Commodity ETF Alert December 2012 Issue

| December 11, 2012 | 0 Comments



No doubt about it, cotton is one of the worst performing commodities in the marketplace over the past two years.

In fact, cotton’s performance has been absolutely abysmal, dropping from $2 a pound in early 2011 to just over $0.73 as of today… a 63% price reduction.

Now, to be clear, cotton’s percentage drop is that large because the soft commodity exploded to 150-year highs in early 2011.

What sent prices soaring to nosebleed levels in the first place?

Massive flooding in Australia and Pakistan ravaged cotton farms and sent 2010- 2011 production below normal levels.

What’s more, the world’s 2nd largest cotton exporter, India, restricted cotton exports in 2011 to help their struggling domestic textile industry.

Mix tight global supplies with huge demand out of China and investors suddenly realized the global cotton market was woefully undersupplied.

Not surprisingly, hedge funds and other investment houses piled into the bullish cotton trade and sent prices to levels not seen since the US Civil War!

Of course, those remarkable prices seen in early 2011 were unsustainable…

It wasn’t long before cotton prices started easing as US farmers switched away from food crops like corn and soybeans to plant highly valuable cotton.  By the end of 2011, cotton prices had plunged back below $1 a pound… a 50% drop from earlier in the year.

The downward price trend carried over into 2012 as demand for high-priced cotton waned and global stockpiles grew.  China, the world’s largest cotton importer in 2010, reduced inbound shipments and increased reliance on manmade fibers such as polyester.

And that leads us to today…

According to the United States Department of Agriculture (USDA), the global cotton market is amply supplied as 2012 draws to a close.  As a matter of fact, the government agency states there are 80 million bales of global cotton inventory left over from the 2011-12 growing season.

That equates to a monstrous 67% global stock-to-use ratio.

What’s more, the USDA expects a global cotton production to top 116 million bales in 2013, with 17.7 million of those bales coming from the US.  If production actually comes in at those levels, we’ll likely see cotton prices continue dwindling lower.

But as long timer readers know, USDA estimates can be wildly optimistic…

Case in point, in early 2012 the USDA estimated that US corn production would hit all time highs.  As a result, most investors were bearish on corn prices in the spring of 2012.

But we all know what happened next.

Record high temperatures and lack of rain in the Midwestern US had the USDA quickly dropping their 2012 crop estimates by July.  It wasn’t long before corn prices were surging to record highs of $8 a bushel.

As many readers know, we established a long corn position in April 2012 when the grain was trading for a mere $6. This year’s corn trade was one of our most profitable of the year.

The same thing could happen for cotton in 2013…

You see, even though cotton inventories are at their highest levels in years, there’s a hidden bullish aspect to the cotton market.

Let me explain…

With cotton dropping to the lowest price since early 2010, farmers around the world are switching away from cotton and back to food crops.  With corn trading at $7.50 and soybeans over $14.50, cotton is not a competitive crop for farmers to grow.

In fact, many agricultural economists believe anything less that $1 a pound for cotton will prompt many US farmers to abandon cotton in favor of higher priced grains in the 2013 growing season.

Of course, the other key to the 2013 cotton puzzle is global demand…

And by the looks of recent US export data, China is still the key figure in global cotton demand.  As a matter of fact, the country purchased 50% of the 416,000 US cotton bales sold in early December.

If China’s heavy buying continues and farmers opt out of production in 2013, we have the perfect scenario for higher cotton prices.

And remember…

Futures markets are a discounting mechanism.  In other words, all pertinent fundamental information, present and future, is factored into current prices.  And that means this year’s swollen inventories are already priced into the cotton market.

But what hasn’t been priced into the market is the growing possibility that 2013 global cotton production could come in well below USDA projections.

Folks, there’s no doubt that global cotton supplies are abundant.  But with farmers switching away from cotton towards higher priced crops, we could see the USDA lower global production estimates in early 2013… which mean higher prices for cotton!


The iPath Dow Jones Cotton ETN (BAL) tracks cotton prices.  The ETN reflects returns potentially available through an unleveraged investment in cotton futures contracts.  Since BAL is a relatively liquid ETF, you shouldn’t have a problem establishing a position in this market.



As you can see, cotton prices have slowly increased in November.  And given the bullish thesis stated earlier, we should see prices trade higher into early 2013. However, we’ll likely see plenty of volatility in BAL from week to week.  In other words, don’t be surprised to see BAL fall a bit while we’re in this trade.  Much like our corn trade earlier this year, patience will be required.


iPath Dow Jones Cotton (BAL) is trading at $48.67.
Buy BAL up to $49.00 per share.
Our profit target is $55.00 or more.

Commodity Review

Energy JJE $16.81 $17.42    -3.5%
Grains JJG $56.17 $55.33    +1.5%
Industrial Metals JJM $35.58 $32.68    +8.9%
Precious Metals JJP $92.48 $93.17    -0.7%
Softs JJS $52.54 $53.53    -1.8%
Livestock COW $28.00 $28.14    -0.5%
All Commodities DJP $41.89 $41.63    +0.6%


Multiple influences are tugging at the price of oil…

Ongoing Fiscal Cliff worries have bulls sitting firmly on the sidelines, waiting for signs of a resolution.  However, Middle East tensions are keeping bears from overtaking the market.

The result is a range bound market with $90 being the top end of the range and $85 the bottom.

Take a look…


Where will crude prices break next?

It’s pretty simple really.  If Congress can alleviate Fiscal Cliff worries by the end of year, oil prices will likely rally.  On the other hand, if politicians can’t get a deal hammered out by December 31st, crude’s destined to break below $85.

Unfortunately, a trade in the oil market right now is essentially a bet on political progress in Washington.  And that’s a bet I’m just not willing to make.  Let’s keep watching oil for a long entry in coming weeks.

As far as natural gas is concerned…

Warm temperatures are once again suppressing prices.  As you know, a cold week in early November sent natural gas surging to $3.90 mmBtu.  However, weather forecasters are now predicting a warmer than usual December across the Northeastern US.

If we don’t see colder temperature arrive soon, natural gas will likely continue falling. Remember, natural gas prices are highly susceptible to heating demand this time of year.  If consumers aren’t cranking up the heat, gas demand will weaken and prices will fall.

But whatever you do, don’t give up on our trade in the US 12 Month Natural Gas (UNL) just yet.  As you know, our official entry point in this trade is $16.66.  And that means we still have a bit of wiggle room with UNL currently trading at the mid $17 area.

If temperatures cool in early January, UNL will return to higher levels.  One thing’s for certain though… we need to see Old Man Winter make a statement in coming weeks for natural gas to trade higher.

For now, let’s keep UNL at a hold…


Grain markets have entered into strong range bound trading in recent months.

For example, after enduring a shocking rally earlier in 2012, wheat is now stuck in a trading range between $8.50 and $9.00 a bushel.

However, unlike crude oil, wheat prices are not as susceptible to the whims of Washington politicians.  Instead, the hearty grain reacts to fundamental changes in monthly USDA grain supply/demand reports.

This month’s report comes out today (December 11th) and traders are expecting a slightly bullish report, as US winter wheat crops are in poor condition.  This may supply a few weeks of bullish activity in wheat.

However, in the long run, wheat appears destined to trade lower.  In fact, many analysts see wheat as exceptionally overvalued at $8.50 a bushel.  And I would have to agree.  Being bullish on wheat at $8.50 a bushel is akin to being bullish on oil at $140 a barrel.

There’s simply little room for prices to advance much higher until demand destruction cures high prices. The same goes for corn.

For now, steer clear of the grain markets…


Industrial metals have strengthened dramatically since we last spoke…

In fact, the PowerShares DB Multi-Sector Metals Fund (DBB) has now surpassed the buy-up-to-price of $19.00 suggested in the last update (November 27th).  What’s more, industrial metals were the strongest performing commodity group over the past month.

What’s going on?

A better than expected November US jobs report, along with bullish China industrial production data, has industrial metals on the upswing.  For example, copper is making a bullish run for the $3.80 a pound level.  As you may know, copper is a core holding in DBB along with zinc and aluminum.

Let’s move DBB to a hold and be patient.  As long as the Fiscal Cliff doesn’t give us a nasty surprise in coming weeks, industrial metals should keep gaining ground.


Gold and silver are still having a tough time gaining ground in what’s usually one of the strongest months of the year for the precious metals.

What’s going on?

Part of the reason for the stagnant price performance in recent weeks is due to the ongoing Fiscal Cliff uncertainty.  Investors simply aren’t willing to pile into risk assets of any kind amidst all the uproar.

But that’s only part of the story…

Weaker than expected third quarter Chinese gold demand is putting a damper on prices as well.  In fact, Chinese demand dropped by nearly 11% from the same period last year.  A weakening economy and subdued inflation has Chinese investors pulling back on purchases of the yellow metal.

Of course, the question now is “where do price go from here?”…

Given the ongoing uncertainty in the US political landscape, I wouldn’t be surprised to see gold and silver trade around current levels- $1,700 and $33 an ounce respectively- through year-end.

However, once 2013 rolls around and investors have an idea where the global economy is heading, we’ll likely see precious metals prices firm up.

Remember, Federal Reserve Chairman Ben Bernanke has promised a zero interest rate policy into 2015… and that’s highly supportive for precious metals.  What’s more, there are rumors floating around the street that Bernanke may up monthly QE3 purchases to further support the US economy.

Let’s keep both our IAU and SLV positions at a hold until further notice.

Now, on the other hand, our trade in Powershares DB Gold Short (DGZ) is back in the green.

As you know, we made the trade in DGZ just in case gold experienced some bearish turbulence.  So far, it looks like that was a very smart move as we’re currently sitting on a small gain in DGZ.

Like I said a second ago, I don’t expect much out of precious metals by year-end unless Congress comes to an agreement on the Fiscal Cliff.  So let’s keep our position in DGZ at a hold until further notice.


No doubt about it, softs are easily the worst performing commodity sub-sector over the past few months.  Case in point, coffee and sugar are currently testing their respective 52-week lows thanks to data revealing abundant global supplies.

There’s really nothing to get excited about in soft commodities at this point (with the exception of cotton of course).  It’s best to steer clear of sugar and coffee until the current spate of bearishness runs its course.


As long time readers remember, this year’s drought not only wreaked havoc on grain farmers, but it also did a number on cattle ranchers.  Many were forced to reduce their herds this summer due to lack of feed.  As a result, cattle prices took a hefty dive mid-year as a sudden supply of cattle crossed sale ring floors.

However, cattle prices have rebounded nicely in recent months thanks to multiple USDA reports showing multi-decade lows in feeder cattle placements.

What’s more, investors expect cattle feedlot numbers to continue dwindling into 2013. That means cattle prices are open to gains in coming months.

Portfolio Changes

  • This month we’re adding cotton (BAL) to the portfolio.

Category: Commodity Trading

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.