Commodity ETF Alert November 2012 Issue

First it was European debt problems that threatened to take the US economy (and just about everything else for that matter) down the drain.

Then it was fears of a global economic slowdown that had investors second-guessing the markets.

And if all that weren’t enough, now there’s another storm brewing… one that could cause immense problems for the US economy in the very near future.

What is this potential disaster?

… the Fiscal Cliff.

Federal Reserve Chairman Ben Bernanke coined the term “Fiscal Cliff” to describe a US budget issue that, if not solved, will likely push the US economy into a deep recession.

Let me explain how it works…

At midnight on December 31st, 2012, a series of automatic government spending cuts and tax increases go into effect here in the US.

Not only will taxes on businesses and individuals rise dramatically, but the US government will decrease spending in areas such as defense and education.

Why are these changes to taxes and spending occurring in the first place?

It all comes down to decreasing the US deficit.  The Budget Control Act (BCA) was signed into law in August 2011.  According to the Congressional Budget Office, the BCA will reduce the US budget deficit by an estimated $560 billion in 2013 and an estimated $7 trillion over the next ten years.

Now, pretty much everybody agrees that decreasing the US deficit is a good thing.

However, the problem with the BCA lies in the timing… 

Tax increases and spending cuts from the BCA will decrease US gross domestic product (GDP) by an estimated 4% in 2013.  And since the US economy is already dancing on the edge of recession, this Fiscal Cliff will put the US economy in a very precarious position.

Of course, our main worry is how the Fiscal Cliff will affect commodities…

First and foremost, we have to consider the Fiscal Cliff’s potential affect on the US Dollar.

As you know, we’ve talked a lot about the dollar recently.  Due to Ben Bernanke’s September 2012 announcement of QE3, I’ve contended the greenback was ready for a hefty slide downward.

However, if Congress doesn’t act to reverse the Fiscal Cliff, or at least minimize the near-term impacts, the dollar could do the exact opposite of what I’m expecting.

Due to Fiscal Cliff uncertainty, the greenback may soar as investors sell risk assets such as stocks and commodities.

And remember, there’s a strong inverse correlation between commodities and the dollar.  In other words, when the dollar rises, commodities generally fall.  So if the worst comes to pass with the Fiscal Cliff, we want our commodity portfolio to be protected.

So here’s what we’ll do…

Since the majority of our open portfolio positions are linked to precious metals, we’re going to purchase an inverse gold ETF- the PowerShares DB Gold Short ETN (DGZ).

Should the dollar shoot higher due to Fiscal Cliff issues, DGZ should rise right along with it.  Of course, our open positions in iShares COMEX Gold Trust (IAU) and iShares Silver Trust (SLV) will likely weaken.

Now let me be clear…

I’m still very bullish on gold and silver in the long run.  So don’t close your positions in IAU or SLV.  However, the short-term political antics surrounding the Fiscal Cliff could give us a few months of volatile trading in precious metals.

By adding DGZ to our portfolio, it will give us an opportunity to protect our precious metals positions should gold and silver fall in coming months.

ABOUT INVERSE GOLD

The PowerShares DB Gold Short ETN (DGZ) performs the opposite of gold.  In other words, when gold falls a given percentage — DGZ rises the opposite percentage.  DGZ can be traded intraday just like any other commodity ETF we’ve had in the portfolio.

TECHNICALLY SPEAKING

But here’s the best part about this trade in DGZ…

We don’t have to risk much to put it on.  If the Fiscal Cliff is averted and gold continues higher, we’ll still have our positions in IAU and SLV.  What’s more, we’ll close our trade in DGZ if it falls below $11.00.

In other words, we’re risking a mere $0.44 from our entry price.  That’s a very small price to pay to protect our valuable precious metals positions!

 WHAT TO DO NOW:

PowerShares DB Gold Short ETN (DGZ) is trading at $11.44.
Buy DGZ up to $11.60 per share.
Our profit target is $13.00 or more.

ENERGY COMMODITIES

Global economic growth worries have bears in control of the oil market.  In fact, crude’s went from the low $90 a barrel range down to $84 in just the past three weeks.

However, the prime buy zone for oil is approaching.  Stay tuned for another oil trade in coming months.

On the other hand, natural gas is still working its way higher…

As a matter of fact, the seemingly abundant commodity touched $3.80 mmBtu when the December 2012 contract came into play.

However, we’ll need a chilly winter here in the US to keep the price of natural gas moving higher.  If temperatures are colder than usual, I have no doubt we’ll see gas jump over $4.00 in coming months.

What’s more, natural gas is unlikely to be effected by the Fiscal Cliff issue.  US temperatures and inventory levels are the two prime catalysts for natural gas movement.

We’re currently sitting on a 15% gain in our US 12-month Natural Gas ETF (UNL). Let’s keep holding UNL for higher prices ahead!

GRAIN COMMODITIES

According to the USDA, a healthy late-season rain in the US heartland kept an already dangerous situation in grain markets from getting more serious.  As you know, corn, soybean, and wheat exploded to record highs this past summer as drought consumed large swaths of the US, raising fears of a supply shortage.

But now supply fears are easing as the USDA is reporting global grain inventories may not be as bad as previously thought.  We’ll likely see additional weakness in corn and soybeans in coming weeks.

INDUSTRIAL METALS

Global growth worries have copper, aluminum, lead, and zinc doing the same thing as oil… weakening.  However, it’s much too soon to call it quits in our PowerShares Multi-Sector Metals Fund (DBB) trade.

However, due to the near-term uncertainty surrounding the Fiscal Cliff, I’m moving DBB to a HOLD.  We may see additional weakness in base metals as uncertainty looms.  Be ready to buy DBB once Fiscal Cliff uncertainty is out of the way.

PRECIOUS METALS

Precious metals performed poorly in October.  Both gold and silver endured substantial pullbacks thanks to a bit of unwelcome strength from the US Dollar.

To some analysts, the recent weakness in precious metals is worrisome.  However, if you study yearly trends, you’ll find precious metals usually encounter weakness in October.  It isn’t until early November that gold and silver turn on the afterburners and shoot higher into year-end.

Of course, how much strength we see for precious metals in the last two months of 2012 depends largely on the Fiscal Cliff issue and the US Dollar.

At any rate, be patient with our positions in gold (IAU) and silver (SLV).  Now that Barack Obama has been re-elected President, more easy money policies will be coming our way… and that’s very good for precious metals.

We’re currently sitting on an 8% gain in IAU, and a minor loss in SLV.

Keep positions in IAU and SLV at a hold until further notice…

SOFTS

Soft commodity markets are experiencing significant weakness in recent trading.  In fact, coffee and sugar are currently testing their respective 52-week lows.

What’s going on?

For starters, coffee is expected to return to a surplus market in 2013 according to the International Coffee Organization.  As you may know, a surplus is when supply of a commodity outpaces demand.

Meanwhile, the price of sugar is dropping thanks to a strong crop from Brazil’s Centre South region.  September output from the region is up 30,000 tonnes over the same period last year.  That has investors being very cautious with sugar.

An opportunity to buy into specific soft commodities is coming.  But as of today, it’s best to stay on the sidelines.

LIVESTOCK

The cattle market is once again setting up for higher prices due to surprisingly weak feedlot numbers.  In fact, cattle placed in feedlots for September were just over two million head… 18% below last year.

Much of the weakness in feedlot numbers has to do with grain prices.  When corn and wheat shot to record highs recently, feedlots were unwilling to purchase as many cattle due to higher feeding costs.

Low feedlot numbers will likely put upward pressure on cattle prices in coming months.

• This month we’re adding inverse gold (DGZ) to the portfolio.

Category: Commodity Trading