NEW COT REPORT
The New Commitments of Traders with Options "Supplemental" Report
Commodity Index Traders
On January 10, 2007 the Commodity Futures Trading Commission, which produces the weekly Commitments of Traders reports, began releasing a new supplemental report that separates Commodity Index Traders from the other categories for 12 selected agricultural commodities. Up until the release of this report, the size of the positions held by commodity index funds had been obscured by the fact that some of them were categorized as "Commercials" in the COT reports, while others were put in the "Non-Commercial" category. While a large portion of the unprecedented growth seen in the commercial participation in wheat in 2005 and in corn in 2006 could have been attributable to commodity index funds, up until now there was no way of determining the extent of their participation. What the new report has shown was that pace of index fund growth was larger than most market observers had expected. It also showed that in several markets, those traders that would have been traditionally considered "Commercials" (before the advent of index funds), are currently holding what would appear to be record net short positions.
It is important to realize that the index funds are passively managed and that the price movement of an individual commodity may have little or no impact on the number of contracts that an index fund will purchase. Index fund managers buy and sell futures based on the number of shares they sell. Unlike traditional speculative funds, the do not "trade" futures by buying and selling based on technical or fundamental indicators. Certainly, rising commodity prices attract investors to a particular fund, but the connection between a particular commodity's performance and a fund's performance is blurred by the fact that several commodities make up a fund.
For example, a typical investor may transfer $5000 from a mutual fund that specializes in health care stocks to a mutual fund that tracks an index of commodity markets that includes a mix of wheat, crude oil and coffee, among others. If wheat prices fall $1.00 over the ensuing six months but crude oil rallies 20% and coffee doubles in value, the investor may actually see a positive return in his or her investment and may increase his or her position in that particular fund, which would require the purchase of more wheat despite a declining market. On the other hand, if grain markets rally sharply in the next 6 months but energy markets drop 50%, the investor may show a negative return and drop out of their commodity investment, requiring the index fund manager to sell wheat, despite an increasing market. It is important to realize that with a $9.00 break in crude oil since Christmas and a new high for the Dow, there could be plenty of investors who might shift assets away from stocks and into commodities.
The initial reaction to the new report has been mostly bearish, but this knee- jerk response does not seem to take into account the huge change in the "real" net position of the commercial trader in most of the agricultural markets. The following is an interpretation of the traditional Commitment of Traders reports with options, followed by a quick analysis of the new data which pulls out the index fund traders for most of the grain and livestock markets. In addition, we have enclosed charts which show some of the data on index funds going back one year.
Selected Commodity by Commodity Review (as of January 3, 2007)
Corn: The traditional Commitment of Traders report with options showed the market in a classic bullish setup with non-commercial traders net long 281,825 contracts and non-reportable traders net short 102,664. This would leave the market vulnerable to increased fund buying and increased small trader short covering if resistance levels are violated. If we take out commodity index fund traders, the new supplemental data shows that traditional trend following funds were net long 247,646 contracts, not the 281,825 posted. Index fund traders were net long 421,579 contracts. Keep in mind that commercial traders are holding a net short position of 566,561 contracts. While the trend following funds are close to holding a record net long, the commercial net short is far and away at an historical record, which has bullish implications if the trend turns up. (See chart.)
Wheat: The traditional Commitment of Traders report with options showed the market in a bullish setup, but the selling trend of the funds is a negative short term force. Non-commercial traders are still net long nearly 20,000 contracts after dumping about 8,600 for the week ending January 3rd. If we take out commodity index fund traders, the new supplemental data shows that traditional trend following funds were net short 1,094 contracts, not the 19,755 net long posted in the normal report. (See chart.) Index fund traders were net long 201,104 contracts. The shift from a net long to a net short position and the selling trend of traditional funds is a bearish short term factor. However, commercial traders are holding a net short position of 172,589 contracts, where in the past a net short position of more than 45,000 has been a rare occurrence.
Soybeans: The traditional Commitment of Traders report with options showed the market in a classic bullish setup with non-commercial traders net long (and buying more) and non-reportable traders net short. This would leave the market vulnerable to increased fund buying and increased small trader short covering if resistance levels are violated. If we take out commodity index fund traders, the new supplemental data shows that traditional trend following funds were net long 47,071 contracts, not the 59,579 net long posted in the traditional report. Index fund traders were net long 129,727 soybean contracts. On the other hand, commercial traders hold a net short position of 152,630 contracts. In the 1995 to 2003 time frame, a net short of 75,000 contracts was extreme.
Cattle: The traditional Commitment of Traders report with options showed the market in a classic bullish setup with non-commercial traders net long (and buying more) and non-reportable traders net short (and selling more). This would leave the market vulnerable to increased fund buying and increased small trader short covering if resistance levels are violated. If we take out commodity index fund traders, the new supplemental data shows that traditional trend following funds were net long near 27,834 contracts, not the 42,938 posted in the traditional report. This means the market is "less" overbought than expected. In addition, the commercial net short position is now 86,207 contracts. Prior to 2005, a net short position of 40,000 contracts was considered an extreme. (See chart.) As a result, the commercial net short is far and away at an historical record, which has bullish implications if the trend remains up.
Hogs: The traditional Commitment of Traders report with options showed the market in a bullish setup, but the selling trend of the funds was a negative short term force. Non-commercial traders were net long 8,383 contracts after dumping about 6,029 for the week ending January 3rd. If we take out commodity index fund traders, the new supplemental data shows that traditional trend following funds were actually net short 2,146 contracts. (See chart.) The traditional fund traders shifted from a net long to a net short position for the week ending January 3rd, which is a short term bearish force.
7 Technical Trades for 2007
Using some longer-term cycle and seasonal analysis along with traditional technical indicators and some Commitment-of-Traders analysis, we have worked up what we feel are the 7 best technical trades for 2007 along with some alternative option strategies.
1) Buy April hogs at 62.72 with an objective of 72.17. Risk the trade to 61.47. Options Alternative: Sell the April hog 58 put and buy the April hog 66 call for a net premium paid of 50 points. Risk 70 points and hold for a run to the 72.17 objective in April futures.
While the short term trend is down with the market in a tight downtrend channel, this is normally a continuation pattern of a longer-term bull market. A move through the high end of the channel (65.10 on Tuesday, January 16th) would trigger a resumption of the uptrend. A 50% retracement of the contract high to low range is at 62.75, and short-term technical indicators are in an oversold condition.
2) Buy April crude at 55.76 with an objective of 64.77. Risk the trade to 54.76. Options Alternative: Buy the May 62/67 bull call spread at 105 with an objective of 375. Risk 60 from entry.
While the short term trend is decisively down, a 0.618 retracement of 5-year bull market leaves 54.83 as a key support level. A 15-week cycle is due February 5th, and a 9-week cycle is due January 15th. The November lows on the weekly chart came in at exactly at 50% of the 3-year range. Relative strength readings are showing a loss of downside momentum, which suggest that the time is right to watch for a technical sign of a significant low into this timing window.
3) Buy May coffee at 123.60 with 147.10 objective. Risk to 119.80. Option alternative: Sell 1 May coffee 120 put near 660 and buy 4 May coffee 155 calls near 165 each. If the longer term objective of 157.05 is hit by March 15th, the 155 calls should be priced near 875 and the 120 puts near zero.
A 50% retracement of the contract range is 119.90. A 56-day cycle missed the December 15th highs by one day, with the next cycles due on March 9th and May 28th. The short term trend is down with the market operating under the negative influence of the December 15th reversal, but the longer term trend off of the weekly and monthly charts is still in a bullish setup. The fund net long position is well short of an overbought condition.
4) Buy April gold at 608.15 with an objective of 692.40. Risk to 592.90. Option Alternative: Buy 2 April gold 670 calls at 4.50, sell 1 on bounce to 9.00 and hold the other for a run to 692.40 in the April futures. If the 692.40 level is hit by early March, the 670 call should be near $24.50.
The 50% mark of the 2-year range at 569.00 managed to hold on washouts in June and October of 2006. The recent COT reports showed trend following funds net long around 68,000 contracts as compared with a record of 189,000. A weekly close over 664.00 would be considered a bullish development. For April gold, a 50% retracement of the July 2005 to May 2006 rally comes in at 607.80.
5) Buy May corn at 364 1/2 with an objective of 452 1/2. Risk the trade to a close under 355. Options alternative: Buy 2 May corn 420 calls at 7 each. Sell 1 at 14 and hold the other for run higher to 452 1/2 in the May futures.
The 364 1/2 level marks 50% of the July 1996 high to the August 2000 low. The longer term uptrend is still intact in spite of the break off of the late December highs. A consolidation or setback is needed to correct the overbought condition and the steepness of the rally for the weekly and monthly charts. If we assume that the September 21st gap of the downtrend channel is a breakaway gap and that the November 2nd gap is a measuring gap, traditional gap theory leaves 458 1/2 as the upside objective for May corn.
6) Buy July soybean oil at 28.64 with objectives of 33.10 and 41.42. Risk to 27.64. Options Alternative: Consider selling the December soybean oil 27.50 put near 120 and buy the December 32.00 call near 205.
A 50% correction of the October to November rally is 27.96 with a 0.618 retracement at 28.64. Watch these key support levels for signs of a reversal in the short term trend, especially into the next cycle timing windows. The 20-day cycle has worked well recently, with ones due January 30th and February 27th. Open interest setting back on the correction is a sign of short term weakness. Watch for a turn back up in the open interest trend for a short term buy signal. With the planted acreage situation, December oil is also appealing.
7) Sell March T-bonds at 113-14 with an objective of 106-23. Risk the trade to a close over 114-20. Options Alternative: Consider selling the June T-bond 116 call and buying the June T-bond 110 put at the same price. Or, consider buying 4 June T-bond 109 puts at 15 each and selling 1 on a rally to 60 to recoup expenses. Hold the other 3 for a futures break into May.
The market broke out to the downside of 6-month uptrend channel in late December and appears poised for a recovery bounce which looks to be a selling opportunity. If the other 6 strategies work out, commodity inflation may be an issue and short T-bonds should work well.
*Projected options values are based on options pricing models and are not guaranteed.
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