Commodity ETF Alert June 2010 Issue

The troubles in Europe are kicking sand in the face of the markets.  Both the equity and the commodity markets are filled with doubt.

The economic landscape is looking shakier by the day.

What once was a debt problem for Greece is spreading into a debt problem for many other European nations.

The number one question in investors’ minds is, “Can the debt problems be contained?”

As time goes on, the risks of a debt “contagion” are rising.  The problems may start cascading into a spiral of deflation.

Nobody knows for sure how it will play out.  But some investors aren’t taking any chances.

Many economically sensitive commodities are seeing drastic declines.

So this begs the question…

Where can we put our commodity capital to work without large downside risks?  Is there a commodity where the downside risk is minimal?

Where can we find shelter from the current commodity storm?

Look no further than sugar.  After months of steep declines, the sweet spot for investing in sugar is here.  Much of the downside risk in sugar is depleted.  But more on that in a minute…

So what’s the story with sugar?

Sugar needs no introduction.

Sugar comes primarily from two sources… sugar cane and sugar beets.

Originally, people just chewed on raw sugar cane to get their sweet fix.  But then the Gupta Indians on the Indian subcontinent made a discovery that changed the world. Around 350 A.D., these Indians discovered how to crystallize sugar.

The crystalline form is the sugar we know and love today.

Once this sweet advancement was made, sugar became a valuable commodity.  It was more easily transported and stored in the crystalline form.  It was traded amongst merchants around the world.

Currently, sugar cane is grown in over 100 countries around the world.

Around 70% of worldwide sugar production comes from sugar cane.  Approximately 1.8 billion metric tons of sugar cane was produced worldwide in 2008.  The largest producers of sugar cane are Brazil, India, and China.

Sugar beets make up around 30% of worldwide sugar production.  Beets are grown in colder climates in countries with more advanced agricultural practices.  The largest producers of sugar beets are France, Germany, and the U.S.

Approximately 250 million metric tons of sugar beets were produced worldwide in 2005.

Weather has a big role in the production of sugar cane.

Sugar cane needs a minimum of 24 inches of annual precipitation.  This is why the majority of sugar cane production comes from temperate and tropical climates.

When the weather gods don’t cooperate, it can put the sugar market in frenzy.  This was exactly what happened in 2009.

Poor growing conditions in India and Brazil sent sugar markets skyward.  When the world’s two largest sugar producers have poor growing conditions… the sugar market reacts.

After a huge bull run, sugar was trading at 29-year highs in early 2010.

World sugar supplies were tight as India and Brazil weren’t able to produce as much sugar cane as expected.  It sent prices upward as the sugar market was pricing in a production shortfall.

But the sugar market is just like any other market… it’s a discounting mechanism.

It’s always discounting future information in today’s prices.  When sugar was trading at near 30-year highs, the market was worried about a sugar shortfall for 2010.

But that was so yesterday…

Here we are well into 2010 and sugar prices have been falling since those recent 29-year highs.  The sugar market has moved on.  It’s now pricing in the 2010-2011 growing season.

The 2010-2011 growing season is shaping up to be better than last year…

The Brazilian growing season was more favorable this year.  As harvesting progresses, analysts are now expecting a 10% jump in Brazilian sugar production over last year’s depressed levels.  Brazilian sugar producers are getting back on track.

India is also shaping up to have a better crop for 2010-2011.

The monsoon season is just starting.  Weather analysts say this year’s monsoon should bring a good amount of rain to India.  Nearly 60% of India farmland is irrigated by natural rainfall.

A good monsoon season is essential to a good sugar cane crop.

As the market prices in more favorable growing conditions, sugar prices have been dropping.  In fact, prices have dropped nearly 50% in recent months since January of this year.

So why is sugar ripe for investment at these levels?

The recent sell-off in sugar has been extreme.  The plunge has set up a buying opportunity we can’t afford to miss.  Even though sugar production is expected to normalize this year, global sugar stocks are still relatively tight.

The sugar market is expected to continue to tighten in coming years.  Demand for sugar cane is growing.

While sugar demand remains strong throughout the world, there’s a new and growing use for sugar cane… ethanol.

Ethanol is a growing industry in Brazil…

As oil prices remain at elevated levels, more attention is being placed on ethanol.

According to the Brazilian Sugarcane Industry Association (UNICA), over 90% of light vehicle sales in Brazil are “Flex Fuel” vehicles.  These vehicles can burn either traditional gasoline or ethanol.

It’s estimated by the end of the 2010/2011 sugar cane harvest, the “Flex Fleet” will grow 9% over current levels.  This means more and more cars are burning ethanol in Brazil.

According to UNICA, this year over 50% of cane production is going into ethanol in Brazil. 

As time goes on, ethanol production will put pressure on sugar cane inventories. Growers will need to expand production to keep up with demand.  Growers will also need ideal weather conditions for growing cane.

Another bad growing season like 2009 and sugar prices are likely to skyrocket again.

As sugar cane inventories remain tight in years to come, sugar prices should remain volatile.

Just as sugar has plummeted in recent months, it can turn and surge just as easily.

By buying sugar at these levels, we’re picking it up at the bottom of a multi-year range.

This isn’t to say sugar can’t go do down a bit more from here.  But the large downside risk in sugar is now gone.  This is just what we’re looking for in this type of market environment.

We don’t want to buy an economically sensitive commodity and risk a large downside move against our position.

However, there’s excellent upside potential for sugar going forward!

The bottom line is this…

Sugar has seen heavy selling in recent months.  This gives us a chance to pick up sugar at great prices.  It also gives us a bit of protection against a large move against our position.  As sugar cane sees competition between sugar and ethanol use, inventories are likely to be tight in the future.

Also, when the U.S. Dollar starts to weaken again, we should see buyers step into the sugar market.

ABOUT SUGAR

The iPath DJ-UBS Sugar ETN (SGG) is an ETN reflecting the price of sugar.  SGG tracks the Dow Jones-UBS Sugar Total Return Sub-Index.  This index reflects the returns potentially available through an unleveraged investment in the futures contracts on physical sugar.

TECHNICALLY SPEAKING

Take a look at the chart…

 WHAT TO DO NOW:

The iPath DJ-UBS Sugar ETN (SGG) is trading at $40.60.
Buy SGG up to $44.00 per share.
Our profit target is $60.00.
Don’t forget your position sizing.

ENERGY COMMODITIES

Oil is still incredibly volatile.  After a brief dip down to $68, we saw a nice bounce up to $75, only to retrace back down to $70 in recent trading.  This high volatility is due to the market deciphering a constant barrage of news on the global economy.  One day things are looking better, the next they look downright horrible.

Investors are highly uncertain on what the future holds.

Here’s the way we look at it…

The long-term supply/demand scenario is incredibly bullish for oil.  However, the current economic mess points to another round of deflation dead ahead.  Another deflationary cycle would likely push oil back down to the multi-year lows of the $40 range… or lower.

So here’s what we’re going to do with our position in OIL…

Keep holding it for now.  If we get news global economies can avoid another deflationary spiral, oil will likely stabilize and head higher in coming months.  However, if the debt “contagion” spreads to other countries, we could see energy commodities head lower quickly.

Remember from our last update we recommended holding our position in OIL unless it closed below $20.00.  Let’s keep the same game plan going forward.  If OIL closes below $20.00, sell your position to conserve your capital.  We cannot run the risk of riding crude oil back down to the multi-year lows.

If crude bounces, great… we’ll hold on to it and ride it back up.  If it falls, we’ll get out and look to reinvest at lower levels.

Our investment in UGA is in the same boat as OIL.

We’re underwater and we need to conserve capital if the markets continue to head lower.

We got the “snapback” rally we were looking for in UGA in our last update.  But in recent trading, UGA is faltering.  If UGA closes below $31.00 going forward, exit your position to conserve capital.  If UGA can hold above that level, hang on to it.

Hopefully, we’ll see a nice bounce in coming weeks as the summer driving season heats up.  But if we don’t, the deflationary news out of Europe may take over and drive UGA lower.

GRAIN COMMODITIES

JJG is weakening in recent trading.  The selling is a combination of two things… a dramatic increase in the U.S. Dollar and a nearly perfect planting season.

The strong dollar is definitely not helping our trade in JJG.  The dollar is surging as the euro plummets in value.  So if anything, we can point to the problems in Europe as indirectly affecting grains via the Euro/Dollar relationship.

I know that’s not what you want to hear, but we can’t ignore the facts.  We’re down 10% from our official entry of $35.79 in JJG.  The spring planting season is going off without a hitch and grain inventories are looking strong.  This is not the bullish scenario we were looking for.

Let’s conserve capital on this trade right now… exit JJG.

INDUSTRIAL METALS

The recent sell off in industrial metals is widespread.  Aluminum, nickel, and copper are all seeing dramatic declines.  The nature of this selling is worrisome for the global economy.

This sudden sell off in industrial metals is pointing to a drop off in demand.  This is bad news for the global economy as it could be pointing to a double dip recession.

A double dip recession would obviously be very bad.

With unemployment in the U.S. already lingering at 9.7%, a double dip would push the number even higher.  This will have a huge deflationary effect on commodity markets. Lack of end demand would push most commodities lower.

Our position in copper (JJC) is now closed.  We said in the last update to exit the trade if JJC closed below $38.00.  JJC closed below this level last Friday.

We put ourselves in a position to catch copper on a pullback in an up trending market. This was a good setup but sometimes it just doesn’t work out.  We’re doing the right thing by controlling our downside risk.  We don’t want to take the chance of riding copper back down to the multi-year lows.

PRECIOUS METALS

Gold isn’t seeing any of the problems other commodities are.  In fact, demand for gold is skyrocketing.  The price of gold is back near the recent all time highs.  After pulling back in recent weeks, gold is seeing some incredible strength.

Keep in mind, the U.S. Dollar has been very strong in recent months due to the problems in Europe.  The fact that gold is showing this much strength in the face of a strong dollar says something.

It tells us gold is quickly becoming sought after as the place to go for “safety”.  And with all the uncertainty in the global economy, its no wonder gold is holding its lofty heights.

We’re up nearly 30% on our investment in IAU.  Keep holding your position as we still see further upside for gold.

Silver is off its recent highs as volatility is bringing out some sellers.

Remember, silver is notoriously volatile.  It’s no surprise we’re seeing some selling from the recent highs.  However, we still remain very bullish on silver in the long run.  It’ll go through selling fits here and there but should head higher in the long run.

Platinum and palladium have seen selling over the last few weeks.  These metals are closely tied to automobile manufacturing and the economy.  With recent fears of a faltering global recovery, these metals may see a drop in demand.

SOFTS

Coffee is still in its trading range from the last three months.  Buyers step in at the bottom of the range, only to sell at the top.  However, we could see some buying activity in the short term due to potential freezing temperatures in Brazil, a major coffee producer.

This could put a bid under prices but won’t be enough to start a new uptrend.

Cocoa got a nice technical bounce off the recent lows.  But with the recent strength in the dollar, the upside is limited for cocoa in the short term.

LIVESTOCK

Cattle prices are pulling back after a three month surge.  Feedlot numbers are building again and putting pressure on prices.  The recent fear and volatility in the stock market may also be having an effect.  Consumers may buy less beef if the economy starts to weaken in coming months.

• This month we’re adding sugar (SGG) to the portfolio.
• Grains (JJG) is now closed.
• Copper (JJC) is now closed.

Category: Commodity Trading