as long as it’s still under our maximum buy price of $31.50 per share!

Commodity Review

Energy Commodities

Since we discussed the oil market in detail above, let’s take a quick look at natural gas…

Unfortunately, the gaseous commodity broke below the floor of a months’ long trading range at $2.63 mmBtu in recent trading.  The downturn took our position in the US Natural Gas Fund $UNG to our risk control line at $12.13 in yesterday’s session.

It’s unfortunate, but we must adhere to our rules and close this trade. While I still feel natural gas is very close to forming a bottom, our risk management guidelines are essential to long-term success.

Be ready to jump back in natural gas at a moment’s notice!

What about Uranium?

While uranium isn’t typically classified as an energy commodity, we’re going to include it in this section because of its use as a nuclear fuel.  The price of U3o8 has firmed up the past month and half, rising to $37.25 a pound from $35.25 in mid-July.

That’s good news.

However, our position in Cameco Corporation $CCJ is ignoring uranium’s strength and is instead trading in a volatile sideways fashion around $13 a share.  We may need to see overall equity market uncertainty subside before $CCJ can really find its bullish legs.

Keep holding $CCJ for a strong potential rebound as the price of uranium recovers.   Remember, our risk control line for this trade is at $12.17.

Grain Commodities

With the fall harvest season underway, grain prices are once again under pressure.  Corn is back under $3.80 a bushel while soybeans are trading in the $8.60 a bushel area.  Both of these price points are near multi-year lows.

What do we have to look forward to in these markets?

Not much…

As long as favorable weather conditions help US farmers get their crops out of the field, grains will likely stay subdued.  What’s more, global demand uncertainties must be overcome before bulls have any chance in these markets.

For now, it’s best to steer clear of the grains complex.

Industrial Metals 

No doubt about it, base metals have been a tough market for quite some time.  Not only has copper collapsed to multi-year lows over the past six months, but so has aluminum, lead, nickel, and zinc.

What’s going on?

Global demand worries stemming from Chinese economic weakness have investors shunning the entire sector.  While it’s tempting to buy into these ultra-low prices, there just isn’t sufficient evidence to suggest a rebound is at hand.

However, once we see a massive dose of short covering across the base metals complex and an improvement in Chinese economic data, our sentiment towards the sector will turn bullish.

Precious Metals

Last week’s Federal Reserve meeting brought buyers back to the precious metals complex.  Gold and silver turned higher late last week as investors learned the Fed will likely keep interest rates near zero through the end of this year.

According to Fed Chairwoman Janet Yellen, the US economy is growing at a moderate pace.  However, economic weakness centered in Europe and China are creating risks to the global economy.

As a result, we won’t likely see a change to US interest rate policy as long as global growth concerns are paramount.

So far the situation is being used as a rallying cry for gold…

The yellow metal is approaching a very important technical resistance area at $1,150 an ounce.   If gold surpasses that level in coming days, I suspect we’ll see another strong dose of short covering.

Given the right conditions, gold may jump to $1,200 an ounce in October.

Keep in mind, the same economic worries sending gold higher have the potential to send silver to $17 an ounce- a 13% jump from current prices.

Softs

Cocoa is the only asset holding strong in the softs complex.  The chocolate centered commodity is rallying back toward the mid-July highs at $3,400 a ton due to ongoing supply concerns out of Ghana and Ivory Coast.

According to recent International Cocoa Organization (ICCO) reports, production cuts in the two countries are likely this season due to extended bouts of dry weather.

But that’s just the start of it…

Ivory Coast is electing a new president in October.  In the past, the country’s presidential elections have been marred with violence and societal upheaval.  Should violence overtake this year’s elections, it could give bulls further reason to take the price of cocoa higher.

A break above $3,400 a ton would put cocoa at a new 4-year high and open the door for further upside.

Livestock

Live and feeder cattle are experiencing continued selling as the high-demand summer grilling season draws to a close.

What’s more, recent USDA reports suggest the number of cattle entering feedlots is finally increasing in earnest as US producers continue rebuilding their herds.

I suspect we’ve recently witnessed the highest price cattle are going to trade for quite some time.  As supplies increase in coming years, the live and feeder markets will transition back to lower prices.

Category: Commodity Trading