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November 23, 2012

Short Corn, Soybean Meal & Wheat

Buy Cotton

Much of this was copied from a piece I wrote in bullish cotton newsletter (May, 2002) in which I presented my impression of the basic psychological dynamics that drive all commodity prices. I pulled it out today, and updated it a bit, as I think it is a perfect description of why I see Cotton as a major buy…and why I am so forcefully recommending Corn, Soybeans and Wheat as major shorting opportunities.

If you have traded commodities for any length of time, you may have heard the expression, "It is always bearish at the bottom", or conversely, “It is always bullish at the top”. This newsletter addresses these trading adages, which I believe are absolutely true, and how they relate to today’s Cotton, Corn, Soybean and Wheat markets.

Unless a commodity is being replaced by something better, over time (years and decades), total consumption, or demand, for that commodity should be on a fairly constant upward slope. This constantly rising demand takes place simply as a function of world economic and/or population growth.

This means production must continue to grow as well.....If production did not grow to keep up with demand, the price of a commodity would have no place to go but up, continually, and probably through the roof....and in reality, total production of most commodities, over time, does grow to keep up with demand.

With this in mind, it can be said that, from time to time, as regards just about any necessary commodity, you need to hear that expression, "record production", or, "record crop".....If you don't, at some point, you are probably going to hear that other expression, "record prices".

There can be exceptions to anything, but I would say, demand growth, over time, is much more of a constant than production. The population of the planet grows every day, meaning increased demand for just about any commodity, in general, regardless of what is happening to inflation, GDP, the business cycle etc....Production, however, does go through more fluctuations due to low or high prices, economic conditions, political policy, weather, war....whatever....

So…Supply and Demand are both always growing, but I would depict the rate in which they grow with the following chart…

Sometimes supply is greater than demand and sometimes it is the opposite.....but they are never equal. Maybe there is some hypothetical point in time where you could say they are exactly the same, but generally, both sides of the equation are moving all the time, and  prices, therefore, keep moving as well....up or down. This is pretty basic stuff, but, on the chart, when you have supply greater than demand (when the supply line is above the demand line), you will probably have a period of falling commodity prices, and when supply falls below demand, you will probably have a period of increasing commodity prices..... 

The Psychology of Prices and Commodity Supplies

Every commodity has to have more of it stockpiled than we need. If, for example, you were to reach a point where there was no lumber, or gasoline, or wheat available for the next fifty days, you would have a pretty nasty situation on your hands. Aside from the severe social disruptions, I would guess you might see skyrocketing prices for those commodities to levels nobody has ever even dreamed of......Therefore, we can never, ever allow those stockpiles to get to zero....Running out of flour in your house is not the same as the world "running out" until the next crop gets harvested---We always have to have extra supplies of everything we use.

Those extra supplies in agricultural commodities are referred to as the "ending stocks" or "carryover" (what is left over each year from the previous year's harvest), the size of which varies from year to year depending on how much was produced, and how much was used.

In the years where the carryover is very tight, you tend to get higher prices, which is what we now have in Corn, Soybeans and Wheat....and these high prices are usually accompanied by seemingly unanimous analysis suggesting prices will stay high, or go higher, as in, “There isn’t enough to go around! We might run out of it! Be a buyer!”.

And on the flip side, when you have a "mountain" left over, you tend to get lower prices, which is very much what we now have in Cotton, and quite naturally, the overwhelming majority of analysis in cotton expresses the idea, "We have so much of it, we will never use it all! Don’t even think about it going up! For years!”

But it’s just not that simple…

As we all have seen on innumerable (literally) occasions, when a market has been screaming higher, at some point, all that so “logical” bullish fundamental analysis quite typically becomes fully accounted for in the market’s price…with the result being, when you hear, “There’s not any left”, you are probably at the LOW point in supplies (how can you get any lower than “not any left”), and the HIGH point in prices, as, for a variety of reasons, the next stage in the cycle is supplies generally WILL grow and prices subsequently WILL fall to reflect the lack of “shortages”.

And it’s just the opposite at a market bottom...The very visible mountain of product results in low prices, and all the analyst’s “logic” then suggests price will remain low, or trade even lower…BUT the impact of those low prices quite naturally influences farmers to switch to higher price crops, meaning less acreage and production, when at the same time, low prices can also mean increased demand…and the next thing you know, prices have “unpredictably” gone higher instead of lower.

I’ve tried to create pictures of these two scenarios (a top and a bottom) in the two charts following…with the first chart representing where I believe we are in Corn, Soybeans and Wheat…


And the next one being where I think we are in Cotton…


If you follow the commodity markets to any degree, you certainly have heard enough of the bull story for Corn, Soybeans and Wheat to understand why I think the markets HAVE already accounted for the drought, exports, tight stocks, the ethanol mandate, the notion that farmers “don’t have to sell”, etc…and I do think owning puts in all three of these markets out in the May or July contracts is one of the best trades I have ever seen in this business…and I don’t just blithely throw down that sort of statement…My opinion, as always, may be wrong, but I look at the following three charts and think they have nowhere to go but down…and a lot...I think anyone who wants to bet on the upside, or any farmer who is holding his crops for higher prices, is totally ignoring the 40 years of history on all these charts…These markets go up AND down…and I am staying short until we see a strong hit on the downside.







And Cotton?

Check out this excerpt off my newswires from a few weeks ago…

“Allenberg estimates that China now has 41.3 million bales of cotton in their strategic reserves, enough to allow them to operate their mills at current levels without importing cotton for 6 entire years.”

Yes…Those sound like pretty scary numbers if you are thinking about buying cotton…But this IS the perfect example of what I refer to when I say that bottoms are made when supplies are enormous and opinion is 150% bearish. Maybe you’ll think it’s a different animal but think about the Dow at 6500 in March, 2009. There wasn’t a reason in the world to buy that market then…In fact, talking heads galore were calling for 5000…with all sorts of “logic” to back up their opinions…Believe me, I can’t find a bull ANYWHERE in Cotton…It’s the way this stuff works. Anybody who ever would sell Cotton has long since done so…



Maybe I’m wrong, which means you could lose up to 100% of what you put on the table, but every time I look at these long term charts, and every time I pick up another bullish commentary on Corn, Wheat and Soybeans, all I keep thinking is, “Find more people to get on the short side of these 3 markets. Get them there and keep them there. I think this could be SO big”.

Commodity markets and long commodity traders DO get trashed every so often…These markets have been BULL! BULL! BULL! For too long now.

I think the timing is perfect. In my opinion, the biggest commodity story in 2013 will be the collapse of the Corn, Wheat and Soybean markets.

My opinion…What do I know?

Give me a call. Put your money on the table. I wish I could do it for you but I can’t. All I can do is keep selling you (yes) and telling you exactly what I think.

Sign on my wall: ONE GOOD TRADE IS ALL IT TAKES…I think I’ve got 4 great ones right here.

Happy Thanksgiving.




The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Corn, Soybean Meal, & Wheat puts, and Cotton calls.

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