Tuesday, May 24, 2011


Good Morning!

I am pleased to announce that the new site is up and running.  From now on, all posts can be found at http://www.futurescommentary.com/

You will find improved functionality, including the ability to subscribe by email!

I hope you enjoy the new site, and I look forward to hearing your feedback.

Best regards,

Jaime Macrae

Friday, May 20, 2011

Price Dictates Priorities: Crude Oil Rig Count Surpasses That for Natural Gas - May 20th

Price Dictates Priorities:  Crude Oil Rig Count Surpasses That for Natural Gas
May 20th, 2011

Energy producers in the United States are very responsive to price when it comes to allocating resources.  One popular measure of drilling activity is the Baker Hughes Rig Count, which expresses the number of active drilling rigs in the United States.  Producers respond to rising prices by increasing drilling activity, and typically reduce the number of active rigs when prices fall.  Below are two charts that show the price of both crude oil and natural gas, overlaid against the number of active rigs for each commodity.

U.S. Crude Rig Count vs. Crude Oil
Courtesy of Bloomberg

U.S. Natural Gas Rig Count vs. Nat Gas
Courtesy of Bloomberg

The natural gas chart shows that as the price of natural gas fallen over the past three years and found stability in the $4 - $5 range, drilling activity has declined as well.  Conversely, the number of rigs drilling for oil has risen rapidly as prices have rallied over the same time period.  What makes this particularly interesting this morning is the for the fist time since the early 1990s, more rigs are now drilling for oil than are drilling for natural gas (see chart).

U.S. Rig Count – Nat Gas vs. Crude Oil
Courtesy of Bloomberg

At first glance this would seem to portray a natural gas market that is setting the stage for another major rally, but it is important to realize that with improved drilling techniques producers are yielding more gas from each well, and production has actually increased 7 percent since 2008 when the rig count began to fall. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Thursday, May 19, 2011

Drought or Flooding: Mother Nature is determined to disrupt the Wheat Crop - May 19th

Drought or Flooding:  Mother Nature is determined to disrupt the Wheat Crop
May 19th, 2011

One way or another, wheat crops around the world are suffering from adverse weather conditions.  Some areas are struggling to get the crop planted amidst major flooding, while others are seeing their crop whither in extreme drought.  While global stockpiles are substantial, and there does not seem to be any prospect of a serious shortage, this year’s crop seems doomed to disappoint.

Spring Wheat Planting

Farmers in the Dakotas are having a very difficult time planting this year’s crop of spring wheat (the variety traded in Chicago).  As of last week only 36 percent had been seeded, compared to the 10 year average of 75 percent.  The outlook for progress in the coming week seem dim, as there is more rain in the forecast, and anecdotal reports from farmers indicate the soil moisture has staying power, so it would take an extended dry period to facilitate planting.  Similar conditions exist in the Canadian prairies.

Winter Wheat in the Southern U.S.

Farmers in the South, specifically in Texas and Oklahoma, would probably love to have the problems of their colleagues to the north.  Drought conditions in some areas are the worst in decades, and crop has suffered as a result (this being Hard Red Winter Wheat, the variety traded in Kansas City).  As of last week, the USDA reported that only 32 percent of the crop was rated good or excellent, a worsening from the week before, and well below the ten year average of 48 percent.  44 percent of the crop is rated poor or very poor, which is the worst reading on record for this reporting period after 1996, when 46 percent was in bad condition.  While there have been some scattered showers, it is unlikely that the crop will show significant improvements at this stage in the season.

International Droughts

France, which is the largest producer of wheat in the EU, is experiencing a serious drought, with the driest April since 1953.  As a result they are expecting the size of the crop to decline by 12 percent from last year, to a four year low.  Production is forecast at 31.65 million metric tonnes, down from 35.7 million metric tonnes last year. 

To the east, there are similar conditions being reported in China.  In central Hubei province, they are experiencing the worst drought on record.  China is largely self-sufficient in wheat, so if they had to turn to the world market for significant imports it would be a very bullish development.  Hubei province however is not a very large wheat producer, so this drought may not have too big of an impact.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Wednesday, May 18, 2011

Structurally Bullish Palladium

Structurally Bullish Palladium
May 18th, 2011

The fundamental backdrop for palladium continues to improve, moving from a surplus of 680,000 ounces a couple of years ago to a shortage of 490,000 ounces last year.  Johnson Matthey Plc, one of the top dealers and analysts in the PGM space, is forecasting the largest supply deficit in a decade in 2011. 


The biggest source of demand for palladium comes from automobile producers, who use the metal in catalytic converters.  While demand from this space fell dramatically following the financial crisis and ensuing economic contraction, it has since rebounded and is now at a record high.  Consumption from car manufacturers jumped 35 percent last year to 5.45 million ounces. 

Another big source of demand, which is relatively new, is from investors buying physically backed ETFs, much like the well known GLD or SLV.  These funds have only been buying the metal for a few years, and have accumulated 2.173 million ounces so far.  Last year they bought 1.09 million ounces, up 74 percent from a year earlier.  As more and more retail investors turn to commodities, and specifically metals, as a store of value and a hedge against what seems to be inevitable inflation, this could prove to be a significant source of future demand. 

All told, total demand rose 23 percent last year to 9.63 million ounces. 


The supply of palladium is a little bid weird.  The largest source comes from South African mines, which traditionally produce between 2.5 to 3 million ounces.  The second biggest source are the Russian mines, however Russian production is supplemented by sales from government stockpiles.  The government sales, which last year totaled 1 million ounces, are seen as crucial to maintaining balance to this market which would otherwise be in perpetual and very serious deficit.  The catch is that the quantity of government stockpiles is a closely guarded state secret, so it is impossible to predict if and when these sales will dry up.  Standard Bank Group Ltd. has predicted that they will be depleted as early as this year, though it is unclear what this prediction is based on.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Tuesday, May 17, 2011

Weakness in the Cocoa Market - May 17th

Weakness in the Cocoa Market
May 17th, 2011

The cocoa market continues to come under pressure, with a string of bearish developments in West Africa.  There are several main points that are weighing on the market.

1 – The four month political standoff that had turned violent, and caused the cocoa trade to grind to a halt, is now over.

2 – The export ban has been lifted in the Ivory Coast, the world’s top producer.

3 – The banking sector has resumed operation in Abidjan, the commercial capital.  This was a prerequisite to the resumption of exports as the traders were lacking the necessary financing to arrange shipments.

4 – Major commodity firms have returned to the Ivory Coast.  Cargill, one of the world’s largest traders announced today it has resumed operations.

5 – Large stockpiles that had built up in warehouses in Abidjan while the export ban was in force have not spoiled en masse.  While approximately 10 percent of the beans stored have suffered rot, the bulk of the stockpiles have maintained their quality.  This was one potentially bullish factor hanging over the market as reliable figures had yet to reach the market. 

6 – Production is forecast to have grown significantly from last year, up 100,000 tonnes in the Ivory Coast, and up almost 300,000 globally. 

7 – Output in Guana has boomed, with forecasts for a crop of 920,000 tonnes, up from 632,000 tonnes last year.  It is commonly believed that smuggled cocoa from the Ivory Coast is responsible for much of this gain, however improved farming techniques have also added to the crop size.

The bull camp points out that there is currently around 500,000 tonnes of cocoa stored in warehouses in the Ivory Coast, awaiting export.  The country typically ships 100,000 tonnes per month, so if could take quite a bit of time for these beans to hit the market. 

All told, the outlook for the price of cocoa is not good. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Monday, May 16, 2011

Speculators Shun Copper - May 16th

Speculators Shun Copper
May 16th, 2011

Last month I wrote about the copper market, noting that it looked top heavy and I examined some changes taking place in China that could contribute to a slide [Copper(Top) Heavy – April 18th].  The last two weeks have seen the selloff intensify, along with many other commodities, and Friday’s CFTC Commitment of Traders report revealed that speculators are quickly turning their backs on the copper market.

CFTC Large Non-Commercial Traders vs. Price
Courtesy of Bloomberg
The speculative community has held a large net long position since last summer, and over the past few weeks have been liquidating their positions en masse.  Open interest has been declining steadily as well, indicating reduced speculative participation in the market.  While there are many factors in determining the market price of copper, this is yet another strike against the red metal. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Friday, May 13, 2011

Canadian Dollar - May 12th

Canadian Dollar
May 12th, 2011

The loonie has drifted lower over the past couple of weeks; this morning trading down to the low end of the channel in which it has been appreciating steadily since last year.  Despite the weakness in absolute terms, the Canadian dollar has shown impressive strength over the past week when viewed against a backdrop of rapidly declining commodity prices.  Crude oil and the Canadian dollar have a very strong positive correlation, as the fossil fuel is our nation’s largest export, so in the face of a double digit decline in the price of oil it is reassuring to see the currency continue to trend higher.  The same is true with regards to the price of gold.

Below is a weekly chart of Canadian dollar futures over the past year.  As you can see, the appreciation has been steady and unwavering.  When compared to the dramatic rise in other similar currencies, specifically the Australian and New Zealand dollars, it has also been somewhat tempered and thus seems more sustainable.  Currency markets tend to trend better than most, since the fundamentals that underpin the moves usually persist for long periods of time. 

Canadian Dollar Futures - Weekly
Courtesy of Bloomberg

The Fundamentals

One of the most important determinants of a currency’s trend is the differential between the interest rates in the two countries.  When the interest rate is higher in one country, that nation’s currency tends to strengthen relative to the other.  The reason is easy to understand.  To illustrate, let’s look back in time to the once ubiquitous ‘yen carry trade’. 

Monetary policy in Japan has been extremely accommodative for many years, as the central bank embraced a policy of zero interest rates in an effort to stem persistent deflation, as policy know as ZRIP (zero interest rate policy).  Meanwhile, further south in Australia, the central bank was fighting persistent inflationary pressure, and as a result interest rates were much higher.  Thus was born the yen carry trade:  borrow money in Japan at extremely low interest rates, sell the yen to buy Australian dollars, and invest those dollars in a higher yielding instrument.  This process has the effect of lowering the value of the yen against the Aussie dollar, as investors pressure the yen with their sales and bid up the price of the Aussie dollar with their purchases. 

The Bank of Canada followed the Federal Reserve’s lead and brought the overnight lending rate down to a record low of 25 bps in April of 2009; the Fed had reduced their rate to a band between 0 and 25 bps a few months earlier in response to the financial crisis.  By mid 2010 however, the Canadian economy was recovering well, and inflationary pressure pushed the BOC to start raising rates, which they have now done three times, bringing the overnight rate to 1 percent.  The Fed is unlikely to raise rates anytime soon, so this is a long term positive for the Canadian dollar that could persist for years into the future. 

Canada’s economy is one of the strongest in the developed world, and while unemployment is rising south of the border, Canada is adding jobs at an impressive rate.  Last week the unemployment rate fell to 7.6 percent (in line with historical norms), while the U.S. unemployment rate ticked higher to 9 percent, up from 8.8 percent the month prior.  A strong economy supports a currency, while a weak one does not.

The Federal Reserve had embarked on a path of money creation on a scale that is unprecedented.  Despite rhetoric about the ‘benefits of a strong dollar’, it seems evident to most that there is a concerted effort to devalue the U.S. dollar in order to boost export markets, and inflate their way out of an unsustainable debt situation.  Canada meanwhile is moving towards a balanced budget, and has not been forced to resort to such extreme measures to prop up its economy. 

All told, the outlook for the Canadian dollar is very positive.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Wednesday, May 11, 2011

USDA Supply and Demand – Corn and Soybeans - May 11th

USDA Supply and Demand – Corn and Soybeans
May 11th, 2011

This morning the USDA released its first supply and demand estimate for the 2011/12 crop year, as well as an update on last month’s report for the marketing year.  Below are the highlights:


The immediately bearish headline was the increase in the projected ending stocks for the current marketing year, up to 730 million bushels from 675 million bushels last month.  This probably reflects declining export demand in the face of record high prices.  The past several weeks have seen sharply lower exports, below the level required to meet USDA expectations.  This is necessary, as without some rationing the U.S. could find itself with extremely tight supplies towards the end of the summer. 

The first estimate of ending stocks next year was 900 million bushels, still very tight by historical standards, and while it is likely to be construed bearishly in the short term, could provide long term support for new crop prices. 

Drilling a little bit deeper into the USDA’s numbers, it is interesting to note the estimate for ethanol demand, which has slowed to almost no growth.  After rising 23.2 percent in 2010, and 9.5 percent this year, the USDA projects demand for ethanol to rise a paltry 1 percent in 2011/12.  Projected demand for the alternative fuel is probably the most important determinant of price of corn after production, as more than 40 percent of the crop now goes towards ethanol.  Until recently, blenders were allowed to add up to 10 percent ethanol into their gasoline, earning a nice tax credit, not to mention reduced costs as ethanol prices still lag those for the fossil fuel.  At the current level of production, ethanol is pushing up against that 10 percent ceiling as compared to gasoline production.  Recently, regulation was approved to allow up to 15 percent ethanol in gasoline blends for newer vehicles.  If the ethanol industry increases production to take advantage of the higher blend rate, the USDA’s estimate could prove to be too low, pointing to tighter than expected ending stocks.


USDA projected ending stocks for soybeans were also revised slightly higher, up to 170 million bushels from 140 million last month.  Once again, this is probably due to declining exports.  China has released beans from its official reserves in an attempt to ease food price inflation, reducing demand for U.S. beans.  Projections for next year show a small decline to 160 million bushels. 

The interesting bit from today’s report is the reduced export demand, down to 1.54 million bushels from 1.55 this year.  Export demand is the key driver of soybean prices in the U.S., as exports account for over 45 percent of production.  China is the largest importer of U.S. soybeans, and bean oil, while the EU is the largest buyer of bean meal.  The de-stocking in China would seem to point towards higher demand down the road, when they decide to replenish supplies.  As such, the reduced export forecast seems suspect.  International demand for U.S. beans rose 17.4 percent in 2009/10, 3.3 percent in 2010/11 (despite ‘beans in the teens’), so a -0.6 percent change next season may not be realistic.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Tuesday, May 10, 2011

Flooding on the Mississippi is putting a Bid under Gasoline Futures - May 10th

Flooding on the Mississippi is putting a Bid under Gasoline Futures
May 10th, 2011

With the exception of silver, gasoline has been the star commodity since last week’s broad commodity selloff, up 7.77 percent since last Thursday.  It is worth noting, that over the same period, heating oil, which is a closely related distillate, has risen only 4.24 percent, and crude oil has rallied only 5.27 percent.  Unlike the other energy products, gasoline is now trading near its recent peak.  The question is why.

Seasonality plays a role.  As I have discussed in recent posts, gasoline tends to get more expensive relative to its related products during the summer months, when people spend more time on the road.  The summer driving season officially kicks off on Memorial Day later this month.  While this is certainly a bullish factor, it does not on its own explain the strength in the gasoline market.  What is more important at the moment is the risk of significant production losses stemming from flooding on the Mississippi River.

Grain traders are already well aware that the flooding along the U.S.’s largest river system, which drains 41 percent of the continental U.S., has been the worst in several decades.  Already, the Army Corps of Engineers have been forced to blow levees further upstream to reduce strain on the river banks.  This has affected agricultural lands in Missouri, and has prevented farmers in many states from planting their crops.  Now however, the flooding looks like it may threaten oil refineries in Louisiana. 

There is now talk of opening the Morganza Floodway to relieve the flood threat between New Orleans and Baton Rouge.  If this happens, at least 2 refineries will be affected.  While this is manageable, if the river rises and there is flooding further downstream, there are 11 refineries with capacity of 2.5 million barrels a day, 13 percent of total U.S. production, which could be affected.  Flooding at the refineries could shut down production for several months, much like after Hurricane Katrina.  This does not appear to be an imminent threat, but until the river crests, which should happen in two weeks, it will remain on the radar of energy traders and may keep a bid under gasoline. 

Monday, May 9, 2011

Inter-commodity and Calendar Spreads - May 9th

Inter-commodity and Calendar Spreads
May 9th, 2011

After any large shift in the market, such as last week’s extremely volatile session, I prefer to wait a few days before looking at any new trade ideas, in other words ‘wait for the dust to settle’.  I will therefore use today to discuss spread trading in futures markets.  There are two broad categories of spread trading:  inter-commodity and intra-commodity (calendar) spreads. 

Inter-commodity Spreads

An inter-commodity spread entails buying one commodity and selling another related commodity, expressing a view on the relationship between the two contracts irrespective of the overall direction of the market.  This type of trading can be an excellent way of gaining exposure to a class of commodities (such as the energies, or grains), without a strong opinion on the outlook for the market in general.  By inoculating the trade against the movements of the broad market, it is possible to profit in both upward trending and downward trending markets.  Let’s look at some recent examples. 

On March 29th, 2011 I wrote in this blog:

The general rule of thumb when it comes to the seasonality of the refined products is that heating oil is strong in the winter months, when demand rises in response to cold weather, and gasoline is strong in the spring/summer months when more people ‘hit the road’ boosting demand for the fuel.  This seasonality is clearly demonstrated in the forward curve for RBOB gasoline futures, with higher prices seen in the summer months.

Spread Between RBOB Gasoline and Heating Oil
Courtesy of Bloomberg

As the chart above demonstrates, (with the exception of 2008) gasoline generally trades at a premium to heating oil starting somewhere around February or March, and trades at a discount sometime towards the end of the summer.  Currently the two products are trading at nearly the same price, and the trend is in favour of the RBOB, as would be expected based on historical seasonality.” 

Since then, the spread has moved steadily in favour of the gasoline (see chart).

Spread Between RBOB Gasoline and Heating Oil
Courtesy of Bloomberg

What is even more important to note, however, is how that spread has behaved over the past few sessions.  On Thursday of last week, the refined products fell precipitously, with June heating oil falling 2561 points, and June RBOB gasoline futures falling 2271 points.  The spread moved 290 points in favour of gasoline.  Since the plunge, markets have been recovering.  This morning the heating oil is up 531 points and the gasoline is up 1088 points.  Again the spread has moved in favour of the gasoline, by 507 points.  This shows that when you are correct about the direction of the spread, you can profit even during the most tumultuous of markets. 

Intra-commodity Spreads

The other common variety of spread trade is the intra-commodity or calendar spread, when you buy a commodity for delivery in one month, and sell the same commodity for delivery in another.  This type of trade expresses an opinion on differences in supply and demand during different type periods.  It is very commonly used in grain trading, especially when the months reflect different crop years.  Last week I wrote about one such spread in the corn futures, specifically the spread between July and December futures, or old and new-crop corn. 

I wrote, “In recent years, December futures have tended to trade at a 15-30 cent premium to July futures.  This year however, due to extremely tight physical supply, old-crop July futures have been trading at a steep premium to the new-crop December futures.  The spread peaked earlier this year at $1.33 ½ July over, and has since been declining.  Given recent developments, namely the difficulties planting the corn crop and thus the possibility of a smaller crop, and the waning demand for old-crop corn, this spread could continue to narrow.” 

At the close prior to that comment, the July futures were trading at a 73 ¼ cent premium to December.  Corn did not sell off as violently as most markets last week, but declined nonetheless.  This morning the corn market is trading higher.  Since that comment was written however, the spread between July and December has narrowed to 47 ½ cents.  By trading the spread and not taking an outright position in the corn, we were able to make money in both up and down markets.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Thursday, May 5, 2011

A Comment on the Psychological Nature of Trading - May 5th

A Comment on the Psychological Nature of Trading

Anyone sitting in front of a quote terminal this morning, is either jubilant (hopefully because they’ve been reading this blog and have some short positions in copper, cocoa, and silver, not to mention a favourable calendar spread in corn futures – offset of course with a still-profitable long position in the coffee that is suffering from a big decline), or experiencing a serious drawdown.  I will forego any specific discussion today, and focus instead on some of the psychological hurdles to successful trading.

Profits can be addictive, and at times seem to come easy.  In my experience, early success in trading can be one of the worst things to happen to a new trader, as it builds unrealistic expectations for future profits, which can often lead to overly aggressive trading when times are tougher, often resulting in losses.  On a day such as today, when the absolute size of the moves whether they are up or down are very large, quick mental calculations will taunt even the best of us… “Short just one silver contract would give me a profit of $16,500 today alone!” 

Whenever I find myself entertaining notions of trading in such a market, I take a cold shower and remember what my top priority must be:  MANAGING MY RISK.  Quick and easy profits are certainly attractive, but ‘quick and easy’ is misleading, and incredible profits can quickly turn into devastating losses.  My advice:  Take a deep breath and remember why you entered into your various positions.  What has changed?  Take a step back and think about what your exposure is.  Is it time to take something off the table, reduce your risk, or place some stops?  Whether you are on the right side of the big moves or not, volatile markets call for defensive trading.  Keep your head and you’ll keep your capital as well.

Good luck and happy trading!

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Wednesday, May 4, 2011

Normalcy Returns to the Cocoa Market

Normalcy Returns to the Cocoa Market
May 4th, 2011

One of the last remaining barriers to normal trade out of the Ivory Coast seems to be resolving, with Citigroup and Societe General reopening bank branches in the country last week.  While the export ban was lifted in mid-April following the capture of ex-President Gbagbo, the cocoa trade was unable to resume as the financial markets remained un-operational.  The return of the banking sector will provide local traders with access to the financing required to resume shipments. 

A return to normalcy may put pressure on cocoa prices, which are still 65 percent above the 5-year average.  The sharp increase in the price of cocoa was largely due to the stalled trade in the Ivory Coast, which is the world’s largest supplier of the beans, and accounts for 34 percent of global output.  The supply of cocoa is plentiful, growing 10 percent from last year to 3.89 million tons, compared to consumption of around 3.73 million tonnes, bringing the market to a surplus of around 156,000 tonnes from a deficit last year of around 107,000 tonnes. 

Farmers in the West African country have just begun to reap the mid-crop, the smaller of the two annual harvests, which typically puts seasonal pressure on prices.  There is also more than 500,000 tonnes sitting in warehouses in the commercial capital of Abidjan available for export.  The backlog may take up to three months to clear.  Currently there are seven container vessels at the port in Abidjan ready to load cocoa.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Tuesday, May 3, 2011

Corn Spreads - May 3rd

Corn Spreads
May 3rd, 2011

New Crop Corn

Farmers in the United States are having a difficult time planting their crops so far this year, with very little progress made over the past week, which is typically the peak of the corn planting season.  Cold and wet weather is largely to blame, keeping machinery out of the fields.  Yesterday’s USDA update on planting progress indicated that a mere 13 percent of the corn crop has been seeded, as compared to the 10 year average of 43 percent, and last year’s excellent 66 percent.  The worst year on record was in 1984, when only 6 percent was seeded at this point.  Late-planted corn generally results in yield losses, and looking back at ’84 we see that yields came in 18.7 percent below trend.  A similar loss in yield this year would be catastrophic, as the tight supply and demand does not allow for much in the way of a reduced crop size.  Taking a closer look at the individual states, we see that the 5 largest corn growing regions are all significantly behind schedule as compared to the average:  Nebraska is behind by 20 percent, Indiana by 29 percent, Illinois by 36 percent, Iowa by 40 percent, and Minnesota is behind by 45 percent with only 1 percent reported to be planted.  The two states that were responsible for the bulk of this year’s increased acreage, North and South Dakota, have planted 0 and 2 percent of the crop, respectively.  Weather forecasts are calling for drier weather in the Corn Belt, which could help farmers, and it is important to remember that with modern farm technology, the crop can be planted in an astonishingly short period of time.  As usual for this time of year, Mother Nature is driving markets.

Old Crop Corn

The supply situation is extremely tight, as discussed in earlier posts, and in order to maintain sufficient stocks through the end of the crop year, demand must cool off.  The record high price of old crop corn does seem to have brought about the rationing the market so desperately needs, and export sales have been slowing down.  Weekly export inspections showed exports at 34.63 million bushels last week, down from 36.58 million the week earlier.  This compared to the 44.09 million tonnes required each week to meet the USDA’s export projections for the year.  Cumulatively, 59.3 percent of the USDA forecast has been exported, compared to 63 percent on average for this time of year. 

Old-New Corn Spread

In recent years, December futures have tended to trade at a 15-30 cent premium to July futures.  This year however, due to extremely tight physical supply, old-crop July futures have been trading at a steep premium to the new-crop December futures.  The spread peaked earlier this year at $1.33 ½ July over, and has since been declining.  Given recent developments, namely the difficulties planting the corn crop and thus the possibility of a smaller crop, and the waning demand for old-crop corn, this spread could continue to narrow. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Monday, May 2, 2011

A Catalyst for a Bull Market in Natural Gas? - May 2nd

A Catalyst for a Bull Market in Natural Gas?
May 2nd, 2011

Natural gas has been stuck in a protracted bear market after making a significant high in 2008.  One of the biggest factors weighing on the price of natural gas is the continued expansion of shale-gas production in the United States.  Insignificant several years ago, domestic production of natural gas from unconventional sources, now possible thanks to hydraulic fracturing coupled with horizontal drilling techniques, represents a significant portion of U.S. gas supply.  By 2009, the last year with complete data available, shale-gas composed 19 percent of total production.  The Energy Information Agency’s Annual Energy Outlook 2011 forecasts U.S. gas production to swell to 26.3 trillion cubic feet by 2035, with nearly half coming from shale developments.

Nymex Natural Gas Futures
Courtesy of Bloomberg

It has been my view for some time that the proliferation of shale-gas development would keep a ceiling on natural gas prices in North America, with a few possible developments that could spark a sustainable rally.  One of which would be significant investment in LNG export capacity, which would provide a link between domestic prices and the world market.  Currently, the North American benchmark is around $4.50 versus around $8.00 in international markets.  Another potential catalyst for a bull market in natural gas would be legislation that hampers the development of shale gas resources, possibly due to environmental or health concerns.  Some recent developments in the U.S. may put this on the radar screens of energy traders in the near future. 

The FRAC Act

The Fracturing Responsibility and Awareness of Chemicals (FRAC) Act, introduced in June 2009, would require public disclosure of the chemicals used in the hydrofracking process.  Hydraulic fracturing involves pumping heated and pressurized water, mixed with a cocktail of chemicals, into shale formations, separating the rock and allowing the gas to escape.  Under current regulation, companies are exempted from disclosing which chemicals are used, arguing that they must maintain the secrecy of the ingredients for proprietary reasons.  The Energy Policy Act of 2005 exempted the process from regulation by the EPA under the Safe Drinking Water Act, a rule commonly called the ‘Halliburton Loophole’.  Since its introduction, the FRAC Act has been under review by the Subcommittee on Energy and Environment but never came up for debate.  Under Congressional rules, any legislation that did not come up for debate is cleared from the books once the session ends.  As a result, this Bill is no longer under consideration, though members often reintroduce bills once the new session begins.  Recent developments seem to support the notion of this legislation making a comeback, though its ultimate fate is far from certain.

Diesel Fuel Discovered

The aforementioned ‘Halliburton Loophole’ does not exempt the process from regulation in cases where diesel fuel is used, due to the high level of toxicity and risk it poses to drinking water supplies.  A year-long investigation that released its findings in January of this year found that between 2005 and 2009, at least 32.2 million gallons of diesel fuel was pumped into the ground as part of fracking operations in 19 states, in violation of the mutually binding agreement between the government and the energy companies.  Diana DeGette, who first introduced the FRAC Act, and who is currently a ranking member of the Subcommittee on Oversight and Investigations said in a statement, “Our investigation has shown that for the past several years, the fracking industry has ignored federal regulations and a mutually binding agreement, and injected over 30 million gallons of one of the most toxic chemicals into the ground, potentially contaminating drinking water aquifers in communities nationwide,”.  This could help open the door to further regulation.

Most Recent Findings

On April 18th, 2011, a report from the democratic members of the House Energy and Commerce Committee and House Natural Resources Committee revealed the use of 29 different chemicals regulated under the Safe Drinking Water Act as potential human carcinogens.  The report highlights the potentially harmful effects of the hydrofracking process on human health, and could help build support for a re-emergence of the FRAC Act in the current congressional session. 

Any move to tighten regulation of hydraulic fracturing may have a significant impact on future natural gas supplies, and could be the catalyst to mark the bottom in this protracted bear market.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Friday, April 29, 2011

U.S. Government Debt, the Decline of Fiat Currencies, Gold and the Fed - Apr 29th

U.S. Government Debt, the Decline of Fiat Currencies, Gold and the Fed
April 29th, 2011

The USD against Other Currencies

The U.S. dollar has been falling precipitously against virtually every major currency around the world.  Sentiment is reaching extremely low levels, and based on the CFTC’s Commitment of Traders report, speculators are short of the greenback in every major pair, with the exception of the Japanese yen.  Below is a chart of the net USD position of large non-commercial traders (typically interpreted to represent the positions of large hedge funds and trading desks), overlaid against the U.S. Dollar Index.

U.S. Dollar Index and Net Large Speculative Positions
Courtesy of Bloomberg

During this week’s post FOMC press conference, the first of its kind, Fed Chairman Ben Bernanke was asked about the Fed’s stance on falling U.S. dollar.  He was very clear that the Fed believes that a strong dollar is in the nation’s best interest.  If he believed what he was saying, it seems no one else did, as the U.S. dollar proceeded to make new lows. 

The U.S. Dollar against Non-Fiat Stores of Value

It is always important to remember that when we look at currency values, it is always relative to another currency, but how are fiat currencies doing in general when measured against some other tangible store of value.  The obvious example are the precious metals, and more specifically gold.  Gold has been rising steadily, making new all-time highs on 14 days in April.  Some might argue that gold is not money, but tell that to Utah, where legislation was recently passed that made gold legal tender.  The trend is up against every major currency, though it has not been making new highs against all of them.  Most notably, in term of the Australian dollar, gold has not surpassed the high made in 2010, nor its all-time high made in 2009.  Below is a comparison of the yellow metal in USD vs. Aussie over the past few years.

Gold in USD and Aussie
Courtesy of Bloomberg


If you were to listen to Bernanke, the only thing pushing inflation higher is the rising gasoline price at the pump, which is the result not of a weakening U.S. dollar and overly accommodative monetary policy, but outside geo-political events in the Middle East and North Africa.  Let’s turn instead to reality.  Over the past 12 months, virtually every commodity has seen significant gains, with few exceptions.  The prices of raw material are highly sensitive to excess money creation, and are a fantastic leading indicator of current and future inflation.  This is not “transitory” as some would like us to believe. 

To the Point:  U.S. Government Debt

Given that the U.S. dollar is in decline, and inflation is on the rise, why are investors willing to lend money to the U.S. government for 30 years for a paltry yield of around 4.4 percent?  The answer is pretty easy to understand:  the Fed is holding long-term yields down artificially by maintaining ultra-loose monetary policy, effectively tethering bond yields to the overnight rate.  The mechanism that facilitates this is a simple carry trade.  Borrow from the Fed for what amounts to next to nothing, and invest the proceeds in higher yielding government debt.  And who says quantitative easing is about to end…

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

Thursday, April 28, 2011

Corn, Beans, Wheat, and Mother Nature - Apr 28th

Corn, Beans, Spring Wheat, and Mother Nature
April 28th, 2011

Farmers across the eastern and southern Midwest and the Delta regions are struggling to get their crops planted, facing persistent rains and cold soil temperatures.  The important growing regions in the Midwest are forecast to experience severe flooding until May 2nd, and this is reflected in the slow progress being made in the fields.  As of the last USDA Planting Progress report, released on April 24th, only 9 percent of the corn crop has been seeded, compared to 46 percent last year and the ten-year average of 23 percent for this time of year.  Only 6 percent of the spring wheat crop has made it into the ground, compared to 39 percent last year and a ten-year average of 27 percent.  A friend recently forwarded some photos of the flooding, and I will share one of them here today. 

The rains have not been bullish for all crops, as it has spread somewhat to the parched winter wheat growing regions in the South, helping to push wheat futures down sharply in yesterday’s session. 

Cold Soil Temperatures

Underneath the soaked fields, the soil is very cold, currently about 10 degrees cooler than usual in the important corn growing state of Iowa.  Soil temperature is a critical determinant of crop germination, with corn refusing to grow in soil below 50 degrees (Fahrenheit).  Soybeans that are exposed to temperatures less than 28 degrees (2 below in Celsius) need to be replanted.  Forecasts call for temperatures to drop below freezing twice next week in the upper Great Plains, and the cold may spread to northwestern Iowa and Wisconsin.  This is bad news for field crops, as we are in the prime planting period for corn and spring wheat.  To achieve optimal yields in Iowa for example, corn needs to be planted by May 2nd, and as a general rule, corn planted after May 15th will risk lower yields.  Should planting delays persist for much longer, it could lead farmers to switch to soybeans, though we should keep in mind that with modern farm technology; a lot can be accomplished in a short period of time. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group