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Commodity Futures Forecast

Despite recent moisture in the central Corn Belt, the USDA outlook compiled from previous conditions painted a less optimistic picture for yields. The result has been a strong mid-summer rally that is receiving supplemental fuel from export prospects and tight global supplies. In the meantime, yesterday's Producer Price Index reflected a drop in raw materials including some agricultural commodities. What's a trader to do?

Usually, rain during this portion of the season leads to dramatic corrections because most of the yield is determined during pollination for corn or podding for beans. Currently, rain is in the forecast for the Dakotas and will move across the upper Midwest through Saturday. Thereafter, the unreliable 5-day forecast displays another system developing in the southern midsection that should move west along lower latitudes. This implies that most growing regions will receive some rain over the next five days. Still, the USDA report seems to dominate the picture.

Interim volatility may become too severe for position trading futures. This is because swings can take on limit proportions without a breakout or bust. This forces additional stop loss exposure that many traders find unacceptable. The alternative is to use options. As mentioned in my previous Reports, my longer-term perspective remains bullish while my harvest outlook is bearish. While I believe the world still faces a shortage situation, past experience tells me that any time a large crop comes to market, prices weaken.

The exception to this rule is a harvest squeeze. I have not seen such action in many years. Therefore, I am not inclined to bet on a contra-seasonal event this year. Obviously, circumstances can change. I warned that excessive moisture during the harvest could mitigate against a bear stance. I am not so bold as to make a weather prediction two months out.

The Crop report coupled with export prospects caught our bear spread in beans. After so many successful past experiences, 1997 will go down in my log book as the year the September/August bean spread did not work. It is too late to replace the spread since August expires on the 21st. I would not be surprised to see the spread narrow, once again, before the final day. For those who like spreads, I am feeling more comfortable about the bull spreads in wheat...regardless of today's weakness. I also believe the bull spreads in 1998 beans and corn will make sense based upon the USDA's inclination to pump up prices.

Next year marks a more significant change in farm economics. The phase out of supports leaves choices in the hands of farmers who will have their first year's experience under their belt. Price parity between corn soybeans, and even cotton will be critical in the planting equation. If, indeed, we see an export bonanza, the July/November bean spread in 1998 could rival or surpass this year's performance. The spread is trading around 15 cents July over. This is not a bad place to enter considering that it could widen to $1-plus. Another candidate is the July/December corn which is also trading at 15. I would prefer a more narrow entry because there is more distance between deliveries and a "normal" spread would place a 1.5 to 2.5 cent premium per month on the December contact.

We were stopped out of our short September T-bonds with a $625 profit. I expected more progress, but the reaction to producer prices and retail sales countered the near-term technical pattern. The consensus is that the Fed is not likely to tighten based upon the economic picture. This could revive the bull bias, however, I believe we may see a sideways consolidation through this quarter.

This hints that the short options strangle might make sense if we can obtain sufficient premium for the exposure. Unfortunately, the September options expire next week. This leaves us with October that reflects the December delivery. I will examine the prospects toward today's close. The 115 call and 111 put were providing 64/64 with one month until expiration. With December futures at 11305, we would need a bust below 110 or a rally above 116 to go negative on an expiration basis.

There is no question that this strangle could encounter volatility. This may allow legging into and out of puts and calls before expiration. I am inclined to roll up calls if we experience a rally because I find it difficult to believe bonds can make better than 11600 or drop below 11000 within a month. Economic figures have been benign. The 10-year auction received a sluggish reception while the Beige Book received a final review of “neutral.” The Consumer Price Index was flat.

While orange juice is not one of the more popular commodities, I have enjoyed many a wild and profitable ride from this market. The recent private forecast for the “largest crop in history” kicked a market that was already historically weak. With September O.J. trading at 7070, I am tempted to buck the technical trend with a purchase. Yet, I am reminded of a time when I felt a similar urge in sugar with prices at 4 cents. I figured sugar couldn't go any lower. When it dipped below 2.5 cents, I was licking my financial wounds and pride. Still, we are seeing very cheap juice in the pre-season.

This could represent one of the most sensational buying opportunities in this market's recent history. Of course, timing is everything!

August 14, 1997Philip Gotthelf

Commodity Futures Forecast

7000 Boulevard East, Guttenberg, New Jersey

Consensus National Futures and Financial On Line Index
Financial Commentary Index

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