Commodity ETF Alert September 2010 Issue

| September 13, 2010 | 0 Comments

A WRENCH IN THE WORKS

Have you ever heard the saying, “Throw a wrench in the works”?

It originated in America around 1900.  Low paid factory workers used to literally throw wrenches into industrial machinery.  This of course would stop the machines… and give the workers a much needed break.

I probably don’t need to tell you… this was bad for business.

Don’t get me wrong, working conditions were awful and wages were absurdly low.  But imagine how difficult it would be to run a factory if you constantly had to deal with stoppages.

Well, we’re dealing with a serious ‘wrench in the works’ in commodities right now.  And it’s on a global scale.

Here’s the thing…

Have you ever stopped to consider everything it takes to farm crops?

There’s a lot more to it then you might expect.

Think about it.

Fields need to be plowed.  The earth needs to be fertilized.  Seeds are planted. Irrigation has to be closely monitored.  Pests and diseases have to be controlled. Crops are harvested.  And finally, the end product is sold on the market.

It’s a long and complex process.  There’s a lot that could go wrong… and plenty of chances for the proverbial wrench to interfere with the works.

Unfortunately for farmers, 2010 is looking like the year of the wrench.

I’ll get back to that in a moment…

Earlier in the year, I recommended investing in grains.  Back then, we were preparing for the winter harvest.  We wanted to get in before the uncertainty of the planting season.

The trade didn’t quite work out as planned… A nearly perfect planting season and a strong U.S. Dollar pushed grain prices lower.

But this time it’s different.

There’s a whole new reason to buy grains.

We’re seeing a shift in the fundamentals in the grain markets.  And it’s giving us a great opportunity to get back into grains.

First, a little background.

Fundamentals are usually the key factor in commodity price moves.  It may seem like an obvious statement… but compared to equity prices, commodities are downright rational.

Don’t get me wrong, it’s not always the case.  And certain popular commodities like gold and oil trade more like market benchmarks rather than raw materials.

But generally, commodities trade on supply and demand dynamics.

Now, I’m not going to focus on the demand side of the equation this time around.  With demand, it’s simply a matter of commodity prices increasing as demand increases.

The key issue I do want to focus on is supply.  It’s a major fundamental factor which can’t be ignored.  And it’s a huge deal for agricultural products such as grains, sugar, and coffee.

And there’s one thing impacting supply more than any other… weather.

Good or bad weather conditions can significantly influence the production of agricultural commodities.  Anytime adverse weather conditions hit, it changes the projected supply of crops.  And small changes in weather at the wrong time can have huge consequences.

So why is this important?

Because this year, there’s a wrench in the works of agricultural production.  And it’s severe weather.

2010 seems to be the year of extreme weather.  We have the most severe drought in Russia in 130 years.  We have a massive flood in Pakistan which potential damaged or destroyed a quarter of the country’s crops.  And, we’ve already seen four hurricanes. What could be next… locusts?

Let’s face it.  It’s been a harsh year.

And the damage to the crops is just starting to really hit home.  In fact, the Russian drought may have wiped out 40% of the country’s wheat harvest.

Global production levels of corn, wheat, and soybeans are being called into question.

And now we’re seeing it in the U.S.

Last week’s USDA report on corn shows shrinking supplies and a decrease in ending stocks.  And hot and dry weather conditions continue to hurt corn yields.  Commodity funds are purchasing boatloads of corn in anticipation of tighter supplies for the rest of the year.

Wheat is bearing the brunt of the damage from the Russian drought.  The awful growing conditions in Russia’s wheat belt have forced the government to ban wheat exports.

The export ban has already pushed wheat prices as high as $8.50 a bushel back in early August.  Outside of wheat’s record high of $13 a bushel in 2008, that’s as high as it’s been in over 15 years.

The price has pulled back some since its August high. But that’s good news for us. Russia has extended its ban on wheat exports into 2011. Bottom line… wheat prices basically have one way to go. Up.

Soybeans haven’t had the same bullish action as corn and wheat.  The big USDA report from last week showed stable and comfortable supplies of soybeans.  But that’s nothing to worry about.  Further increases in corn and wheat should also pull up the price of beans.

Here’s what it really comes down to…

Severe weather has fundamentally altered the grain markets.  Supply shortages are now a fact.  And the bad news is just starting to roll in.  What’s more, these supply issues won’t go away until next year’s harvest at the earliest.

Grain prices have gone up in recent weeks as fear of shortages began filtering across the news services.  But, there are plenty of investors who will wait for actual crop shortfalls to be reported before they take a side.  That means as USDA reports come out and show lower supplies, we should see grain prices jump higher.

That’s why I’m recommending taking a position in grains right now.

Supply deficits are expected in coming months.  And as a result, grain prices have the potential to skyrocket.

Let’s take advantage of the extreme conditions and make some money in grains.

ABOUT GRAINS

We’re in a great spot to profit from rising prices in the iPath DJ AIG Grains ETN(JJG). The JJG is an exchange traded note (ETN).  The price and movement of the ETN is based on an index tied to futures contracts in corn, soybeans, and wheat.

Remember, because of tracking errors and expenses, the actual value of the ETN might be slightly different than the underlying commodities.  It’s nothing to worry about, but important to point out.

TECHNICALLY SPEAKING

Take a look at the chart…

jjg091310

As you can see, JJG is currently trading over $43.  I would have preferred to wait for a pullback to get into shares.  But the supplies are only getting tighter.  We can’t wait any longer or we might miss the ride up.  Just look at what prices did in 2008!  We might be on the cusp of that kind of upside…

 WHAT TO DO NOW:

iPath DJ-UBS Grains Total Return (JJG) is trading at $43.40.
Buy JJG up to $45.00 per share.
Our profit target is $60.00.
Don’t forget your position sizing.

Commodity Review
 

COMMODITY TICKER CURRENT VALUE LAST MONTH CHANGE
Energy JJE $21.33 $22.81   -6.5%
Grains JJG $43.40 $41.18    5.4%
Industrial Metals JJM $39.40 $39.17   0.6%
Precious Metals JJP $65.42 $62.63   4.5%
Softs JJS $57.80 $48.61    18.9%
Livestock COW $30.20 $29.43   2.6%
All Commodities DJP $41.30 $40.76    1.3%

ENERGY COMMODITIES

Crude oil has been range bound between $70 and $80 a barrel for the last few months.  It’s keeping our position in OIL in the $21 to $24 range.

And that’s okay.  OIL is a longer-term investment for us.  It’s tied to the health of the economy.  And we’re just now seeing an uptick in positive economic news.

Crude oil inventories are still at high levels.  So I don’t expect a strong move higher in the near term.  But that could change quickly, especially when the economy shows real signs of strength.

Of course, there’s very little downside in oil given the ever increasing demand for energy.  The medium to long-term fundamentals look great so let’s hang on to our OIL shares.

Natural gas may have bottomed out.  I’ll be keeping a close eye on the price of natural gas in the coming weeks.  I’ll let you know if a buying opportunity arises.

GRAIN COMMODITIES

As I discussed earlier, the fundamentals in the grains market are changing dramatically.  Severe weather conditions are cutting into supplies of grains across the globe.

Buying JJG will get us exposure to corn, wheat, and soybeans.  Each of the three has a strong fundamental case to increase.

Grab your shares of JJG now.

INDUSTRIAL METALS

Copper is often a leading indicator of economic health.  And the improvement in the economic outlook for China (and much of the rest of the world) sent copper prices shooting higher recently.

After some profit taking last week, copper prices have leveled out.  With China growing, I’m expecting demand to accelerate.

Our PGM position is holding steady.  Platinum is up slightly in recent days on the glimmerings of economy recovery.

As the economy improves – and automobile sales pick up – we should see a nice bump in the price of platinum.  Grab your shares of PGM while it’s still in our buy range.

PRECIOUS METALS

Gold is back near records highs…

August was a good month for the yellow metal as investors flocked back into the safety trade.  And our position in IAU continues to be a nice winner for us.

We might see a small pullback in gold prices as better than expected economic news hits the wire.  But as long as unemployment remains and the threat of inflation is a major issue, gold will continue to be a safe haven for investors.

Gold also held up pretty well through last week’s equity rally.  That’s good news for us.  Continue to hold on to IAU for further gains.

Meanwhile, silver is on a tear.

This is what we’ve been waiting for.  At some point, the gold/silver ratio had to catch up to historical norms.  And silver has been part of a buying frenzy in recent days.

Our position in SLV is now up over 20%.  And I think the upside is even higher. Continue holding on to your SLV shares for now.

SOFTS

Sugar declined immediately after we grabbed our gains in SGG.  However, SGG has broken through a key resistance level and is heading higher once again.  I feel it’s reaching overbought territory.

Cocoa has pulled back a bit lately.  And NIB is hovering below our entry point.

Supply expectations have stabilized as weather conditions in the Ivory Coast have remained favorable.

But don’t worry…

Remember, we’re expecting a big increase in demand for cocoa as the holiday season approaches.  Improvement in the global economy will also help our cause.

Keep holding your position in cocoa (NIB), and buy below $45.50 if you haven’t already…

LIVESTOCK

Cattle climbed into overbought territory and had a sharp selloff recently.  For prices to really get a nice bump, economic conditions will have to improve more than expected.

Meanwhile, I’m a bit more bullish on hogs.  Slaughter levels have come in below expectations in recent weeks.  Supply is expected to increase in the fall, so prices will continue to be volatile.

Portfolio Changes

  • This month we’re adding grains (JJG) to the portfolio.  See above for all the details.
  • We recently closed out our sugar position (SGG).

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.