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STRATEGY FOCUS
Prepared by Merrill Lynch & Co.
Global Securities Research & Economics Group
Midwest Grain Harvest Is Underway
The active November soybean contract has weakened recently after a steady advance from a low of $5.77 in early July to a high of $6.53 on September 18. Currently, prices are hovering just above $6.22. Overall, our view is that harvest pressure will limit upside over the near term with the harvest starting to pick up momentum. Most recent reports suggest above average yields. In addition, the negative USDA September Stocks report added to the bearish tone and near ideal harvest weather has been the norm to this point. Senior Oilseeds Analyst, Mario Balletto points out that it appears most of the Midwest could remain frost free until after mid-October, raising expectations for yields. A longer growing season as a result of a late frost could add up to 1.8 bushels per acre of increased yield. If yields do in fact increase by that magnitude on only half of the Midwest crop, the total crop would be 40 million bushels higher than the September estimate of 2,746 million bushels. The near-term outlook has now turned negative although we do see the potential for renewed strength later in the year. Harvest pressure is also weighing on corn.
Bonds Remain Very Resilient
In financials, the bond market remains very resilient and prices seem to receive good news at the critical times. In the past, this column has made the case that global money flows are a key factor in the strength of U.S. financials and this still seems to be the case and in our view it is likely to persist for awhile. The latest news in this regard was the weaker than expected Tankan report. The appetite of Japanese financial institutions remains strong for U.S. securities. Additionally, U.S. data has on balance provided support for treasuries. The just released September NAPM report is a good example of this as it fell to 54.2 percent from 56.8 in August. Within the report, the NAPM's production index fell 5.0 to 57.4, new orders dropped 4.8 to 60.6 and order backing fell 10.0 to the crucial 50.0 percent level. While the overall index remains above its key expansion/contraction level of 50.0 percent, the September figure might be an early indication that the trend could be changing. This type of report is what the strong bond market thrives on. As an overall picture for the September NAPM report, you might draw the conclusion that the manufacturing sector is still experiencing low inflation but that the rate of expansion may be easing. Other recent data, such as the 0.3 percent drop in August construction spending, reinforces the bullish case for bonds. The next key piece of the puzzle will be the September unemployment report scheduled for release on October 3.
Base Metals Display High Volatility
Recently, base metals have shown a high level of volatility including the closely monitored copper market. Monday September 30 saw COMEX December futures stage a 5.5 percent one-day rally only to be followed on Tuesday with virtually all those gains being erased by mid-session. The more active London Metal Exchange 3-month contract followed a similar pattern. On Monday, London took out key 10- and 30-day moving average levels prior to the downside reversal. Copper appears to be at a critical point at both the LME and COMEX. In the latter case, the $1.00 psychological level is the key point while in London $2140 is the level that the market needs to take out on a short-term basis. Failure to accomplish this would likely result in a test of the recent $2076 double bottom low. On the upside, the August double top at $2205 would be the next significant level. The seasonal patterns are favorable but copper really has no strong trend which may be reflective of a mixed fundamental outlook. Over the remainder of the year our expectation is that copper will be a broad range trading affair. Looking beyond that, however, our bias would lean negative based on expectations of increased supply along with questionable Asian demand prospects.
Zinc Prices Collapse
Zinc prices collapsed this week as did the zinc spreads which are almost always a good guide to market direction. Key support at the September 15 low of $1380 and the double bottom low of $1350 was taken out and trendline support was literally annihilated. The $1370-1380 area now represents resistance. On the downside $1320 is crucial 200-day moving average support. If that is violated, a case for a test of the April low of $1225 could be set in motion. The chart outlook is bearish and the major fundamental rationale for the rally, a huge short position by Chinese interests against a large commercial long seems to have been alleviated. The outlook is bearish and the 200 moving average appears to be in jeopardy.
As for commodities in general, the CRB is currently at 243.25 up from 240.05 two weeks ago. Our view remains that commodities as a whole are in a non-inflationary range bound pattern that is likely to persist well into 1998. This week's gold rally, which we view as temporary, did not change that outlook.
(Reprinted by permission. Copyright © 1997, Merrill Lynch, Pierce, Fenner & Smith Incorporated.)
October 2, 1997William O'Neill
Merrill Lynch & Co.
Global Securities Research & Economics Group
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