Commodity ETF Alert March 2013 Issue

| March 12, 2013

 

SUGAR… OVERSOLD AND READY TO RALLY!

Without question, sugar has been one of the poorest performing commodities over the past year, falling 22%.

Why is sugar so weak?

Abundant Brazilian supplies (the number one sugar producer in the world) have sugar sitting near 52-week lows at $0.18 a pound.

What’s more, the International Sugar Organization just raised their 2012/13 world sugar production surplus estimate to 8.5 mm tonnes.

Clearly, there’s plenty of sugar available to global consumers.

Due to these strong supply numbers, bears are in firm control of the sugar market.

As a matter of fact, according to Commodity Futures Trading Commission (CFTC) data, there’s currently a huge short position in sugar.

In other words, professional investors are betting the price of the sweet commodity will continue weakening in coming months.

But believe it or not, this short position creates a remarkable bullish thesis for sugar.

Let me explain…

According to a recent commitment of traders (COT) report, bears are holding a 57,000 contract short position via sugar futures and options.  That’s one of the largest short positions on record for the sugar market.

But here’s the deal…

With sugar prices at depressed levels not seen since mid-2010, US sugar producers are falling on hard times.  In fact, according to the Wall Street Journal, many US sugar producers are on the verge of defaulting on USDA loans.

That has some agricultural economists thinking the US government is about to intervene in the sugar market.

In such a scenario, the United States Department of Agriculture (USDA) would buy sugar in the domestic market in order to prop up prices.  In turn, sugar processors would be able to sell their crop at higher prices, avoiding a default on their government loans.

Now let me be clear…

The amount of sugar the USDA will buy will likely be relatively small.  In other words, the USDA won’t buy so much sugar that prices soar to all-time highs.

However, this looming government intervention will likely be enough to encourage sugar bears to cover their short positions.  As you may know, covering a short position requires the short-seller to buy back the sold contracts.  Doing so effectively closes the position, but has the side effect of sending prices higher.

What’s more, with this sweet commodity trading at such depressed levels, the odds of prices falling dramatically are low.  Add in the possibility of government intervention in the sugar market, and we have a recipe for sugary profits in 2013.

But that’s not the only thing sugar has going for it…

As you know, the US Dollar has been on quite a tear lately.  Recent economic data shows the US economy is strengthening.  As a result, the greenback is trading at levels not seen since August 2012.

Take a look…

USD Chart

As you can see, the dollar has rallied strongly over the past few weeks.  But now that rally is becoming overextended.  We may see the greenback rise to the 83.5 level (red line) in coming weeks, but after that we’ll likely see a hefty correction.

As a result, the recent weakness in commodities (including sugar) should abate in the near future.

Considering the facts above, now’s the perfect time to establish a long position in the sugar market!

ABOUT SUGAR

This month we’re using the iPath DJ-UBS Sugar ETF (SGG) to get long the sugar market.  SGG reflects the returns potentially available through an unleveraged investment in sugar future contracts.

TECHNICALLY SPEAKING

SGG Chart

As you can see, SGG has been stuck in a brutal downtrend since October 2012 (blue line).  But just in the past few trading days, SGG has popped above the prevailing down trend (green circle).  This is a great sign that selling pressure is starting to wane.

Now let me be clear…

It’s highly likely this ETF is starting to form a bottoming pattern along with sugar futures.  However, we may see SGG retest the $65 area in coming weeks, so use caution entering this position.  In other words, use appropriate position sizing.

Regardless of the short-term gyrations, odds are in favor of higher sugar prices in 2013!

WHAT TO DO NOW

iPath DJ-UBS Sugar (SGG) is trading at $67.32.
Buy SGG up to $68.25 per share.
Our profit target is $75.00 or more.

COMMODITY REVIEW

COMMODITY TICKER CURRENT VALUE LAST MONTH CHANGE
Energy JJE $17.66 $17.77    -0.6%
Grains JJG $52.44 $52.42     0.0%
Industrial Metals JJM $32.89 $35.65    -7.7%
Precious Metals JJP $83.92 $88.60    -5.3%
Softs JJS $53.28 $52.11    +2.2%
Livestock COW $26.28 $27.32    -3.8%
All Commodities DJP $41.63 $41.63    -2.5%

 

ENERGY COMMODITIES

Thanks to a few bearish inventory reports, oil has dropped nearly $8 a barrel since mid February.  According to the EIA, crude stocks rose 3.8 million barrels in the week of March 1st.  That puts total US inventories (excluding the strategic petroleum reserve) at 381 million barrels.  Upon closer review, you’ll find that’s 10% higher than last year’s inventory levels, and well above the 5-year range for this time of year.

What’s all that mean in English?

US crude supplies are abundant right now.  As a result, the price of oil will likely drop to the mid-$80 a barrel range in the near future.  As you know, we’ve been patiently waiting for another trade in the oil market.  That time is drawing near.

As far as natural gas goes…

A slew of winter storms that worked their way across the US over the past three weeks is propping up the price of natural gas.  Last week’s EIA natural gas inventory report showed a draw of 146 billion cubic feet- much bigger than analysts’ forecast.
Due to this unexpected drawdown, natural gas is trading at multi-month highs near $3.65 mmBtu.

However, as long as we don’t get another month of Old Man Winter pushing his weight around, we should see gas prices ease in coming weeks.  With gas in storage still 15% above the 5-year average, odds are gas bears will enter the market soon.

Let’s be patient and wait for the relative warmth of Spring.  Once it hits, we’ll likely see natural gas return to the low $3.00 area.  At that point, we can establish another long position.

GRAIN COMMODITIES

Last Friday’s USDA WASDE report had some surprising information.  Investors suspected the USDA would increase 2012-13 corn ending stocks estimates, reflecting the record crop to be planted in the US this Spring.

But it didn’t happen…

Instead, the USDA kept ending stock estimates at 632 million bushels, the same as last month.  As a result, corn prices are gaining ground as investors price in the possibility of low year-end supplies.

As you know, we’ve been bearish on corn ever since the grain broke to record highs in mid-2012.  But if the USDA is changing their supply tune, we might have to release our bearish thesis.

Let’s see how the corn market reacts over the next few days, and if next month’s WASDE report shows similar bullish data.

INDUSTRIAL METALS

Copper is acting strangely.  With equity markets roaring to new highs, it’s surprising that the red metal is trading so weakly.  As you know, copper prices are often used by equity investors to gauge the strength of the global economy.

But with ‘Dr. Copper’ now trading at multi-month lows, something is obviously out of whack.  Given the recent strength in US and Chinese economic data, the red metal should be trading closer to $4 a pound.  The recent rise in the US Dollar is clearly having an influence on the situation, but I think the problem goes a bit deeper than that.

As you know, our position in the Powershares DB Multi-Sector Metals Fund (DBB) took another hit over the past two weeks.  As of today, we’re sitting on a 6% loss in DBB.

However, it wouldn’t be wise to sell DBB at these levels.  Given the technical situation in copper, odds are high that we get a strong technical bounce soon.  As a result, let’s keep DBB at a hold until further notice.

I remain optimistic of industrial metals bullish potential this year…

PRECIOUS METALS

Last Friday’s better than expected US unemployment data didn’t help precious metals bulls.  With the US economy gaining 236,000 jobs and the unemployment rate dropping to 7.7%, it’s clear the US economy is gaining steam.

As a result, many commodity analysts see precious metals losing their safe-haven investment status.

To be clear, I am not one of those analysts.  I still believe gold and silver has enormous bullish potential due to monetary easing and excessive debt in the world’s major economies.  Not to mention the metal’s bullish supply/demand fundamentals.

However, we can’t ignore the facts…

Gold and silver are now trading at multi-month lows.  Unless the US employment situation worsens dramatically, gold and silver will face stiff headwinds for months to come.

Rest assured, I’m keeping a close eye on gold and silver.  But unless something drastic happens in the global economy in coming months, precious metals will likely stay rangebound for the foreseeable future.

However, palladium is a completely different story…

The industrial/precious metal bounced to a new 52-week high of $782 an ounce last Friday.  Clearly, this metal’s bullish supply/demand fundamentals are keeping sellers at bay.  Thanks to palladiums recent jump, we’re now sitting on gains in our ETFs Physical Palladium (PALL) trade.

I’m expecting a bit of profit taking in palladium over the next few days, but after that it’s highly likely the metal continues running higher.  Let’s keep holding PALL for higher prices!

SOFTS

Cocoa finally found some intense buying interest late last week with the price jumping $50 a tonne on Friday.  As you know, we’ve been holding iPath Pure Beta Cocoa (CHOC) through cocoa’s recent weakness, expecting an eventual bounce.

As a matter of fact, I moved CHOC back to a buy in our last position update, counting on such a scenario.  As of today, the cocoa ETF is still below our maximum buy up to price of $32.50, so it remains a buy.

Now we just need to see if last Friday’s strength was just a one-day wonder, or if bullish action carries through to this week.  Given cocoa’s favorable long-term supply/demand fundamentals, we’ll likely see prices firm at these levels and continue higher.

However, we have to remain diligent with our CHOC position.  We’re currently sitting on a loss from our official entry price of $33.60.  As a result, we must be ready to control risk in this trade.  We don’t want to see cocoa slip to new yearly lows and extend our losses in CHOC beyond 10%.

As a result, I’m setting a stop loss in CHOC at $30.24.  If CHOC trades at $30.24 at any point in the next two weeks, go ahead and exit this trade.

LIVESTOCK

Lean hogs and feeder cattle saw heavy selling in February.  As a matter of fact, feeder cattle are approaching the 52-week low of $1.35 a pound set in July 2012. While underlying fundamentals for cattle seem bullish at first glance, the long-term picture is starting to appear more bearish.

US cattle ranchers have culled their herds for decades due to various factors.  But now it appears producers are in the process of rebuilding their herds.  As a result, there’s a growing downside risk in cattle prices.

Steer clear of livestock ETFs for now.

Portfolio Changes

  • This month we’re adding sugar (SGG) to the portfolio.

 

Category: Commodity Trading