Futures Edition
Week of June 29-July 3, 2009

CAPITAL MARKETS COMMENT | FUTURES FEATURE TRADE 1: CURRENCY | FUTURES FEATURE TRADE 2: CORN vs. WHEAT | PREVIOUS TRADE RECAP/UPDATE | SUBSCRIBE via RSS | DISCLAIMER

CAPITAL MARKETS COMMENT

Don’t laugh. While we become ever-more convinced with each passing day that we are currently experiencing a deflationary depression that will take global equity indexes to levels way below their March lows before the end of 2009, we think the stock market can rise.  You read it correctly. I am very excited and indeed, quite optimistic about the equity markets.  For this week, at least.

Why the sudden change in attitude? Firstly, the equity markets are working-off extremely oversold conditions on the short-term.  The intentional withdrawal of financial system liquidity engineered by the Federal reserve to “scare” investors into the “safety” of long-dated treasuries that we discussed in last week’s Market Spread Report worked flawlessly (and rather profitably so for our readers), as Monday alone saw a 3% plunge (more so in commodity-producing markets such as here in Canada) in equity prices.  When added to the weakness exhibited in the equity markets on the Thursday and Friday of the previous week, the precipitous decline on Monday created a sharply oversold marketplace.  Indeed, the markets spent the rest of last week working off that oversold condition, and we believe that trend will continue into this coming week.

The selling on Monday was so broad-based; the buying so completely non-existent. It would have awoken any market bear in hibernation.  We actually received numerous telephone calls and text messages from colleagues who currently share our bearish disposition asking on Monday “is this the time to be legging out of our longs and going net short?”  One thing for certain: the amount of short interest, especially amongst retail investors, increased on Monday.  The market just loves to shake out those who are a little too early to the party. What perfect timing, then, for the market to catapult higher — just as the bears begin to sniff the proverbial honey.

Equity prices should also receive a boost from the docket of economic data to be released this week. In particular, the Conference Board Consumer Confidence Report on Tuesday is expected to show a strong gain in consumer sentiment. We may have already received a preview of the Conference Board’s numbers in last week’s Reuters/University of Michigan Survey of Consumers, which showed U.S. consumer confidence improved in June to the highest since February 2008.  Since the November 2008 low of 55.3, the sentiment index has gained 15.5 points, recouping about one-third of the loss posted since the peak in January 2007.   “Such a sizable gain has usually indicated that an end to the economic downturn is on the horizon as consumers begin to increase their spending on houses, vehicles, and large household durables,” the Michigan report said in a statement.  While we at the BHB Group place very little importance on what the US consumer “feels”, nevertheless, the market does seem to pay attention, and as such, a positive reading should support equity prices, if only for this coming week.

Also on Tuesday, global equity markets will close the books on trading for both the month of June and the second quarter. So there could be even more bolstering of equity prices amid so-called “window dressing” in the coming week – a ritual calls for money managers to dump some losers and snap up recent standouts to spruce up portfolios — and their quarterly returns.

Finally, this coming week, as many of you must be aware, is a holiday-shortened one. Here in Canada markets are closed on Wednesday; in the US, all markets are closed on Friday in celebration of Independence Day. But perhaps you were not aware that holiday-shortened weeks are typically quite good ones for equity markets? Did you know, for example, that during the Christmas-New Year’s holiday-shortened week, this decade did not see one week of equity market (Canadian market, at least) declines? Not even one. The data for Independence Dayholiday-shortened weeks is mixed, however a clear pattern is discernable. Since 2001, every odd-numbered year has produced positive returns; each even-numbered year has produced negative equity returns.  And given the fact that that last year’s equity performance left much to be desired (that’s putting it mildly), what better way to make Americans feel better about their country, and Canadians to feel better about theirs, than a pop in their respective stock markets.

For commodity traders, this is an equally important week, as two of the year’s most important reports are released. On Tuesday, the USDA is scheduled to issue both its Acreage and Grain Stocks reports, with its acreage forecast attracting most of the attention. The Acreage report essentially updates the estimates issued at the end of March on the Prospecting Planting (farmers’ planting intentions) Report.  This year, there is added uncertainty to how much acreage was planted of each field crop after wet weather conditions may have caused some farmers, particularly those farmers intending to plant corn in the Eastern Corn Belt, as well as those farmers intending to plant Spring wheat in the Northern Plains to abandon their original intentions in favor of other crops. If it is indeed the case that farmers chose to plant other crops because of the unfavorable planting weather, the loser could be the soybean complex, as the later planting dates associated with the oilseed may have been the favored alternative amongst farmers rather than taking preventative planting insurance payments.

As far as the corn crop is concerned, we believe that the market has overstated the loss of acreage due to unfavorable weather during planting season. Remember that the corn complex during planting season was essentially a tale of two belts. While the eastern corn-belt certainly lost some acreage due to the excessive rains that made it impossible farmers to get the seed planted in time, the rally in December corn futures most likely enticed farmers in the western corn belt (where weather was favorable and allowed farmers to plant within a normal timeframe) to plant more corn than they had originally intended. We believe that the added acreage in the Western Corn belt will help to nearly offset the loss of acreage in the Eastern Corn belt.  As such, we believe there will not be a tremendous change to the March intention figure of 84.986 million acres.

Unsettled weather in the Northern Plains and near-drought conditions in the Southern Plains has also caused a considerable cloud of uncertainty with regards to the US wheat acreage.  Unseasonably cold and wet weather wreaked havoc on farmers’ ability to get the Spring Wheat Crop planted, however a temporary spike in wheat prices caused by the unwinding of short positions amongst commodity speculators should have been the catalyst to get the intended crop planted, albeit in less-than-desirable soil conditions.  In the south, near-drought conditions coupled with the deterioration of last year’s winter crop due to a late-April freeze should result in reduced acreage for Hard Red Winter wheat.  All in all, we believe the wheat acreage report will see but a slight reduction from the March Planting Intentions Report.

Whereas the focus in the grains will be on the acreage report, for the soybeans complex, eyes will be focused on the Stocks report, as this report will shed light on just how tight old-crop supplies really are. If the stocks report does reveal a veritable tightness, it is possible that a lack of selling will cause a potentially sharp rally in the prices of old-crop (July in particular) soybeans during the delivery period.  As far as the new-crop is concerned, the range of estimates for the USDA’s soybean plantings figures is between 75.3 and 79.6 million acres, with a median estimate of 78.3 million acres.  Last Tuesday, Statistics Canada revealed its Principal Field Crops report, which showed that soybeans planted increased by 17% YOY, and 5.8% greater than the March planting intention number. If this is in fact a preview of what we will see in the US Acreage report come Tuesday, we should exceed the high end of analyst’s estimates, a potentially bearish development for the new crop (November contract and beyond).

FUTURES FEATURE TRADE 1: CURRENCY AUSTRALIAN DOLLAR & JAPANESE YEN

Long: September Australian Dollar (AUD)
Short: September Japanese Yen (JPY)

For those short-term traders who believe a one-week rise in the equity markets is imminent, I suggest participating in the upside by putting on a trade where one is long the Australian Dollar, while at the same time is short the Japanese Yen. Given the higher yielding Australian Dollar (3.0% vs. 0.1% for the Yen), this trade is a key gauge for monitoring the market’s overall risk appetite. When investors are willing to take on more risk, they borrow low-yielding currencies and invest the proceeds in higher-risk, high-yielding ones.
The trade also makes sense from a fundamental perspective. Long-term expectations for higher borrowing costs paired with improving fundamentals are likely to drive the Australian Dollar higher over the following week as market participants expect the Reserve Bank of Australia to hold a neutral policy stance going forward from its July 7th interest rate policy meeting. Further, the economic docket for the following week is likely to encourage an improved outlook for growth and inflation as economists anticipate retail spending to rise for the third consecutive month in June. On the other hand, a report released Friday showed Japanese consumer prices fell a record 1.1% in the year to May, with falling demand increasingly blamed as the country’s second bout of deflation in less than two years deepens. The slide may make the Bank of Japan less willing to end unconventional policies, including near-zero interest rates, due to expire in September.
As the chart below shows, from a technical standpoint, the AUD/JPY cross (as this trade is commonly known as) offers an intriguing entry point as the price has moved down towards its lower trendline support line. Stochastics show a short-term oversold condition.

FUTURES FEATURE TRADE 2: CORN vs. WHEAT

Long: New-crop wheat (December)
Short: New-crop corn (December)
One trade that I believe will offer investors the potential for good returns beyond the USDA reports is one in which an investor is long wheat against a short corn position, as fundamentals for corn look very bearish compared to those of wheat.
December corn is the new crop for the year and although it got off to a slow start for planting, growing conditions have been near perfect for corn. The Good/Excellent rating by the USDA on its weekly Crop Progress Report came in last week at 70%, which was 11 points above last year’s rating. Estimates for corn acreage, which will be the focus for the report tomorrow morning, will probably show the market has overstated the loss in acreage.

For wheat, there could be supply issues going forward that may positively affect prices. The price spike we saw at the end of May – the result of speculative funds covering their massive short positions – caused farmers in the Spring Wheat area to plant their crop in less than favorable (excessively cold and wet) conditions. As a result, root development of the crop is decidedly shallow, which can leave the crop vulnerable to inclement weather and disease later on in its growth cycle. Also, feed demand for wheat seems to be growing and we are of the opinion that the USDA is understating those figures. Globally, the supply of wheat crop could come under pressure: Russian wheat appears to be having some issues with protein quality and bug damage; Argentina remains excessively dry; heavy rainfall in Central Europe has delayed harvesting and threatens to lower quality; dryness also continues in the Middle East. Technically, wheat prices are oversold and are due for a bounce. As they do, the speculative funds that are short wheat in dangerous quantities will need to cover some of their position, driving prices even higher.

From a technical perspective the wheat/corn spread looks very good in terms of a proper risk/reward profile. The spread is currently at 190 as of Friday’s close. I would look to use 176 on the spread as support and if we were to close under that area we would consider exiting the trade. By looking at this spread we can see what looks like a nice base that was built and many probes higher looking for demand to surface. We like this trade, however we recommend investors wait until after the USDA report tomorrow AM in order to enter this spread with less risk.

PREVIOUS TRADES RECAP/UPDATE

DISCLAIMER

This newsletter is based upon factual information considered to be accurate and reliable but not independently verified or guaranteed by us. Opinions expressed are those of the author, are subject to change without notice, and do not necessarily represent the views of ScotiaMcLeod. This report should not be construed as an investment recommendation to you to engage in any transaction involving the purchase and/or sale of equity securities, futures contract(s) and/or commodity options. Past performance is not indicative of future results. The risk in trading futures contracts or commodity options can be substantial. Investors should carefully consider the risks of investing in light of their investment objectives, risk tolerance and financial circumstances. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor the information, opinions, and conclusions contained in it be referred to without the express written consent of ScotiaMcLeod.

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