Trend Watch

A Market Letter Prepared by Scott W. Barrie, CTA for Great Pacific Trading Company

February 2000 Volume 9, Issue 2

Grains

Last issue of Trend Watch we highlighted the fabled "February Break". This well known seasonal tendency has its roots in the marketing cycle of grains and the United States tax codes:

Farmers tend to postpone marketing their crop towards the end of the calendar year for tax purposes.
If they wait to sell their grain in the new year, then they incur these revenues in this tax year, not last
year, and do not have to pay taxes on it until next year.

This tends to create supply gluts near production centers, and weighs on prices. This influx of grain tends to begin in mid January, though was offset this year by a surprise reduction in supply estimates from the USDA.

Typically this cycle tends to end in mid February, as farmers turn their attention towards preparation of fields for planting. This shift in market psychology from marketing to planting tends to drive prices higher for spring planted crops.

In this issue of Trend Watch, we highlight the potential for the grain markets to build a "risk premium" into prices, starting in mid February. Traders should be watching the grains very closely, as the strongest years for the grain markets have tended to start with a big rally in mid February and March.

SOFTS

Sugar and Cocoa prices have been extremely quiet in the last several weeks. With the Ivory Coast main crop Cocoa harvest ending and Beet Planting beginning in the next several weeks, the Cocoa and Sugar markets look to have some upside potential.

Inside we highlight the Sugar market and its strong tendency to rally in February and March. Against a backdrop of low prices and increasing demand, things look sweet for Sugar bulls in the coming weeks.

The explosive market, year to date, has been Cotton. This market has been screaming higher as demand is strong. We expect this trend to continue for the next several months.

FINANCIALS

The great bull market of the 1990’s may be coming to an end! Historically the stock market has tended to continue the year in the same direction as it finishes January. With stocks having suffered a set back so far this year, the return on equities that many have grown accustomed to may be coming to an end!

Since 1950, the closing direction of the Dow Jones Industrial Average in January has correctly forshadowed the direction of the rest of the year 90% of the time! With stocks down for the month, we are worried. Also worrisome to equity investors is the fact that Presidential Election years when no incumbant is running have historically seen substandard returns. Though we are not looking for a "crash", the end of this stock market bull run could have a dramatic effect on alot of markets.

... The February break and March Rally

Fear & Greed & Grains

Grain prices oscillate between FEAR and GREED. Gyrations between these polar opposites are directly tied to where the crop is within its natural production and consumption cycle.

Currently, Winter Wheat is towards the tail end of its production cycle, so this market should continue to be dominated by producers fearing lower prices and consumers greedily anticipating them. As it emerges from its long winter dormancy, this crop will be able to be assessed. It is one step closer to harvest, hence supply is more assured and prices tend to decline, at least until the next major hurdle has to be crossed. As such, this market is dominated by producer fear (selling) and consumer greed (postponement of buying).

Corn and Soybeans, on the other hand, are at the beginning of their production cycle as they have yet to be planted. Whatever can go wrong may go wrong; hence, these markets should begin to build risk premiums associated with dangers the crops face before harvest in the fall and early winter. As such, the Corn and Soybean markets should begin to be dominated by consumer fear (buying) and producer greed (lack of selling).

Last month we highlighted the "February Break" and the potential for grain prices to break from mid January to mid February as producers step up the marketing of their crops. This cyclical phenomena has tended to act as a steeping stone for March rally in the spring planted grains.

Grain prices tend to rally when the crop is vulnerable to damage. At no time during the development of the crop is it more susceptible to
damage than at planting. After all, if the crop is not planted it won’t develop!

The tendency for the spring planted grains to rally during the early stages of planting can readily be seen in the monthly performances of the May futures contracts. In the last 15 years, May Corn futures have increased in value more in Match, than the previous 3 months combined. March is the strongest month on record for May Soybeans. Both Corn and Beans have rallied at least twice as often as they have declined during the month of March.

Monthly Grain Futures Performance

So as we enter into February Break, we will be looking for opportunities to establish long positions in Corn and Soybeans for a March Rally, as market attention shifts from marketing and excess supply, to planting and the threat to this years crop.

Planting and Risk Premiums

During planting crops are very susceptible to damage. If it is too hot, too cold, too wet, or too dry then planting can either be delayed or germination will not properly progress. But either way, problems during planting do cause lower yields, and less future supply of grain.

It is because of this risk to the crop, that grain prices tend to rise. Consumers are willing to pay more for secure supply, and producers
demand higher prices for grain in the bin instead of the field. This "bird in the hand versus two in bush" is known as building a "risk premium".

In 12 out of the last 15 years (80% of the time), May Soybeans have rallied from mid February until late March (February 10th to March 27th, respectively). In the last decade and a half, May Beans have gained a total of $1.64 1/2 per bushel in the above-mentioned period. The average rally during this period has been +17 1/2 cents, while the worst break during years which have seen a rally has been -18 3/4 cents.

Hypothetical May Soybean Trade

July Corn has acted similarly from the end of February until mid March (February 25th to March 17th, respectively). Since 1985, July Corn futures have gained 48 1/2 cents during the above mentioned period. On average July Corn has rallied 4 3/4 cents, with most years seeing rallies greater than +9 cents. The worst break in a rally year was -8 cents.

Hypothetical July Corn Trade Performance Table

... Removing the "risk Premium"

Unlike Corn and Soybeans, Chicago Board of Trade Wheat is at the tail end of its production cycle, not the beginning. Chicago Wheat futures are based on Winter Wheat futures which are planted in the fall and harvested in the following summer. During February, Winter Wheat is emerging from its dormant period.

With a combination of tax related selling, clogged transportation arteries, and lower risk to the crop, it is not surprising that winter wheat futures tend to break the hardest during February. In 12 out of the last 15 years, May CBOT Wheat futures have delined during February. This break has been especially bad during the second and third weeks of February. In 13 out of the last 15 years, May CBOT Wheat futures have declined a total of -$1.00 1/4 per bushel from February 9th to February 16th.

Hypothetical May Wheat Trade

Based on the above, we are recommending the sale of May CBOT Wheat market on close on February 9th. We will initially risk -10 cents (-$500.00 before commissions and fees) on this position. If this position becomes profitable by more than +8 cents, move your stop loss to "break even". Hold this position until February 16th, exit market on close.

Because Wheat is at the opposite end of the production cycle from Corn, Wheat prices tend to decline much more than Corn prices during February. Traders can take advantage of this tendency by entering into a spread position, or selling May Wheat and simultaeously buying May Corn. This spread has favored Corn (i.e Corn prices increasing relative to Wheat prices) in 12 out of the last 15 years. Since 1985, May Wheat futures have declined in value relative to May Corn futures from the 9th trading day of February (02/11/00) until the 2nd to last trading day of February (02/28/00). During this time period, Wheat has lost a total of -63 3/4 cents versus Corn. On average during the 12 years which saw Wheat decline relative to Corn, May Wheat prices declined an average of 7 cents relative to May Corn. On average, during the 3 years which May Wheat increased in value relative to May Corn, it did so by 7 cents also.

Hypothetical May Corn/Wheat Spread

Based on the above, we are recommending the sale of May Wheat and simultaneous purchase of May Corn market on close on February 11th. We will initially risk an a 8 cent increase in the spread, or -$400.00 before commissions and fees. We recommend holding this position until the 2nd to last trading of February (02/28/00), at which time you should exit the spread market on close by buying May Wheat and selling May Corn.

For more information on spreads, please contact your 
Great Pacific Trading Company Broker or Paper Trading 
Representative at (800) 479-7920.  Also, please note that 
at the time of this writting, the Chicago Board of Trade 
does not recognize this spread.  As such, traders will have 
to post full margin on both the Wheat and Corn positions.

Sugar is Sweet
and so is the Opportunity in this Market…

Decade lows and a chance for interruption in supply spell opportunity in the Sugar market in the coming months.

In the last half of the 1990’s, Sugar prices collapsed as over production and decreasing usage took their toll. Acreage devoted to Sugar world wide grew substantially from 1990 to 1998. At the same time, consumption of sugar has decreased as more and artificial sweeteners have gained acceptance.

However, this situation may be changing. For the last 2 years, consumption of Sugar has been increasing as consumer tastes for "natural" sweeteners is increasing, and the production of sugar is decreasing. This trend can be seen by the fact that the Ending Stocks of Sugar (Total Supply – Total Usage) has decreased for the last two years.

This trend towards lower free floating supplies and carry-over of Sugar from one crop year to another has us seriously looking for a bullish move in Sugar prices.

The supply situation may get even tighter in the next several months, as we approach the European Beet Sugar planting season. Typically, Beet Sugar is planted in mid March to early April. During this period, the Sugar Beet crop is highly susceptible to damage. Like other field crops, Sugar prices tend to rally when faced with potential crop damage, as the market prices in a "risk premium". With less European use of pesticides and genetically modified crops, the risk of damage to the Beet Crop is even greater this year than in the past. Evidence of this bullish tendency can be seen by the fact that May Sugar futures have a strong tendency to rally from late February to late March.

Hypothetical May Sugar Seasonal Trade:

Exit on 9^th to last trading day of March (03/21)

Based on the current situation in the Sugar market, we are recommending the purchase of May Sugar futures, market on close on February 24^th. We will initially risk –0.54 cents (-$604.80 before commissions and fees) on this position. If this position becomes profitable by +0.30 cents, move your stop loss to "break even", and continue to hold the position trailing your stop loss –0.30 cents below the market. We recommend holding this position until March 21^st, at which time traders should exit market on close.

Disclosure of Risk: The risk of loss in trading futures and options can be substantial, therefore only genuine "risk" funds should be used in such trading. Futures and options may not be a suitable investment for all individuals, and individuals should carefully consider their financial condition in deciding whether to trade. Options traders should be aware that the exercise of a long option will result in a futures position. Past performance is no guarantee of future performance.

Commentary contained in Trend Watch is the result of speculation and opinion. The sources of information from which analysis is derived are diverse and varied: obscure magazine articles to Futures World News and mainstream sources like CNBC and CNN business reports. Although every effort is made to convey and interpret information accurately, I cannot state with any degree of certainty that the news sources are accurate or that any interpretation or analysis will be correct. - Scott W. Barrie, CTA

DISCLOSURE OF RISK: THE RISK OF LOSS IN TRADING FUTURES AND OPTIONS CAN BE SUBSTANTIAL; THEREFORE, ONLY GENUINE RISK FUNDS SHOULD BE USED. FUTURES AND OPTIONS MAY NOT BE SUITABLE INVESTMENTS FOR ALL INDIVIDUALS, AND INDIVIDUALS SHOULD CAREFULLY CONSIDER THEIR FINANCIAL CONDITION IN DECIDING WHETHER TO TRADE. OPTION TRADERS SHOULD BE AWARE THAT THE EXERCISE OF A LONG OPTION WOULD RESULT IN A FUTURES POSITION.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. 

NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL, OR IS LIKELY TO, ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. 

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM, IN SPITE OF TRADING LOSSES, ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS, IN GENERAL, OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.