I had a remarkable run last summer in the futures markets, mostly from shorting the metals save for gold last August. The trading has been infrequent since then save for spates of shorting the 10 Year Treasury which on balance has been a disaster.
Last week I shorted both Corn and Wheat, even holding them short over the weekend. Frankly was planning to reduce the position but forgot the ag futures markets close at noon pacific and was left holding my breath a bit for the weekend. The basis of this trade effectively was a belief in mean reversion and the Corn trade worked out well with mild rains over Iowa leading to a drop Monday morning. I did not however want to be short going into the crop report, and even went long, but intending to get short again in all but the most dire reports should the price action after the crop report appear safe to do so.
Waking at five A.M. is not a natural strength of mine but I was up and ready for the 5:30 report — believing it would be reported live on Bloomberg TV but knowing I would see the price action quickly.
The first reaction, which lasted all of ten to fifteen seconds was of an immense gain — Corn came in under the most bearish USDA expectations, 123 bushels per acre, lowest average yield since 1995 under even very bearish estimates of 125 bushels per acre. Corn (and other grains) took off:
That spike is not a misprint; all nearly within a minute, swings from the 820s overnight to 843 to 810. I sold the position around 818 after the basic trading range prior to the report had been broken. Same too with the wheat position. The glorious profits of the first moments evaporated into a loss. But this range, once broken, now was it time to go short? I traded in and out of Soybeans, Corn and Wheat. I only took a couple contract short on Corn and got stopped out pretty quickly as you can see by 11 eastern it traded back to the range which I thought was a risk of it going much higher.
Wheat and Soybeans, however, were another story. They have traded up in line with corn but have very different underlying supply and demand characteristics. For one, they are not in shortage as corn is. Second, the report in particular for wheat — up 13% from last year, and up 2% from last month’s expectations. Because the two commodities are fungible they will trade together closely; but it shouldn’t be this closely. I was tipped to this from Barron’s the previous week: Wheat Prices will wane by Owen Fletcher:
Wheat bulls argue that dry weather is a threat to harvests in the Black Sea region and Australia—and that Russia could restrict exports, as it did in 2010. While investors should monitor those issues, world inventories are large enough to weather a drop in production. The USDA predicts that world wheat inventories will total 182.4 million metric tons at the end of the 2012-2013 crop year. That’s down from the total in the past few years, but still 11.3% above the average of the past decade. Supplies are likely to grow as farmers plant more wheat to capitalize on high prices.
Similar demand characteristics appear in play in Soybeans. While I will not pretend to understand all the fundamental drivers, in the classic technicals or fundamentals debate for commodities I think the proper trade is to have at least a basic understanding of fundamental possibilities and wait for extreme price situations to develop, top out then enter the trade with a stop close to the previous highs (often a rookie mistake but I think that is for more range-bound markets).
So I shorted December wheat (again):
Went short at 908.5 — with a 918.5 stop. Safe enough, right? How did I choose the stop — was it where the pain was or where the trade would be proven wrong? This is the best trading reminder I have gotten out of Hedge Fund Market Wizards.
And in fact, it was really just where my pain point was, a slightly over 1% loss; there was no inherent reason for it, save for being in the gap between the Friday close and Monday electronic open. Do gaps fill? Sure? Was I nervous? Definitely. I did move the limit up just a touch further, and that made all the difference:
The 918 stop had I held it would have been two points within the intermediate daily top and would have made me pissed to have been knocked out at the high. Everything now was negative for wheat — yes the Russians could close exports and I’d be screwed but the initial 918 was just fear from pain point — something that could be said for that matter for 922, but I just got lucky!
Why this pain point? Because the position size was just too large. Too large for the account’s equity level and certainly for my level of knowledge of the commodity. Fortunately the drop from there was almost immediate so I did not have long to last in consternation. As a foolish side note even though it was vindicated I even added 5 contracts to the position.
ZW bounced around for most of the rest of the day, between 897 and 910, with a finish at 902 (via a last minute run from the 897 lows – meaningful or not?) I wound up getting out of the postion altogether to think whether I wanted an over-the-weekend position, and wound up getting back in but lightening the position in order to spread the “grains have topped out” thesis to soybeans as well:
The soybean trade was put on at 1641, just as the intraday was approaching its third run at the lows — hoping of course for a final dive underneath but it wound up three points higher.
My final commodities position is the old nemesis ZN which I’ve finally put on a position that doesn’t have an incredibly tight stop, one which I hope to be rolling over for several months:
ZN is something where the tight stops have probably served me well minimizing losses over the last few months. Still, this is a market that has topped out. Even assuming a European collapse or other severe dislocation, there is little room to move US Treasuries beyond 1.6% in yield. The economy and inflation (see Corn & Wheat & Soybeans, above!) is picking up and with them the risks in Treasuries. When everyone is in on a crowded trade it is time to go the other way.
That is actually a trick graph since it shows the US Treasury 10 year up to 2006, where we’ve seen 6 years of appreciation since. To close it out, a chart of US Interest rates back to the 1790s:
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