Many commodities have been on the rise recently, but sugar is s a standout, soaring to 28-year highs. I’ll take a look at the outlook for sugar and gold, as well as for the Treasury market and stock indexes. Investors seem to be thinking the economy is brightening enough for to continue taking on more risk, but will statements from the Federal Reserve at the conclusion of their two-day policy meeting on Wednesday support that view?
Sugar has been on quite a run this year. ICE October sugar futures jumped 11.7 percent last week, and are up76 percent this year amid mounting supply concerns. The contract touched 22.44 cents a pound on Monday, August 10, the highest since 1981.
Poor weather has affected production in India and Brazil, the world’s two largest producers. India has been experiencing extremely dry weather, as the monsoon season looks weak this year and production is expected to be down at least 20 percent this season. On the flip side, Brazil has had too much rain. Global sugar stocks are estimated to be near record lows, and buyers including governments and international food and beverage companies are competing for tightening supplies. Both Mexico and Egypt last week announced large purchases of sugar and other countries are expected to follow.
The sugar market is in uncharted territory, having traded above current levels only two times in its history. Both involved massive spikes, in 1974-75 and again in 1980-81. In London, Liffe October white sugar futures jumped above $566 a metric ton, the highest since the contract was launched in July 1983.
Sugar remains strong after a significant breakout above 18.75 last week, and has been spiking every day for the past five days. Sugar has been up 14 of the past 15 sessions, almost unheard of in any market. The Relative Strength Index (RSI) was above 90 percent on Monday, which indicates an oversold condition. Profit-taking is likely to set in, but I’d recommend using pullbacks as buying opportunities. I would buy sugar futures around 20.55 – 20.60, and sell a 20 cent call as a hedge. Use a stop of 18.90.
The noted improvement in the U.S. employment situation caused an unwinding of the Treasury safe haven bid on Friday, August 7. The unemployment rate in July was reported at a better-than-expected 9.4 percent, while non-farm payrolls fell 247,000. Expectations were for over 300,000. You may remember we started the year with more than 700,000 jobs lost in both January and February, so I think given the improvement we’ve seen, the downside breakout in Treasuries following the employment report was justified. Strength in the equity market over the past month has compounded the flight out of Treasuries, and the downside action could’ve been even more severe.
The August 4 Commitments of Traders Report from the Commodity Futures Trading Commission showed non-commercial traders were net short 109,090 30-year Treasury bond futures contracts, while non-reportables were net long 1,130. That means the combined speculative and fund position was net short 107,960 contracts. Until the combined position is 160,000 net short, to me that wouldn’t suggest the market has become extremely oversold just yet.
For the 10-year Treasury note futures, non-commercial traders were net short 85,433 contracts, while non-reportables were net short 94,049, for a combined speculative and fund net short position of 179,482. That position is not particularly extreme either, in my opinion.
Given there is a very large supply pending this week, and yields are sitting close to the highest levels since mid-to late-June, the market could be at a decision point. With $75 billion in new debt flowing into the market this week, it will be interesting to see if the cash market sees a pick up in demand.
The market is also be facing the two-day Federal Open Market Committee meeting this week, and a statement from the Fed is expected Wednesday afternoon, August 12. After the better-than-expected July employment report, some market participants may be anticipating a statement hinting at an end to quantitative easing, but I think that might be a touch premature. Other traders think the Fed will signal an end to Treasury buybacks at the end of the next tranche in September, by not extending the program.
If the equity markets were to regain upside momentum, it may be possible for September Treasury bonds to fall to the next solid support level near 114. I get the sense that demand will be good enough in the upcoming auctions to arrest the rise in yields, at least temporarily. I also think the Fed will be emboldened by the latest economic news, but they also don’t want to see long rates rise prematurely, as the battle to revive the housing sector is far from won, even though we have seen some improvements since mid-year.
I recommend positions on the short side in Treasury futures and wouldn’t be surprised to see a slide to 114-14 in the September 30-year bond futures, and to 114-17 in the 10-year note futures. The Treasuries have seen a short-covering rally before the FOMC meeting, pulling the ten-year note contract up to 115-20. The 20-day moving averages comes in at 116, and that’s where I’d recommend establishing a short position, with a stop at 117-17.
Gold fell sharply on Monday, August 10, posting five straight losing sessions as the dollar has regained some strength. There is a feeling that as the U.S. was the first to fall into the recession that is affecting countries across the globe, we will probably be the first out, and the first to start tightening rates. That has given the dollar a temporary boost.
However, I remain long-term bullish gold and think declines won’t be extensive. The actions the Fed has taken in the past year to quell this economic crisis are very inflationary in the long run. I also feel the dollar will remain in a long-term downtrend. European central banks have indicated a lower-than-expected ceiling on bullion sales over the next five years, and that’s a headwind that gold won’t have to fight. I think gold will approach $1,000 an ounce, and likely trade above that level in coming months.
The stock indexes have rallied about 50 percent from their March 9 lows to reach new highs for the year, but are at a tenuous technical area. The recent optimism in the stock market was based on an improvement in the employment picture as well as stronger-than-expected quarterly earnings. Companies have cut to the bone to post better results; some 75 percent of companies in the S&P 500 have topped analysts’ expectations for the latest reporting period.
We’ve also seen housing prices start to move up recently, as well as improvements in new and existing home sales. Manufacturing is starting to pick up, and China’s GDP has been advancing rapidly. China is really the straw that’s stirring the drink globally. Fund managers are buying to keep up with the S&P 500’s performance.
The stock market has had a terrific rally, and is a long way off the bottom. However, there are still a lot of problems for this market. Credit is tough to get and will remain tough to get. People have lost a lot of net worth and haven’t gained it back. Some have lost their jobs or have taken pay cuts, and have less discretionary income to spend.
It seems like the abyss has been avoided, but is there really growth? Time will tell. We are at a difficult juncture in the markets. I think it’s likely the stock market will see a correction in the early fall, in September and October, a time of year when the stock market has historically had difficulty.
Please feel free to give me a call if you have any questions on this topic, or how to develop a customized trading strategy based on what’s taking shape in markets of interest to you.
Futures trading involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
© 2009 MF Global Ltd. All Rights Reserved.