THE SPECULATOR
Prepared by Berkeley Futures Ltd.
Japan's Economic Quagmire
(May 15, 2000) After the Labour party's recent electoral set back, Tony Blair can at least comfort himself with the thought that a general election is at least a year away and could be put back a further 12 months if the polls do not look favourable. His Japanese counterpart, Yoshiro Mori, has a much more immediate electoral challenge. He is expected to call a general election at the end of next month but, with the economy so depressed, the ruling Liberal Democratic party cannot be confident about its chances of re-election.
Growth in the first quarter of this year may just nudge into positive territory--the government's official forecast is for a rise of 0.6 percent--after having fallen in the previous two quarters. But the latest economic figures do not suggest any broad-based recovery. The number of unemployed rose 220,000 to 3.49 million in March, putting the unemployment rate at a post-war high of 4.9 percent for the second month running. The finance minister, Kiichi Miyazawa, has admitted that the unemployment situation is likely to deteriorate further before it starts to get better. The number of bankruptcies is also rising again.
In the light of these figures, it is not surprising that households have been reining back their expenditure. Household spending fell by 4.3 percent, on an annualized basis, in March and the retail sales index has now fallen for 36 straight months. There is also worrying evidence of deflation taking hold of the economy. Year-on-year consumer prices fell 0.5 percent in May.
Japan's Retail Sales And Bankruptcy Rate
Growth of Japanese M2 Money Supply
This is the seventh month in which prices have fallen. Even in the few sectors which are showing strong growth--such as personal computer where sales rose by 30 percent last year--prices have been falling.
The weak consumer demand has obviously had a very severe knock-on effect on the retailing sector, with profit margins coming under increasing pressure.
The lack of confidence on the part of consumers has meant that the government's ever larger fiscal packages have had little impact on the domestic economy. Even though it only accounts for just under 10 percent of the gross domestic product, the authorities have, therefore, been pinning their hopes of recovering on the export sector. And it is for this reason that they have intervened so vigorously to stop the yen's appreciation.
The only other option remaining to the authorities is the expansion of the money supply. The Bank of Japan's monetary policy has so far remained orthodox, in that it has refused to monetize the debt by buying government bonds. But, as deflationary forces tighten their grip, the Bank really has no option other than to purchase government bonds and pump up the money supply.
Deborah Owen, Editor
How To Use The Bridge/CRB Futures Index
Background To Commodity Indices
The Commodities Research Bureau Index, based on the spot price quotations of a basket of selected commodities, was first compiled in January 1934 by the U.S. Bureau of Labor Statistics and released to the general public in January 1940. In 1952, the index was revised and based on a new sample of 22 commodities (instead of the previous 28) and calculated on a 1947-49 base. Since then, it has been rebased and technically altered several times. From May 1981, the Commodity Research Bureau (CRB) began calculating the index on a daily basis. Today the Spot Market Price Index is a measure of the price movements of 22 basic commodities whose markets are among the first to be influenced by changes in economic conditions. As a result, this index serves as an important early indicator of probably changes in both inflation and business activity.
The Bridge/CRB Futures Index
The Bridge/CRB Futures Index (the Bridge ownership and branding only came about in 1997) was first calculated by the CRB in 1956. Like the spot index, it was originally made up of 28 commodities, 26 of which were traded on exchanges in the U.S. and Canada and two in cash markets.
The aim of the Bridge/CRB Futures Index is to monitor the broad trend in commodity prices. Commodities were therefore selected on the basis of being widely used for further processing, freely traded in an open market, sensitive to changing conditions and sufficiently standardized so that uniform and representative price quotations could be obtained over a period of time. Subject to these restrictions, efforts were made to include representative commodities from as large a segment of the economy as possible. International influences on the economy were taken into account by the inclusion of some key commodities (such as crude rubber and tin) which are important in international trade. Highly fabricated commodities were not included because they generally embody relatively large fixed costs and consequently react much more slowly to changes in market conditions. Both in the sample and in the index structure, an attempt was made to prevent the price movements of any one commodity (particularly agricultural products) from dominating movements of the index. In order to ensure that the index continues to fulfil its representational role, its components have been periodically adjusted to reflect shifts in market structure and trading activity. Since 1957, there have been nine revisions to index components.
Today the Bridge/CRB Futures Index is made up of the following 17 commodities in six groupings
Energy--Crude oil, heating oil, natural gas
Grains--Corn, soybeans, wheat
Industrials--Copper, cotton
Livestock--Live cattle, lean hogs
Precious Metals--Gold, platinum, silver
Softs--Cocoa, coffee, orange juice, sugar
Chart Of The Bridge/CRB Futures Index
Index Construction And Calculation
Construction of the index is not as simple as one might hope but the complexities are worth mastering as they give the user a better understanding of the anomalies of the futures contract. The Bridge/CRB Futures Index describes itself as a three-dimensional index. As well as averaging the prices of 17 commodities (as in a two dimensional model), the index also incorporates an average of prices across time, within each commodity, i.e., each commodity is priced as an average of several of its forward contracts. Equal weighting is used for both the arithmetic averaging of individual commodity months and for the geometric averaging of these 17 commodity averages. The advantage of the equal weighting is that no single month or commodity dominates the index. This makes it harder to manipulate and means that it is less subject to the price distortions associated with temporary supply and demand imbalances in any one month or any one commodity. The following three step process is employed when calculating the Bridge/CRB Futures Index:
1. Each of the 17 component commodities is arithmetically averaged using the prices for all of the designated contract months which expire on or before the end of the sixth calendar month from the current date (except that no contract is included in the calculation when in the delivery month and there must be a minimum of two and maximum of five contract months for each commodity).
2. These 17 component averages are then geometrically averaged by multiplying all of the numbers together and then taking the 17th root of this number.
3. The resulting figure is then multiplied by two factors, firstly to adjust the index to the 1967 base-year average and, secondly, to allow for the revisions to the index since 1987.
Currently the index is calculated by Bridge Information Systems and disseminated by the New York Futures Exchange every 15 seconds during the trading day. Only settlement and last-traded prices are used in the index's calculation; bids and offers are not recognized. Where no last-traded price exists (typically in the more distant contract months) the previous day's settlement price is used. This can result in the index lagging behind its theoretical value. This tendency to lag is evident at the end of the day when the index value is based on the settlement prices of the component commodities and explains why the underlying index often closes at or near the high or low for the day.
The Futures Contract
The Bridge/CRB Futures Index has been recognized as the main barometer of commodity prices for many years and is certainly the commodity index most widely followed by the financial press around the world. Globally, the index is now the accepted standard for measuring changes in commodity price levels and used as a broad indicator of commodity price trends. It is therefore both an ideal instrument for economists to use in their macro-economic analyses and for investors to consider as a benchmark.
Commodity trading, via the futures markets, has for many years been regarded as a most speculative form of investment. Returns on this type of trading activity have been renowned for showing far greater volatility--and seemingly much less predictability--than those obtained from government securities or equities. Nevertheless, if proper trading discipline is applied, they can be a useful alternative investment. Even the cautious Warren Buffet has been dabbling in the silver market.
The competitive nature of the investment industry has resulted in fund managers being put under ever increasing pressure to find new asset classes in which to diversity their holdings, improve returns, reduce risk and hedge against inflation. Investing in a basket of commodities--in order to gain exposure to `an asset class' at a particular moment of the global economic cycle--can therefore be considered as a legitimate investment strategy. To take advantage of the growing requirements for a composite commodity investment vehicle, the New York Futures Exchange began offering in 1986 futures contracts on the Bridge/CRB Futures Index.
Since this time, the contract has become a powerful addition to the investor's armory. Traders of the futures contract have direct exposure to the changes in valuation of the component commodities.
The Bridge/CRB Futures Index Futures contract specifications are indicated below.
Contract Quote: Index points e.g 260.05
Trading Symbol: CR
Contract Size: $500 x index (e.g. futures at 260.05 are valued at $130,025)
Trading Months: January, February, April, June, August and November
Trading Hours: 9:40 a.m.--2.45 p.m. New York time (except that trading in all contract months on the last trading day of each expiration months shall be from 9:40 a.m. to 3:15 p.m. New York time)
Minimum Price Fluctuation: 0.05 (5 basis points) = $25.00
Position Limits: 5,000 contracts net long or short
Last Trading Day: Second Friday of the expiry month
Contract Settlement: Cash payment at maturity
Example
If a trader felt that commodity prices were going to pick up, he could, for example, buy the Bridge/CRB Futures Index at, say, 216.00. At the onset of the contract he would have to make a margin payment to his broker which would then be marked to the market on a daily basis. If the index rallied up to 218.00, he would have made a profit of $1,000. Conversely, if he had been wrong and the index dropped two points, he would have lost $1,000.
John Millers
Runaway Economy
The U.S. economy continues to move with the speed of an express train, showing few signs of slowing down despite the gentle application of monetary brakes applied by the Federal Reserve Bank. The latest unemployment figures produced the lowest rate of unemployment (3.9 percent) for 30 years, whilst showing hourly earnings rising at 3.8 percent year on year--the fastest rise for 10 months. This latter data backed up previous Employment Cost Index data (an indicator that is closely watched by the Fed) which showed a 1.4 percent rise in the first quarter of the year. This is the fastest rise for more than 10 years. GDP growth was 5.4 percent in the first three months of the year--way above the Federal Reserve's targeted non-inflationary growth level--while the price deflator (the widest measure of inflation) rose 2.7 percent, its highest level for 5 years. The clear message from this plethora of data is that the Federal Open Market Committee (FOMC) which decides interest rate policy, will need to increase the pressure on the monetary brakes in order to slow the economy down. Interest rate rises are therefore likely to increase in severity, with the market now coming round to the view that a half point rise in the federal funds rate will be announced at this week's meeting. It is not clear how much monetary tightening is already discounted by the markets. However, we will look at where support may be found on both the Dow Jones and S&P charts since these indices have been behaving rather differently recently.
Dow Jones Index
The daily chart of the Dow Jones shows the index has two major trendlines associated with it, both dating back to April of last year. One is a rising trendline across the peaks that have occurred during this time. It is currently at 12,008, rising at the rate of 3 points per day. The other is a falling trendline across the low points which is currently at 9616 and is falling at the rate of 3 points per day. This pattern is one that is not often seen on the charts and is known as an expanding wedge which, if broken on the downside, signals a major change of market sentiment. Thus, any break below 9616 could portend the market crash that some fear. However, until and unless this level breaks, it is just as likely that the non-directional volatile trading seen recently will continue. Technically, so long as the index remains below trendline A at 11,344 (falling at the rate of 5 points per day) and below the 200-day moving average at 10,806, the bias of sentiment will be negative. A move below support at 10,552 would confirm this negative tone and target the 9616 trendline. A move back up through the 200-day moving average, however, would target the 11,344 trendline, and suggest that the Dow was heading for calmer waters.
S&P 500 Index
Looking at the S&P 500 chart, there is no obvious pattern to see but the overall tone of the chart is more positive than that for the Dow. The longer-term trendline only dates back to October of last year, but is sloping upwards. This trendline is currently at 1357, rising at the rate of one point per day. The index is also above the 200-day moving average at 1395. While these two support levels continue to hold, the technical bias for the index is positive. There is a short-term down trend above the index at 1458, falling at the rate of 3 points per day. This trend needs to be broken to confirm the positive view for the index, in which case a move back to the old high at 1574 should be seen. However, if the lower trendline support were to give way, together with the support level at 1327, the index would probably fall sharply to the 1240 area.
David Cocker
May 15, 2000 Berkeley Futures, Ltd. 38 Dover Street, London, UK, W1X 3RB 0171-629-1133