April 24, 2012
Anatomy of a dead bull market…
The mystery of how overwhelming opinion changes the future
As I’ve said many times, I believe the markets are more influenced by mob psychology than anything else. I have long been convinced there is NO way you can plug in supply and demand figures and come up with some number that represents exactly what the price “should be” for any commodity. If this were true, prices would never fluctuate. They would just jump to that magic number and stay there. But they don’t. They are ALWAYS on the move and I believe they are moved more by emotion than anything else…trite but true…Fear and Greed.
Using the current Corn market as an example, what follows here is my own description (maybe too lengthy) , of the real forces that shape commodity prices. I believe you can take everything I’ve written here and apply it any commodity we trade.
The Corn Market since last summer…
when it was supposedly headed for the moon.
CHART 1- Based on fundamental analysis of supply and demand, late last summer, the whole commodity world was screaming, “Buy Corn! We could run out of it next year!”. When we were up there at $8.00, there WERE calls everywhere for $10.00 Corn. I mean, it very much resembled mass commodity hysteria…and this virtually unanimous fear of sharply higher prices therefore induced ANYONE who routinely uses Corn (like a Cattle or Poultry feeder for example) to go ahead and buy far out into 2012, through either forward contracts or in the futures markets…In other words, if you know you are going to use a million bushels of Corn during the next year, every $1 move takes a million dollars off your bottom line…So if you are scared to death you will be seeing Corn $2 higher, you buy ahead, like I said, either with forward contracts (agreements with producers based on current prices) or you buy futures far out into the next year, thereby protecting yourself against higher prices…
CHART 2 - However, when you do reach the point where EVERYBODY is convinced Corn is a rocket on its way to $10, and ALL of those end users frantically buy ahead, you DO eventually reach the point where ALL (or nearly all) of the buying for the next year has then been absorbed by the market…and it is this final AVALANCHE of FORWARD (and fervent speculative) BUYING, that produces one last sharp, brief runaway spurt into new contract highs, or in this case, as noted on the chart, the explosive run from about $7.00 to $8.00 in the concluding two weeks of this roaring bull market.
CHART 3 - Okay…So now all this buying has been done FOR THE NEXT YEAR …which, by the way, is exactly what many airlines did with jet fuel back when Crude hit $150 in 2008 (accompanied by calls for $200 a barrel), and they consequently did not benefit from the ensuing 80% drop in Crude prices…the point being, believe me, the people who actually do use these commodities do NOT know where the market is going. I SWEAR IT. They get scared. They make horrible decisions right along with everybody else…and just dive in, AT THE HIGHS, with both hands…At any rate, after all this buying has hit the market, what comes next?
Well, the other side of the equation is the farmers…and believe me (again)…They don’t have a clue as to where prices are going either. They are all sitting there with this commodity that has practically turned to gold during the past few months, and hearing all the same claptrap that is scaring users into buying ahead, and they are thinking, “Hellfire! I ain’t selling here. I’ll sell when it gets to 10 bucks!”…So the farmer decides to just sit on his grain and wait for higher prices.
However, there IS some selling going on. Crops are coming out of the fields and it can’t all go into storage and the farmers do have to sell some to meet cash flow needs…or maybe they just sell a little just thinking this is good common sense…But in general, if they don’t have to sell it, they don’t…Meanwhile, all the buyers really are GONE…and the ensuing result is just a small amount of selling meets virtually NO buying (other than late-coming speculative traders) and you do actually have something of a “buyerless” vacuum in the markets. The next development is this relatively small amount of selling produces a STRAIGHT down, one month, $2.00 a bushel crash which can be seen on Chart 3 immediately after the contract highs were made at $8.00…I assure you, that sell off came on NO particular news whatsoever, and for all the reasons mentioned in this little story, you do have a decent synopsis of how bull markets actually do end…You DO reach a point where all the buyers HAVE bought, and I don’t care HOW bullish the fundamentals are, they are now all “in the market”. For a time, there are no buyers left…
CHART 4 - So then what...?
Even though the market is now $2.00 lower, all the “fundamentals” that were so
bullish a month earlier are still out there. The bull story is still THE
story…and you do get some new buying (prices are a lot lower now) met by some
farmer selling (they get scared into selling some after watching prices
evaporate), such that you get prices kind of at a standstill for a while, thus
producing something like the last seven months of sideways action. BUT, again,
the bull story is STILL out there…that “stocks are tight and exports are
strong”, and even though there is a monster crop probably coming next fall,
between now and summer’s end, there just “might not be enough to go around”…With
this in mind, MANY farmers STILL are holding their Corn in the bins, and STILL
thinking they are going to be able to sell at higher prices. So they wait.
Analysts everywhere repeat that useless line I have read a 1000 times…”Farmers
won’t sell at current prices. Prices HAVE to go up to induce them to
sell.”…Meanwhile, buyers, who covered themselves at the highs STILL don’t need
to buy. Maybe they have some buying they need to do, but it’s on a hand to mouth
basis, and they just aren’t as motivated by fear as was the case last summer at
$8.00…The bottom line is buying and selling pressures are somewhat equal.
CHART 5- So the market sits there. USDA reports come and go, generally still fortifying the perspective that “Stocks are tight. Demand is strong.”, and after those reports, especially if they are perceived as “bullish” (seemingly they ALL are), the market may go straight up a few days, but this is mostly due to speculative fervor, not actual users who need the commodity…BUT as there is a LOT of corn still out there to be sold, every rally quickly runs out of spec buying (they all jump in a few days) and then is met by farmer selling…and again, not necessarily a lot, but when the buying is tapped out, not much selling at all easily pushes the market back down again. , which is exactly what we had a few weeks ago when the March 30th USDA report came in with stocks “smaller than anticipated”. As you can see on Chart 5, the market jumped hard for a few days, due, I believe to speculative buying and nothing else, then was driven right back down by farmer selling.
CHART 6 – So this brings us to the present…Where is this market on April 24rd and what is the rest of the story? Yes, all of this has been easily stated (my version of the past) but what happens now?
To reiterate a few points…
The first thing is, according to all of the bullish analysis out there, Corn is NOT supposed to be anywhere near its current $6 level. It is “supposed to be” a LOT higher.
As I stated before, buyers DID buy heavily ahead last year when the bullish hype was off the charts. And, yes they will certainly have to buy some more as we move through the summer but I believe they will now be doing so on an as needed, short term hand to mouth basis.
On the other hand, farmers still have a LOT of corn they have yet to market…that is, SELL.
So here is what I believe comes next…because I have seen this so many times before…with the same chart set up, at one time or the other, in virtually all of the commodities we trade…
Corn is now hovering dead on its lows for roughly the past year.
In the real world, if you are a user…a buyer that does need to do some buying…your attitude about this market is quite different from a farmer who needs or HAS to do some selling…The buyer maybe gets up in the morning, and seeing that Corn has been weak over night, and with it here at the lowest prices he has seen in a year, probably does not feel any great anxiety to get some buying done. Maybe he has other things he needs to take care of that are not as imminently pressing, so, very simply, he does “something else”. Maybe he runs some errands, fixes machinery, does paperwork, goes to a baseball game, whatever…He has plenty already bought ahead and Corn is not running away on the upside, so instead of buying more corn, he goes and does other things for the day…He is a buyer who can wait to do his buying…
The producer, however, is in a different boat. First he missed the opportunity to sell at $8.00, and before he could blink, the market was at $6.00. But still, with all the bullish talk out there, he felt like the market would eventually make it back to the highs (at least) and he would get a lot sold there…But it never did. So here he is 7 months later, and not only has he been paying to store and insure the Corn (costing him money), it is now back at the lowest price since he harvested the crop…and STILL he’s sitting on a LOT of it...and worried sick. When HE wakes up and hears that “Corn is a nickel lower overnight”, his mentality is quite different from the guy who maybe wants to do some buying. The farmer NEEDS to get some sold…and a LOT of it, since he’s been waiting, and waiting and waiting for higher prices…and if the market starts getting away from him on the downside? Well, he is thinking in terms of some SERIOUS money going down the drain…This is NOT a Monopoly game. This is REAL money. And until he gets his crop sold, he is on the hook…and now VERY worried.
So, what happens if it DOES fall through those lows…?
Well, believe me, the buyers do NOT start rushing into to cover their needs. They still find “something else to do”.
But sellers? They (and there is a world of them) do the classic charge for the doors at the same time…EVERYBODY is in the same shape…They should have sold. They didn’t sell. Now they HAVE to sell. They have already forfeited BIG percentage bucks and they are now motivated by FEAR more than anything else. Meanwhile, the buyers are still sitting on their hands…There is a daily avalanche of selling and the market drops relatively straight down…and what you actually then see is the inverse of what happened at the top…at last summer’s all time highs, when buyers were everywhere, sellers were non-existent, and Corn was able to rally a Dollar in the last two weeks of the bull market…except, in this case, with a falling market, fear can be a greater stimulus than greed, and that $1 move made at the highs can translate into $2.00 when the market is crashing into new lows.
Obviously, this last part of the story has not taken place but I am telling you that it absolutely can. As evidence, last week I included over 40 various historical charts that I defined as being relatively identical to today’s Corn market…And I can assure you the dynamics of buying and selling in all those examples are fairly close to the “mini saga” I have described here, so if you are interested in comparing (again) today’s corn market with all those histories, here is the link to that April 18th newsletter: http://www.crokerrhyne.com/newsletters/04-18-12.htm .
But just for convenience, here is one very recent example…July Wheat last year…This chart is pretty “busy” with all my notes but if you take them one at a time, I think you will get the picture…which, to me, IS exactly the same as the current Corn market.
Does this all mean that Corn is automatically, absolutely going to fall off the cliff here at $6.00? Certainly not. But I do think it is a hell of a strong possibility. And I do know I’ve read over and over how farmers simply won’t sell unless prices go up…and for quite some time now, that argument has been quite in error…
I think it will be “same as it ever was”…Farmers ARE sitting on MOUNTAINS of Corn. One of the biggest crops in history is going in the ground now. We are NOT going to run out of Corn. And farmers are going to do what they have forever done…SELL IT IN THE HOLE…and I honestly believe, in this year of “so tight supplies”, some (maybe MANY) of them might even end up selling old crop Corn (in the bins now) UNDER $4.00.
I THINK THIS IS A MIGHTY SHORT. BUT IT NEEDS TO BE DONE NOW. BEFORE IT FALLS OFF THE CLIFF…NOT AFTER, AS IT MAY JUST BE MOVING TOO FAST TO GET ON BOARD.
Here are a few approaches…
For more leverage…there's this...
Or you can do futures, using maybe a 20 cent stop ($1000 on the big contract, $200 on the mini), but I think the options here are a powerful, powerful tool…
And here, for the longer term perspective, is a repeat of the 40 year picture I used in one of last week’s newsletters…
And finally, here is a blurb off today’s news…
That news was supposed to be fodder for the bulls…but all it did was spur a 10 cent higher opening, followed by a 5 cent lower close…NOT the bullish outcome any bull would have expected...My own impression is, if all that buying in the first quarter didn’t move Corn up, what will? Secondly, I’d say there is an excellent chance all that buying represented the bulk of their buying for now…and that they, like everybody else, will waiting now for the record world crops we should see start to mature in another 5 or 6 months…I mean, hey, wouldn’t you?
ALL THE BUYING IS PRETTY MUCH IN THE MARKET. GET SHORT CORN NOW.
I wish SOMEBODY would just lay into this…Mine is only an “educated guess” but I do believe 3-4 months from now traders will have been stunned (as is the norm) by how gigantic the move down has been in this market.
If you made it through this whole thing, and you do have the speculative cash to use, I urge you to pick up the phone and call me…I do think this is “obvious”, and stupid as it may sound, don’t see how it can be viewed any other way…