In the words of Yogi Berra, “it’s deja vu all over again” in stock land. Fundamentals are questionable; investors are confused; the media are all over the place (as usual); and stocks are smoking HOT. Once again, something doesn’t square. Perhaps Pimco said it best. Government assisted growth is driving stocks higher, not genuine growth. I think we all get that. But who cares, right? We’re willing to ignore reality as long as prices are going up!
If that doesn’t sound eerily familiar, it should. You’ve seen this movie before. The chart below shows the all too familiar emotional rollercoaster ride investors repeat over and over. This is a widely used illustration of investor emotions during a full market cycle. Anyone can find it with a simple Google search.
As you can see, the chart is divided into green and red sections. Green is good times and red is no fun. But something is missing. Where’s the yellow? What good is this chart without some warning time to prepare for red? If traffic lights went from green to red without turning yellow in between, we’d all be dead!
Well, here’s some yellow for you. We are most likely somewhere between “enthusiasm” and “euphoria” on the emotional rollercoaster chart. We might even be past “exhilaration.” And you know what comes after euphoria…UNEASE.
A classic yellow flag in the stock market is when fundamentals don’t support higher prices, but prices keep marching higher anyway. And there’s no shortage of yellow to be cautious about: Corporate earnings growth is slowing; job growth is anemic at best; U.S. and world GDP is sluggish; the Fed is looking for an off ramp from the QE freeway; commodity prices are not following the rally; there’s a world currency war brewing, so on and so forth…But stocks are soaring!
You may be happy about that, but you should be looking over your shoulder. If it seems too good to be true, it probably is. What can you do about it?
Emotional Rollercoaster Guide
Green Light—Add money to winning asset classes. Ideally, this should be done between the “despair” and “enthusiasm” phases.
Yellow Light—Trim your winners and add money to undervalued asset classes. It makes sense to do this between “enthusiasm” and “exhilaration.” Easier said than done.
Red Light—Get defensive…significantly reduce exposure to overvalued assets and increase exposure to non-correlated asset classes. Get your red on when investors are “euphoric."
Diversification is part of the answer to the confused investor dilemma with regards to stocks soaring on weaknesses. Managed futures are worth considering, especially when both stocks and bonds, the two largest asset classes, are at or near all-time highs together.
Depending on a variety of factors, including your risk tolerance, age, how your existing portfolio is allocated and so forth, managed futures could help reduce the emotional highs and lows you have experienced in the stock market and keep you on track towards your desired destination.
Managed futures offer access to a variety of strategies and markets around the world. The key is finding the right Commodity Trading Advisor (CTA).
Risk is often measured by volatility. Whether it’s a liquid, gas or managed futures contract, knowing how volatile something is can help you determine how careful you should be when handling it.
In the managed futures markets, most commodity trading advisors (CTAs) measure volatility to help them make trading decisions, and lately they’ve been witnessing a surge in the CRB Index’s volatility. It’s been shooting higher for the last 50 days or so.
Why is it going up? There are several reasons, but one of the biggest is oil. As we mentioned in our last post (The CRB Commodity Index Could Live or Die by Oil), oil represents 23% of the CRB, which is almost four times larger than the next largest component. Not surprisingly, oil’s volatility has been rocketing lately, too.
In fact, oil has been more volatile than the CRB, as you can see by comparing the y-axes (vertical) of both charts. You can see oil is now slightly over 1.0 and the CRB is around 0.6. Neither reading is excessive. The CRB is actually below average and oil is slightly above. However, the sudden change in direction to the upside could be indicating that a more significant move in oil prices and/or the CRB is brewing.
As far as commodity advisors (CTAs) are concerned, this is good news. They don’t care which direction prices go as long as they go one way or the other for an extended period of time.
In our last post about the CRB Commodity Index, we shared a chart that suggests the CRB could be on its way to making a big move, either up or down (see post). Of course, the timing of such a move is another matter; it could take weeks or months. However, if you look at the components of the CRB it’s easy to notice we should all keep watchful eyes on oil.
Oil is by far the CRB’s largest component. It commands 23% of the index. That’s nearly four times larger than anything else. The next largest components are copper, corn and live cattle, representing just 6% each. Overall, there are 19 commodities in the index, but oil is clearly the biggest driving force.
So, what’s oil’s near-term outlook? Well, it’s not exactly clear. Earlier this week the Energy Information Administration announced that U.S. oil inventories have never been higher since the EIA began keeping records in 1982. Meanwhile, GDP has been sluggish in America, questionable in China and sketchy in euro land.
Additionally, oil is priced in dollars around most of the world, and the greenback has been getting stronger against several currencies. That makes oil more expensive in many parts of the world, regardless of supply/demand fundamentals.
However, it’s not completely bearish out there for oil. We are approaching summer driving season in the U.S. Prices could firm as Americans fill up SUVs and go on vacation.
Meanwhile, almost every major central bank on the planet is trying to stimulate economic activity by holding interest rates near zero and printing money. At some point the central banks’ efforts could reverse the deflationary pressures that have been preventing growth, and oil is one of the first places inflation could show up. If that’s the case, the CRB Index could move in tandem with oil.
After one of the greatest bull-market runs in history, commodity prices topped out in 2008 then crashed along with everything else during the financial crisis. Commodities, in general, have been trying to recover ever since.
In the 2009 to 2011 period, commodity prices rebounded along with stocks as central banks around the world increased money supplies to stoke growth. However, stocks continued to roar higher after 2011 and commodities skidded. The chart below shows the CRB Commodity Index from 1999 to Wednesday, April 24, 2013. As you can see, the CRB has been in a bear market since early 2011. The index is down roughly 25% in that time while the S&P 500 is up about 17%. Why the disconnect?
There are multiple reasons why commodities have been challenged. Two main reasons are China’s commodity consumption slowed during this period along with its economy, and the U.S. Federal Reserve pushed Treasury interest rates close to zero, forcing investors to sell bonds to buy stocks for potentially any return. Normally, such a move would have caused Treasury prices to fall as investors sold bonds to buy stocks, but the Fed offset the bond selling by purchasing massive amounts of Treasuries in the open market. By doing so, the Fed artificially inflated stock prices and held interest rates down.
Meanwhile, many investors also sold precious metals to pay down debts and to chase stock prices higher. That impacted the CRB considerably. Overall, the CRB has fallen to a critical support level (see chart below).
You can see from the lines we’ve drawn on the chart that the CRB is at the bottom of a major channel. If it bounces off the support, the index could be headed toward significant gains, possibly taking out the 2011 high. Of course, the flipside to this is the index could be headed to the 2009 lows if the support doesn’t hold. Regardless, the bottom line is the CRB appears to be on the verge of making a big move one way or the other. That’s good news for managed futures managers (CTAs) who have flexible strategies that can go long or short. All these guys really want is a long-term trend. They don’t care which direction this goes.
There’s a lot of head scratching going on about gold. With all the commercial bank disasters around the world, massive money printing from the four largest central banks on the planet, theories about China secretly stockpiling gold and nuclear war headlines in the media—one would think the yellow metal’s value would be trending higher. But it’s not. It’s cratering.
Gold has been challenging and breaking key support levels for weeks. In February, gold fell below $1,600 per oz. for the first time in 6 months, and Friday the precious metal plunged $75 (-4.8%) to $1,485, smashing the $1,540 “line in the sand” support level for traders, the $1,500 psychological level for individual investors, and falling to lows not seen since July 2011 (see chart below). Today it’s even worse. In late morning trade, gold tumbled another $144 per oz. or -9.6%, placing the yellow metal on track for its worst 2-day skid since February 1983.
Since peaking in September 2011 above $1,921, gold prices were range-bound between $1,525 and $1,800 (see channel in chart below). Friday’s plunge knocked gold below that trading range and into free fall today. Some believe gold could collapse to $1,100 before it stabilizes.
Despite the head scratching, there are reasons gold has been weak. For starters, the U.S. dollar has been strengthening considerably, and that’s likely to continue with the Bank of Japan on a quest to purchase $75 billion per month of its own government bonds, which would double its currency base within two years. Uncertainty in the eurozone is bolstering the greenback, too.
Adding to the selling pressure, ETF gold holdings in vaults have dropped about 900,000 ounces in the past week and a massive 7.2 million ounces year to date (as of Friday). This is likely due to individual investors selling gold ETFs to raise funds to chase stock prices that have been on a tear this year.
The managed futures marketplace has been exploding with new opportunities the past few years. Not only can you more easily invest in commodities these days, you can invest in commodities tied to specific countries.
Singapore Exchange Ltd. (SGX) today announced a new iron ore contract that is directly linked to China’s market. The contract will be settled in cash against the Steel Index Ltd price for ore delivered to the Tianjin port in China.
In a telephone interview with Bloomberg, Kerry Deal at Jeffries Hong Kong Ltd. said, “They [SGX] look at this as a good China play. China is continuing to grow and this is a China priced product.”
Iron ore deliveries hit 20 million tons last month, almost a new record, and China is a big reason for the surge. The country buys about 66% of the world’s seaborne ore (ore delivered by ship) to feed its massive steel making operations. Crude steel output in China surged 9.8% to 2.21 million metric tons (daily average) in February, a new high, according to the National Bureau of Statistics.
First quarter iron ore volume hit 58 million tons this year, nearly tripling output in the same quarter one year ago and more than 2011’s total output.
Iron ore in Tianjin traded around $136 a dry ton last week. The price averaged $128.30 in 2012 with highs at $149.40 and lows below $87, according to the Steel Index.
SGX AsiaClear, the world’s largest clearer of iron ore swaps, is scheduled to start a futures contract this week. Each contract will be for 100 metric tons.
Corn prices tumbled more than a $1 per bushel last week after a recent report from the Department of Agriculture revealed that U.S. supplies were expected to hit 836 million bushels on August 31. The forecast was a whopping 32% more than estimated just one month ago. However, the government revised its estimate again today. It now expects supplies to be 757 million bushels at the end of August. The new estimate surprised the market (some analysts expected 1 billion bushels) and gave corn prices some buoyancy in today’s trade.
Prices hit an all-time high of $8.437 last August, after the drought destroyed crops throughout the Corn Belt, but now a bushel is trading around $6.46. That’s nearly 14% less per bushel than a week ago and about 23% below the all time high.
After the drought, farmers prepared to plant the most corn acreage in nearly 80 years to take advantage of high prices. The potentially massive increase in supply has unfortunate timing consequences since demand in the U.S. has been shrinking while exports have been collapsing at a record pace.
When grain prices in general rocketed last year, meat producers closed plants and ethanol makers shut distilleries. That had a big impact on domestic corn demand.
Meanwhile, export sales from the largest corn grower and shipper fell an eye-popping 54% in the year that began September 1, on track for the biggest annual drop since the government began recording data in 1960. The USDA estimated that shipments fell to 15.52 million tons as of March 28 vs. 34.07 million tons in the same period one year ago.
The median estimate from a Bloomberg survey of 13 analysts calls for corn prices to average $6.15 per bushel in the fourth quarter, compared to $7.11 in the first quarter this year.
Looking ahead, corn prices could stabilize or possibly even rebound if the weather becomes unusually hot and dry. However, the charts look bearish at the moment. Moreover, with both domestic and foreign demand dropping while supplies are on the verge of rocketing, it looks like the trend could continue to be downward with potentially high volatility along the way.
Want to know how to possibly profit or hedge against further corn price declines? Give us a call and let’s discuss some strategies.
What a difference a year can make. Front-month natural gas prices are up more than 110% from the 2012 April lows. A year ago, few investors would touch a natural gas contract with a ten-foot pole. Now they can’t get enough of them. The chart below shows front-month contracts rallying from $1.90 in April last year to more than $4 this year (+110%), and from $3.12 to $4 since late February (+28%).
Prices have been surging lately thanks to high residential and commercial heating demand during the unusually cold March weather. Lower than expected supplies and a drop in production have been pressuring prices higher as well.
Midwesterners have been calling it “the winter that won’t end” and the forecast in that part of the country calls for below normal temperatures for the next 6-10 days.
The increased heating demand is causing natural gas supplies to decline more substantially than expected. According to the U.S. Energy Information Administration (EIA), U.S. inventories were at 1,781 bcf on March 22nd. That was 642 bcf below levels last year, but still 61 bcf above the 5-year average.
According to the EIA, U.S. natural gas production fell for a second-straight month in January (see graph below). Output fell from 72.77 bcf/d in December to 72.1 bcf/d in January. However, November’s 73.53 bcf/d output was a record, so it shouldn’t be a surprise to see some declines. The EIA supply data are delayed by three months, thus we won’t know for several weeks if production increased rapidly in February and March. As such, the weekly inventory data will be closely monitored for hints about production.
Investors obviously want to know if prices are going higher and no one knows for sure if they will, but the trend looks strong. Nonetheless, it’s usually not a good idea to chase prices that have climbed triple digits. If you want natural gas exposure, we suggest you consider investing in several commodities to reduce the risk of owning just one commodity, no matter how hot that one commodity might be. There are many ways to do this. Several managed futures advisors (CTAs) at Triton can structure a commodities portfolio that aligns with your risk tolerance and goals. Click here to see which ones might be good candidates.
Update: Natural Gas Hits 20-Month High on Short Supply News
Natural gas prices roared 4.5% higher Friday after supplies fell below the 5-year average for the first time since 2011. Natural gas for May delivery rose to $4.125 per million Btu on the New York Mercantile Exchange, hitting a 20-month high on heavy trading volume. Prices are up 23% this year.
Trading activity accelerated today after Baker Hughes Inc. said rigs drilling for natural gas fell by 14 to 375, the lowest number of rigs since 1999. The drop in supplies, production and colder-than-expected March weather prompted Goldman Sachs to raise its 2013 price target by 17% today.
A lot of investors and traders are concerned that the S&P 500 failed to reach an all-time high for the 5th time today. It’s certainly not a good sign when you consider that many advisors have been increasing equity allocations lately, according to a recent survey of 40 of the largest wealth management firms in the country. Obviously there’s a lot of selling pressure at these levels from investors who have reached the breakeven point after the financial crisis. And you can’t discount the risk in equities at these levels when you consider how high the S&P 500 has climbed since November 15. It’s up a whopping 15% since then. That’s extreme.
The media have been signaling that the S&P 500’s all-time high is 1555. One chart technician says it’s actually 1576. Watch the video. He says the stock market could be in short-term trouble if the S&P closes below 1535. The technician says the 1440 level is a possibility if the S&P closes below 1535. Conversely, if it closes above 1576, he believes the index will continue climbing to 1620-1640. 1640 is less than 6% above today’s close at 1551. The big question for investors to think about: Is 6% enough return for the risk? Apparently many investors don’t think so. That’s why the index is having issues at these levels.
What can you do to potentially reduce your portfolio risk and still keep an attractive upside? Two words. Managed Futures.
It appears that the greatest bond bull market in history is over and headed for challenging times. As such, things could get ugly for unsuspecting investors who think bonds are “risk free” investments.
According to a recent Penta survey of 40 of the largest wealth managers at banks, trust companies and investment firms, wealth managers on average are beginning to migrate away from bonds by recommending that investors lower their bond exposure from 34% to 29% and raise equity exposure from 45% to 48%.
It’s not hard to understand why stocks allocations are going up. The chart below shows stock (blue line) and bond (black line) prices since 1994, represented by S&P 500 futures and 30-year U.S. Treasury. You can see that stock and bond prices trend in the same direction temporarily, then diverge. During the dot-com boom, stocks roared higher while bond prices cratered. A similar relationship occurred in 2007, then inverted during the financial crisis. On the right side of the chart you can see bond prices beginning to fall while stocks hit new all-time highs. If history is an accurate guide, one would think stocks have more upside potential if bond prices tumble. But who trusts history in today’s world?
Apparently many wealth managers are taking a measured approach, according to Penta. They’re not plowing completely into stocks. Many are also increasing exposure to the “alternative” asset class, which includes hedge funds and commodities (managed futures). Alternatives are especially appealing now since they offer diversification benefits that have the potential to reduce portfolio risk as investors lower fixed income exposure and increase stock exposure.
“THE BIG CHALLENGE going forward is how to mitigate portfolio risk, given reduced fixed-income exposure. Enter alternative investments: Average exposure to alternative investments is at 20% this year, the highest level since Penta began its survey.”
Amongst the firms adding assets to alternatives, Barclays increased its exposure from 23% to 28% and Brown Advisory upped exposure from 19% to 27%.
At Triton, we believe the migration into alternatives, particularly in managed futures, will continue for a long time. Managed futures have a low correlation with bonds and a negative correlation with stocks. In other words, managed futures have a history of making money when stocks or bonds are struggling.*
Managed futures are potentially double hedges against the two largest asset classes (stocks and bonds). These hedges make a lot of sense when stocks are hitting all-time highs and bonds are falling from all-time highs.
Perhaps the biggest reason managed futures are especially attractive now is commodities are extremely sensitive to inflation. Commodities typically go up in value when inflation increases. On the flipside, inflation is a headwind for stocks and bonds. When you consider that central banks around the world are increasing money supplies more than ever, inflation is highly likely to develop. If you don’t make necessary adjustments, your returns could suffer substantially.
If you would like to learn more about how managed futures can potentially enhance returns and reduce risk, give us a call or send an email.
*Past performance does not guarantee future results will be similar.
