First, we have experienced the greatest deflationary decline in U.S. financial history in overall commodity prices. Based upon this deflationary dynamic, there are a number of implications we will look at in this video which I believe we must be mindful of.
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High Probability a Final Bear Market Low is in Place in Overall Commodity Prices
Point two: I believe there is a high probability of final bear market low is in place in overall commodity prices. The sheer violence of the waterfall decline followed by the trading range we have experienced since December argues for a final low; however, there are a couple of qualifiers here.
First, the damage that has been done, wealth destruction, has been so great there is no expectation nor historic precedent for commodity prices regaining the historic price levels achieved last year for a very long time to come.
Carrying Charge Premiums Diminish Wealth Building Opportunity
Secondly, the carrying charge premiums in the various markets, most notably in the crude oil and energy markets, are exorbitant and greatly diminish the probability of any great wealth-building bull market occurring for probably a very long time. In other words, we are projecting a bull market in overall commodities but one which needs to be approached as a trading market for the time being.
As you will see, the excessive carrying charge premiums are also in effect in the wheat, corn, oats, and cotton Just as a review, for those of you that perhaps don’t understand how the carrying charge premiums work, if we take the current contract in the crude oil, let’s just say the May contract, and we look at the contract in May of 2010 (one year hence), the 2010 contract trades between 20 and 30 percent above the current price. In other words, the current price on the nearest futures of the spot market is far beneath the future contract in May of 2010.
When you go out and you buy crude oil for delivery in 2010, you have to pay this huge premium. What we know historically, and we have done a huge amount of research on this, is that when there are large premiums in a market like that, it is a hindrance to making money. This is because, even if there is a bull market, that bull market in the cash market would have to advance 20 to 30 percent over the next year just for you to break even in the futures market.
It is like the market has a 27 percent interest rate. The equivalent of a credit card rate of interest in holding current contracts. This makes market participants dependent upon the market, the spot price, to move up more than what that premium is in order to make money, and that makes things very difficult for those on the long side.
Really, what it amounts to when we have conditions like this is it is better to be a trader in the market back and forth, and it goes back to also the option market; doing option writing can be the most effect means to make money in this environment.
Potential for a Final Low Based on 1920 and 1948 Historic Crash Precedents
I first want to show a table of all of the bear markets which have taken place across our board between 2008 and 2009. We see that most markets did bottom in 2008 and with a number following through into this year. Basically December, October, and December lows is when the final lows were established.
Now, the overall decline in these markets was 60 percent, but you can see that those in the purple were over 70 percent, all of the energy markets and also the copper markets. Anytime you see markets move really into the 60 percent and into 70 percent, we are looking at historic bull markets of the highest order.
The percentage retracement of the previous bull markets which started in 2001 averaged 78 percent. In a matter of about five months, all of these markets retraced what took seven years of advances in price to culminate in the final top.
We have seen a waterfall You could call it a crash, call it whatever you want, the expletive that you would want to use for this market. It is of the highest order of deflation that we have ever seen in 200 years. In 1920 and also 1948 waterfall declines, or crashes occurred, but they culminated. In other words, those precedents established final bear market lows. It is based on those two precedents (1920 and 1948) that I believe that we have a final low in place.
The carrying charge premiums as of March 25th for 12 months out:
- Heating oil: 16 percent higher than the nearest futures
- Crude oil: 21 percent higher than the nearest futures
- Gasoline up 14 percent higher than the nearest futures
- Corn 14 percent higher than the nearest futures
- Oats a whopping 29 percent higher than the nearest futures
- Wheat 17 percent higher than the nearest futures
- Orange juice 19 percent higher than the nearest futures
- Cotton 20 percent higher than the nearest futures
- Lumber 19 percent higher than the nearest futures
Generally, this means that there is going to be basing action, or backing and filling all the way up. That does set our expectations. One thing that is interesting here is that you can see that in the soybean complex which we are holding long call option positions in, you can see that the premium is only six percent in the bean oil. Actually, it would be considered backwardation in the case of the soybeans. The distant contract is trading five percent lower. This would be considered normal premiums. Therefore, by participating in Soybeans, it means that we are buying value, and we don’t need to see the spot or the cash price advance like we would need to see in these other circumstances. That being said, that is a good market for us on this basis to be long in right now.
The Great Bear Markets in History
Crude oil declined 78 percent in five months and eight days. On a percentage basis that ranked as the seventh greatest out of a total of 20 that were in the elite category. But in terms of time, it ranked as number 20 in terms of length. It was far and away the shortest bear market in history; the second shortest being the cotton market during the 1920 to 1921 period.
On that basis, I had felt that we would probably see another leg down in the crude oil, obviously not the velocity that we have seen in our market that we had seen into the December low because we had come down 78 percent. I am not sure if that is gong to be the case. This ranks as the greatest decline in any commodity in terms of percentage move in the shortest period of time in history, and so it ranks at number one of twenty. This decline was rapid, culminating in dramatic fashion, and a bear market low is probably in place.
These are the historic bear markets following the great inflations in history. In 1920, we had this dramatic waterfall decline, but the final low in June of 1921 was a historic low, and the next bull market started, but the bull market was gradual in comparison to the decline.
1929-1932: Great Depression Deflationary Scenario in Commodity Prices
In the 1929 to 1932 period, all of the commodity advances were extremely modest, so this deflationary scenario in commodity prices during the Great Depression is one of a kind in terms of our historic database. The rallying power and consolidation in our market means we have basically divorced ourselves from the likelihood we are mimicking the minor rallies during the Great Depression.
What can we take away from that?
- We are not carrying the earmarks of the Great Depression at least in terms of overall commodity prices
- Our decline was much more rapid than occurred during the Great Depression
- We are experiencing consolidation that we didn’t experience during the Great Depression.
In other words, overall commodity prices definitely have a unique signature that is more akin to the 1920 market than the Great Depression 1930′s market. That in and of itself would tell us that we are not a perfect parallel to the Great Depression. Hopefully that means that we are not going to see our economy disintegrate. That would be in favor of the possibility that we even have a low in place in the stock market, and that certainly is a possibility.
This is the 1949 market, but the waterfall decline in this market occurred and culminated, and then a major low was established, and you can see that the market moved higher here and actually exceeded the bull market top in 1948 but didn’t do so for about two years.
60 Year Cycle Almost Right on Schedule in Commodities
The Goldman Sachs chart (see video) shows projections of how these historic market movements occurred by overlaying them on a current chart to see how a mimicking move would play out.
This 60-year cycle I believe is the most important. It projected a final low in commodities in April of 1949, and our low is February of 2009. That is within two months of this replicating the 60-year cycle 1949 low.
Crude oil bottomed in December, but overall commodities touched a new low in February. On that basis, it would say that we are going to start s long-term bull market in commodities, but it was very modest to begin with.
Great Commodity Bear Markets
In 1974 market spiked up. Then, the market ultimately culminated in a final runaway advance in 1980. We did see a spike up, a sell off, a violent rally, and then a secondary decline, but this waterfall decline in 1974 did culminate in a historic low in 1975.
This was a very short-lived bear market. Following the historic high in 1980, we experienced the crash of precious metals into March of 1980, and then overall commodity prices advanced until September of 1980. That started a long-term bear market which actually didn’t culminate until the year 1998.
(See the video for a chart of the Goldman Sachs commodity index) The recent decline in the Goldman Sachs commodity index is the greatest wealth destruction decline in commodity prices in history in the shortest period of time.
Between July 2, 2008, and February 19th, we declined 66 percent in seven months and 17 days. Recently, we have seen an advance of about 25 percent to the upside. Lately we have had basically trading range action.
The problem is that if we have this modest leg up in commodities and markets like the crude oil are at a 20 percent premium and cotton are at a 20 percent premium in these distant contracts over the front, then that diminishes the potential return to the up side. We need to calculate that into the equation and say that we expect to see some of these markets make modest moves, at least in the futures contracts whereas the underlying cash will be more dramatic.
Fri, Mar 27, 2009
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