Market Matters Blog
Katie Micik DTN Markets Editor

Wednesday 07/16/14

Winning at the Waiting Game? Not in Ag Commodities

Investors can win by waiting in commodities, as a recent Wall Street Journal article suggests, but it's only when markets have a bullish, or inverted, structure. It's a risky proposition in most agricultural commodities right now, DTN Senior Analyst Darin Newsom said.

The Journal article explained the "rolling" strategy: "A fund manager buys a futures contract for delivery next month. Right before it expires, the investor sells the contract, buys a cheaper one for delivery at a later date and pockets the difference."

It went on to say that this strategy would work in 11 of the 24 commodities in the S&P GSCI Index, and that a fund tracking the index itself would have earned 1.8% from rolling contracts forward this year, even though the overall index was down slightly.(Here's the article:…).

"The article states that investment traders can make money in a situation where the nearby futures contract is higher priced than the deferred contract. That is simply an inverted (backwardation) situation, and as such a forward curve reflecting a bullish view of supply and demand by commercial traders. So restating the writer's thesis, investment traders can make money in a market with bullish supply and demand.

"How do they do that? Buying the nearby contract, holding it short-term, and rolling to the next, and the next, as long as the market remains inverted is standard operating procedure. Investors that do that in a carry (or contango) market usually suffer the consequence (e.g. 2008 crude oil)."

So what markets might this work in? Which ones have a bullish forward curve?

-- Corn: The new-crop forward curve shows a strong carry (roughly 67% of cost of carry) = Bearish

-- Soybeans: The old-crop forward curve remains inverted, but an investor will take his life in his hands betting on the August or September contract against the new-crop November

-- Wheat: Moving on.

-- Crude oil: The forward curve is showing contango (carry) but this has been weakening of late. Along with that, investors have lightened their net-long futures holdings.

-- Natural gas: Deferred contracts show a contango in the forward curve. However, what will happen in the market known as "The Widowmaker" is anyone's guess.

-- Gold: A different breed of commodity in that it has a more stable S&D situation. The market tends to show a slight contango, and such is the case again this year.

-- Live cattle: A minefield for an investor that doesn't understand the dynamics of a livestock market. Each contract is a harvest in and of itself. The investor has to be aware of how the current spread relates to historic levels, meaning a backwardation could still be bullish or a contango bearish.

-- Lean hogs: Ditto live cattle, but for traders who also like playing Russian roulette.

-- Cotton: Strong carry in the futures market hints at a continued bearish supply and demand situation despite the recent collapse (seasonal sell-off) in price.

-- Sugar: Forward curve situation similar to cotton

-- Coffee: Contango anyone?

-- Cocoa: Finally, a market in backwardation that investors might buy into. The only problem is that cocoa has been rallying for almost 2 years now.

What I find interesting about the timing of this article is its timing. Money has been flowing out of commodity hedge funds over the past few years, and as Newsom pointed out: "In general, noncommercial positions (mostly net-long) are smaller than they have been in years past. One exception is crude oil where the continued backwardation has led to recent long holdings of 550,000 contracts (more or less)."

While some investors may be happy making 1.8% on commodities, it pales in reflection of the potential earnings in equities right now. The author's premise may be correct. Yet, it's an obvious strategy that's more applicable in some markets than others. It's not a strategy for the grain markets right now.


Posted at 12:59PM CDT 07/16/14 by Katie Micik
Comments (1)
nobody knows what the future will bring mother nature is in control in ag no matter what humans wish
Posted by andrew mohlman at 8:39AM CDT 07/17/14
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