The broad base commodity sell off, based on deleveraging of market participants, has weighed once again on price action.  Many commodity markets are oversold.  Positive price, like that experienced on Wednesday, was certainly overdue.  Whether these markets are able to find support near the recent lows will have more to do with outside influences than supply and demand.

Money flow, particularly the flow of money out of commodities, will continue to be a major factor in determining the price levels of futures contracts.  Whether you believe the grain markets are still overpriced or perhaps undervalued, you have to respect the fact that index funds still carry sizeable long positions.  The most recent CFTC reports pertaining to position sizes indicate Index fund longs constitute over 45% of Chicago wheat open interest, over 25% of KC wheat open interest, over 26% of soybean open interest and over 22% of corn open interest.  The Index long has been reduced and I expect to see a further reduction Friday.

I question how much more liquidation will take place.  Perhaps liquidation will continue.  Lower prices would trigger more liquidation.  Additional capital constraints on Wall St. would trigger more long liquidation.  This would most likely be experienced on a firm by firm basis as it has been of late.  Liquidation of this nature would certainly add to the volatility of the marketplace, but not necessarily result in a major sell off from these levels.  If it is proven that Wednesday’s price is related to value buying, in conjunction with short covering, the attitude toward owning commodities may begin to change.  The agriculture markets will have to hold recent lows to confirm this assumption.  Follow through buying over the next couple days would go a long way toward building confidence in a commodity recovery.  You cannot lose sight of the fact that Wednesday’s recovery may have been a simple short covering rally so a confirmation of value is important.

I question how much selling remains in these markets if the threat of fund liquidation subsides.  To this point and perhaps in the future, much of the selling has come from the fund community, but prospects of additional fund selling has also allowed the bears to confidently sell commodities.  By no means am I saying that the fund liquidation is over.  I am saying recent price action indicates the bulls finally have a building block with which to work.  The Fed has been actively printing money and the dollar appears to be reacting to it.  If the bulls are able to use this building block to stem the downward momentum, sellers will certainly back off and may become rather scarce.

The real opportunity presented here is the opportunity to go back to trading a commodity based on whether or not we have adequate production and supplies.  The funds will continue to be involved.  They invest money and do so based on sophisticated models that indicate what positions they should take and when they should take them.  I have no way of knowing what indications these models are going to give.  It’s very possible that it may not be buy, buy, buy or sell, sell, sell.  However, it is possible decisions could be made for reasons besides whether or not a fund has enough capital to keep a position solvent.  It will take time to determine whether or not commodities revert back to being a viable hard asset investment.  I expect they will.  It will be interesting to see if investments in commodities challenge the levels reached earlier this year.  Funds limiting exposure to commodities may be a good thing for all of us in the long run.

In terms of wheat, the futures market does have potential to move higher from these levels.  Fundamentals are not real strong, but we continue to see some foreign demand.  Unfortunately, SRW did not fit the bill for the recent Egyptian purchase.  It may be difficult to attain that business as the Black Sea Region has a glut of wheat.  The southern hemisphere crop coming under more stress could trigger a respectable rally in this commodity.  Take a look at re-owning cash sales.  The global quality of wheat is lacking.  I expect the hard wheat classes to carry a decent premium.  I also expect high protein spring wheat to continue to carry a respective premium.  Continued export business is a must.  Additionally, moving more wheat into the feed ration would be supportive to a very weak SRW basis.  Based on spot index prices calculated by DTN daily, SRW cash bids averaged 465.92, while cash corn bids averaged 489.25.  On Sept 17th, these averages were calculated on 525 and 2,462 facilities, respectively.  The average cash price for HRS, 318 facilities and HRW, 755 facilities, were calculated at 699.27 and 645.32, respectively.  These figures are calculated daily and can be found at www.mgex.com.      

Do you have a question about this article? For a personal response within 24 hours, please email brian.henry@archerfinancials.com .

 
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