I spent the earliest part of my career as a soybean pit trader and also migrated to Treasury bonds at the Chicago Board of Trade whenever action in the soybean market dried up during the 80s and 90s. I’m going to take a look at fundamental and technical factors driving these markets, where I think prices could be headed next, and offer some trading strategies for you to consider.

Obviously, a slow soybean market is not a problem this year, and I don’t think it will be for at least a couple of crop years to come. Despite a meltdown on July 16, 2007, in the soy complex, I still believe that the longest-lasting soybean bull market in history is likely to remain intact. Down the road, I think the market has a chance to finally pop above price levels that have provided strong resistance in the past. It may be a season or two away, but the fact is there really is no margin of error for any crop adversity over the next couple of years, due to the major competition with corn for planted acres. During my entire career, the area near $10.50 a bushel has always proven to be a ceiling for prices. The rationing of tight supplies in disappointing crop years has always been accomplished as the market reached this level, and due to the amazing productivity of U.S. and Brazilian growers, supplies always significantly bounced back within a year’s time. I think this time around, we will have a different scenario.

Checking the weekly chart, or better yet the monthly chart, you can see how quickly tops have formed near $10.50. These tops have led to bear markets in soybeans, with prices correcting back down to around $6 - $5 a bushel. Given current market conditions, I don’t see that likely to be repeated. Let’s check the new-crop years: the November 2008 soybean contract (“red”), closed at $9.05 ¼ on July 16, and the November 2009 contract (“green”) closed at $8.85. These prices for out-year beans are unprecedented, and indicate the market sees no major supply relief in sight. This highlights the danger that if there is any serious crop adversity this year, next year, or the year after, somebody will have to get priced out of the market. The last time there was a similar spirited contest for tight supplies was in 2004, after a disappointing U.S. crop was followed by a short Brazilian crop. For the first time, China had the money to bid for the tight supplies, whereas in the past they may have backed off buying soybeans. Now, three years later, their currency reserves are at even higher multiples than they were then, and therefore with any yield problem, things could get very interesting.

Brazil, of course, will be able to raise their production somewhat, but not dramatically as growers’ returns there have been held back by a strong currency. Also note, we now have extremely high world energy prices that are impacting development of new acres.

Let’s bring the focus to the immediate situation. The market has seen its first technically damaging session in awhile on July 16. A shift in the weather forecast over the weekend of July 14-15, 2007 quickly set prices back during the overnight session that Sunday evening, pulling prices down about 35 cents. The sinking spell extended all the way to a 50 cent, limit-down close for futures for the July 16 day session. This obviously highlights how extended weather forecasts can change on a dime, and regardless of how clear the left side of chart is, we as traders have to handle what happens to right side of the chart.

Out-of-the-blue price flip flops usually come at interesting levels. Let’s take a look at the daily chart. The only warning sign of a possible correction in soybeans was the major (almost a dollar) price move above the 40-day moving average. Let’s look at recent overbought situations. On February 23, 2007, the November 2007 futures were trading at $8.430, and the moving average was at $7.60. Then on June 18, 2007, the market was at $8.930 and the moving average was at $8.080. Longs were playing with fire with a close at $9.480 and the moving average way down at $8.460.

There is always a fine line between running a position with the trend, and overstaying a market. Tightening up a stop under the lows on Friday, July 13, for Sunday night’s session led to some nasty slippage. While not pretty, that strategy did work to protect accounts that were attempting to ride the trend.

After all, the market was running on emotions a bit the week of July 9-13, since no matter what production is this summer, there is a carryover of nearly 600 million bushels from the big crop last year. So, there is some wiggle room for production this season. This mid-July downside volatility is certainly impressive, and because there is no immediate tightness of bean supplies, a longer correction on decent weather going forward may develop. I would expect the July 16 session high at $9.230 and certainly the overnight high at $9.340 will be very solid near-term resistance and worth scalping from the short side, at least on first approach, with tight stops.

Soybean Trading Strategies

The future balance sheet is still likely to tighten over the next two years. Unless something drastic changes with the ethanol situation, making a trip back on the weekly charts very unlikely. In fact, the Man Global Research team (which is also available to Lind Plus clients) is looking at the $8.85 area as the first near-term support for the November 2007 contract. I also see a pocket of support there, but prefer the top of a gap left from acreage report back on June 29 at $8.750. I recommend putting a stop back under the rising moving average we’ve talked about. Another trade that may set up is back in the November 2008 soybean contract. The same gap would get filled at $8.750, and there’s also a rising trend line that begins last October around that area, and of course the 40-day moving average will also come into play as support. I like a lot of technical reasons to back up a trade. To sum it up: no reason too rush in. There was enough damage done on Monday to wait for the red November trade to set up. The corn market spent the day July 16 down its trading limit as well, and obviously the soybean market is fencing with corn for acres over the next few years. A very successful production year for corn may buy a three-four million acre shift back into soybeans. Much will depend on such unknowns as what future ethanol mandates come out of Congress. The right side of chart we focus on will of course largely depend on the weather in August, as soybeans fill their pods. The soybean market likely to remain impressively volatile for the next couple of months, and maybe if we’re lucky, the next couple of years.

Treasury Futures

Another one of my favorite markets, and one which I’m very glad to see wake up the last few months, is the U.S. Treasury market. Things certainly got more interesting back in May and June as major upside pressure on yields pushed Treasury bond futures prices to multi-month lows. One contributing factor to the rout was the rush into the global stock bull market. Dollars pouring into stocks, however, is not directly bidding up bonds. As the private equity-inspired boom runs amuck with borrowing of cheap dollars to take over companies, the worldwide supply of bonds increases. This may have helped wake up some bond bears from a long hibernation, and shake the nerve of core portfolio holdings who couldn’t take the risk of continued underperformance relative to stock index performance. The inverted yield curve modified quite a bit as demand from China and other central banks was put into question in part by China’s announcements of diversification plans for its mountains of cash. The $3 billion the Chinese placed with the recent Blackstone IPO is $3 billion that won’t make it into the U.S. Treasury market. Yields also rose in interest rate instruments at the long end worldwide, as a check of the German bund and British guilt will show. European central banks have been ahead of the curve relative to the U.S. in continuing to raise short-term rates. Since this is real compaction for reserves of countries running positive trade surpluses, I do like to check these charts daily for technical clues to help trade U.S. 10-year Treasury notes and 30-year bonds.

Housing market troubles in the U.S. helped attract a bid for quality credit, but the real story was what I like to call a Pac-man reversal setup. The market had run too far, too fast, and once price action showed signs of stabilizing in the early morning hours of June 12, the stage was set for a reversal. Traders were waiting to see how the market would react to the U.S. May retail sales report. The market’s lows held, even after a higher-than-expected retail sales report was released at 7:30 a.m. Wise participants realized that the liquidation of old, stale long positions had run its course and the short side was exhausted; the only stops left were buy stops of recently established short positions. The Treasury futures have been recovering ever since, even though there was a tradable pullback on July 4, as Europe underwent a full retest of the June lows.

At the moment, the Treasury futures market seems to be mired in a range trade, waiting for Federal Reserve Chairman Ben Bernanke’s annual Humphrey –Hawkins testimony before Congress on July 18, 2007, and key economic reports out later this week. Core inflation might be a bit of a problem, and energy and now food prices are on a tear, but no change in short-term rates is expected for awhile. The stock market has had quite a powerful run, but I think it may be soon due to stall out. I would consider buying December 111 bond calls, which may prove an interesting bet on the stock market stalling out for whatever reason, and gives you over 100 days until expiration for more sustainable recovery in bond prices to occur. A vertical call spread is also a consideration, buying the 108 call and selling the 112 call, which I see as a wild card based on trouble in the stock market this fall.

James Barrett is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted trading division. If you have questions on this topic or others, he can be reached at 866-419-7698 or via email at jbarrett@lind-waldock.com.

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.

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