The historical commodity super-cycle has not come to an end, even if major commodity index measures and a number of key physical commodity markets finished 2012 well below the historic highs they forged in 2011. Certainly, slower global activity and wall-to-wall global fiscal uncertainty has tripped up many commodity markets over the last two years, but surprisingly that has only resulted in a modest reduction of fund interest in physical commodities. We suspect that just as commodity long interest recovered from almost “zero” spec and fund long positioning in the wake of the sub-prime crisis back in 2008, a simple shift away from recession and toward forward motion in the global economy will serve to rekindle long investments in commodities. In late 2012, the combined speculator and fund positioning in 20 non-financial commodity markets was roughly 42% below the level it registered in February 2011. This suggests investors didn’t abandon ship – they simply stepped aside to weather adverse conditions!
In looking back at industrial commodity supply and demand patterns during the years immediately following the sub-prime crisis, it is clear that global demand was less elastic than would have been expected in the face of economic turmoil. Slow economic conditions over the last four or five years have not resulted in any significant rebuilding of commodity stocks, and only a couple of commodities have exhibited anything resembling burdensome supply.
Clearly, the fear of ongoing slow growth and even a recession tempered the prospects for inflation for most of 2012, but seeing the U.S., Europe and China enter slightly less turbulent waters could rekindle inflationary expectations in 2013. Some may argue that increased U.S. oil production has taken the bullish edge off global energy prices, but tightening supply situations in the gasoline and distillate markets could result in firmer energy prices than one might have expected if they focused only on the crude oil supply.
U.S. grain prices have fallen back to levels which suggest that there was little lasting damage to the global supply from the 2012 drought, but drought conditions have persisted in the central and western United States and there is no guarantee subsoil moisture deficits will have a chance to recover ahead of the 2013 growing season. Therefore, we would expect grain prices to be highly sensitive to any evidence of dryness or above-normal temperatures through the winter months. We also think that a period of extremely tight physical supply will be seen in the soybean market during February and March and extreme tightness in the corn market in April and May.
Another element that weighed on commodity prices in 2012, which we don’t expect to be repeated in 2013, was the slowdown in China’s economy. But with Chinese inflation levels falling back to acceptable levels and a new generation of leaders in place, the world is watching very closely for evidence of revived growth in China and/or signs of fresh government stimulus efforts aimed at kick-starting prosperity in the country’s interior. China also wants to stimulate domestic demand so that its reliance on foreign economic activity is reduced. Therefore, traders should expect China to shift from being a negative factor in commodity pricing for 2012 to being a positive factor for 2013. A modest increase in China’s economic growth could result in a re-tightening of commodity supply, which could foster expanded speculative interest and higher prices.
While the supply of crude oil in the U.S. reached its highest level in 18 years in 2012, product stocks continued to tighten, at one point falling to their lowest levels since the beginning of the sub-prime crisis. This seems to have been the result of a long-term decline in U.S. refinery activity, but idled U.S. ethanol production and soaring Chinese gasoline demand could have been factors as well. Traders who limit their analysis strictly to the crude oil market might start 2013 with a bearish view toward energy prices, when the real focus of the energy trade for the year is likely to center on the gasoline and distillate sectors.
Low U.S. gasoline stocks, declining refinery operating rates, periodic disruptions in ethanol production and news that Chinese gasoline demand is more than making up for weakness in developed-country demand should put gasoline in a bullish posture in 2013, especially if the U.S. and Chinese economies manage even minimal forward momentum. Three years ago, China surpassed the U.S. in annual car sales figures. Analysts think that by 2015 China’s sales will be greater than the U.S., Japan and Germany combined. A recovery to pre-sub-prime levels in U.S. gasoline demand coupled with the estimated jump in Chinese gasoline demand could send global consumption to a new high in 2013.
U.S. and European distillate stocks are also very tight, especially considering that the U.S. is attempting to move out of a recessionary condition. Rising gasoline demand may keep refineries more focused on gasoline production at the expense of distillates in 2013. With East Coast supplies a potential flashpoint and distillate prices capable of benefiting from any prolonged shutdown of U.S. ethanol production, it is possible that early in 2013 nearby heating oil prices will reach their highest levels since August 2008.
In the wake of $140 crude oil, a number of analysts predicted the world had seen peak oil prices and peak oil demand. However, we maintain that peak oil demand type pricing could be seen in 2013, as tight gasoline supplies collide with fresh records in global demand.
Stock market performance in 2012 clearly outperformed most expectations, as the Dow Jones Industrial Average forged a gain of roughly 730 points, while the S&P 500 posted a surprising gain of approximately 165 points. At times, the Dow had managed a very impressive gain of 18.6%, while the S&P at its highs peaked out with an impressive gain of 11.8%. However, towards the end of the year the equity markets were undermined by the lead-up to the election, the approach of the U.S. fiscal cliff and uncertainty regarding the transition of power in China.
Another source of concern may have come from inflated earnings expectations for 2013. Traders might be thinking that the S&P 500 may have difficulty achieving a 13% gain from 2012 given the slowing global growth outlook. Without knowing the endgame of the U.S. fiscal cliff battle, it is difficult to project price levels for 2013. Further uncertainty comes over the fate of capital gains and dividend tax rates. We anticipate a downside reaction in prices as lawmakers come to an agreement on the fiscal cliff. We think a downdraft in the S&P 500 during the first half of 2013 into the 1225-1175 range would present a buying opportunity.
From the beginning of the sub-prime crisis to the peak of the reaction to it, Treasury bonds forged a contract value rally of roughly $47,562.50! In prior market tops (1989 and 1993), Treasury prices saw extended consolidation patterns before beginning to fall in earnest. Some traders might suggest that there was a false consolidation top signal in late 2011/early 2012, but with the 2012 consolidation sitting at 28 weeks and counting going into December of 2012, the chance for a slide away from historic highs is certainly possible in the coming year. As nearby bond prices have already made it down to the 116 to 119 zone a couple of times in 2010 and in 2011, it is possible that the high could already be in place and that a series of lower highs will be seen throughout 2013. Certainly the bull camp holds out hope that the U.S. will at least temporarily fall over the fiscal cliff, but if it avoids that scenario, the bull case for Treasuries could be seriously damaged.
From just ahead of the sub-prime crisis to the peak of global financial turmoil, a single Yen futures contract managed an appreciation of $64,000. In a nutshell, a combination of Japanese repatriation and almost no alternative currency resulted in an epic run up in the Yen exchange rate. Eventually a return to economic normalcy and serious ramifications from the ultra high exchange rate (and severe deflation) will set in motion what could become a historical liquidation.
Into late 2012, gold prices were sitting at an impressive $1,043 per ounce above the sub-prime lows. The bear camp might point out that gold prices were only $166 below the 2011 highs, with a combined spec and fund long positioning waffling between 250,000 and 330,000 contracts! While some traders think that gold is capable of another significant run-up in the event that the U.S. falls over the fiscal cliff, they should bear in mind that during the second half of 2012 the market spent most of its time tracking classic market fundamentals and not behaving like a safe-haven instrument. Therefore, gold looks to be presented with a critical pivot point into the beginning of 2013.
As in other markets, the breadth and duration of the fiscal cliff debacle will have a major impact on gold for the coming year. In our opinion, the surest path to $2,000 gold is a positive and relatively quick resolution to the fiscal cliff and a return to global confidence and growth.
In the 4th quarter of 2012, silver and platinum seemed to outperform gold on a number of occasions. This might have been pointing to their tighter supply and demand scenarios. Silver and platinum might be expected to trade in sync with gold, but if either the U.S. or EU financial troubles moderate, it could shift both of those markets into a faster gear. If we were pushed into the market, we would prefer to be long platinum over being long gold in 2013. The platinum market is plagued by supply problems, and it could see greater demand from auto catalyst production. This could leave platinum supply very tight. However, if there is a major financial meltdown and gold prices soar, platinum could simply be dragged along with other precious metals. We see fairly significant value in nearby gold prices at just above the $1,650 level, and we see similar fundamental value in platinum prices at $1,550.
With the International Copper Study Group predicting a 2012 global copper deficit of 400,000 tons and many months of 2012 registering deficits greater than 21,000 tons, it would seem like the copper market has been able to transverse one of the worst economic debacles of modern times without building a burdensome supply. With signs of a recovery in the U.S. housing market and ongoing infrastructure spending in China, a modest improvement in industrial demand could make nearby copper priced below $3.55 per pound an extremely attractive “buy” for hedge funds. Clearly the downshift in the Chinese economy throughout 2012 weighed on copper prices, as indicated by the nearby chart showing a decline of 76 cents per pound from its high to its low. In looking back, one might suggest that the $3.26 to $3.45 pricing was only justified in the face of economic turmoil. Nearby copper prices in a $3.55 to $3.62 range should be considered cheap in the year ahead, and a return to $4.00 could be seen early in 2013. After all, nearby copper managed a move from $3.30 a pound to $4.02 in the face of the false global recovery view in February of 2012.
After the drought of 2012, the extreme tightness in the corn supply for the first half of 2013 should be a key factor guiding prices and spread relationships. In years when the corn supply is tight into the spring, the May/July corn spread tends to invert (the May contract trades at a premium to the July) as end users tend to need summer coverage and cash markets tend to get the tightest into early May. With the possibility of 2013 exhibiting one of the tightest stock levels on record, a major inversion is possible. Similar years to 2013 include 2012 (+45 cents May over July), 1996 (+26 cents May), 1986 (+22 1/2 May) and 1973 (+14 3/4 May). Look for May Corn to trade to a premium of at least 20 3/4 cents to July, with a possible target of +35 cents May.
Perhaps the U.S. drought is over, the weather will return to normal in 2013 and corn prices will see a range of $5.50-$6.65 per bushel into the summer. But if that does not happen, the impact on corn and feed grain prices could be dramatic. Normal yields are needed for the February-April harvest in South America, and then an excellent start is needed for the U.S. crop in order to avoid a massive weather premium for the December 2013 Corn contract. The U.S. will need trendline yields to avoid a resumption of the longer-term uptrend.
Soybean meal spreads are already inverted on expectations for acute protein tightness for the first half of 2013. The market has also priced in record soybean production for 2013 in Brazil and Argentina, so any weather glitch in South America could be a catalyst for another leg higher in meal. As of late November 2012, cash meal was trading at a $45 premium to the July 2013 Soybean Meal futures. If South America has any production or shipping problem, July Meal should see higher trade ahead. Consider buying the July Soybean Meal 400 Calls and selling the July Soybean Meal 450 Calls.
September and October weather in the northern Delta and the southern Corn Belt was nearly ideal to restore moisture to those previously dry areas. This should help the soft winter wheat crop get off to an excellent start for 2013. The hard red winter wheat areas in Nebraska, South Dakota and northwestern Kansas stayed dry into the fall and were seeing germination problems after planting. This could pose a significant problem for the crop, as both topsoil and subsoil moisture was lacking. In addition, old crop hard red winter wheat ending stocks for the 2012/13 season were tightening, while demand for soft red winter wheat was lacking. The hard red crop entered dormancy with record low crop conditions at just 33% good to excellent. Consider buying July KC Wheat and selling July Chicago Wheat, looking for KC Wheat to take a 105-cent premium to the Chicago contract.
Beef supply could be historically tight into the spring of 2013, as drought in the central U.S. in 2012 and in Texas for the past few years have left the supply of young cattle tight. High corn prices also discouraged placements onto feedlots. On-feed supply as of November 1, 2012, slipped to 94.7% of the previous year, and placements of cattle into feedlots in October 2012 came in at just 87.5% of the previous year. On-feed supply had reached 102.7% of the previous year just when the drought was beginning on July 1. Cattle placements were down from the previous year for June, July, August, September and October of 2012. If weights slip from the record highs that were seen late in 2012, the shift to lower beef production could be more significant than previously expected. Look for upside price targets of at least 140.15 cents for April Live Cattle and 135.35 for the August contract. Consider buying calls on breaks into early 2013.
The pork shortage for 2013 has been well advertised, and April Lean Hogs had been in a strong uptrend as of late November 2012. The foundation of the rally was the idea that pork producers had already completed a breeding-stock liquidation cycle in the summer of 2013. But if U.S. corn demand is higher than the current USDA forecast (as of October 2012), corn supply could be very tight into the 1st Quarter of 2013. This could spark further breeding stock liquidation and put pressure on hog prices. Consider buying the April Lean Hog 90.00 Put if the price of the option slips below 175.
Global money managers are looking for commodity markets that have a chance of showing a production deficit for 2012/13, and cocoa may be a good candidate. Traders are looking for a deficit of 150,000 metric tonnes or more, and that is before taking into account the possibility of an El Nino weather pattern that could significantly disrupt Indonesia’s and West Africa’s production levels. Consider buying May Cocoa 2650 Calls near 65 with an objective of 233.
We expect coffee prices to bottom out when global supply peaks, and this could occur in the 4th quarter of 2012. World production for 2013 looks to come in well under the 2012 level, and as long as outside forces are not too negative, we look for a gradual uptrend.
The sugar market looks to remain in a downtrend into the first quarter of 2013, as another global surplus of 5-7 million tonnes for the 2012/13 season may be enough to pull global ending stocks up from the relatively tight level they have exhibited since 2008.
After one look at a weekly chart for cotton, traders seem to believe that cotton prices are just too cheap. In late 2012 nearby futures were trading around 73 cents per pound versus the 2011 highs of $2.2409. However, global supply is extremely burdensome. Traders should keep in mind that nearby futures hit lows of 66.55 cents in 2010, 40.01 in 2009, 37.05 in 2008 and 46.10 in 2007. Global ending stocks and stocks in China are set to reach an all-time high in 2012/13. Global ending stocks represent a full 270 days of usage, another all-time high. Traders might consider owning May Cotton 70.00 Puts.
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