The Hightower Report

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With the possibility of the US shifting to a more inflationary environment, a look at markets which are relatively cheap may be in order. Orange juice futures moved from a peak of 209.50 in March of 2007 to as low as 64.60 into February of this year. Fears of declining production ahead due to disease issues and signs of better demand have helped boost the market back up towards 100 recently, but the market is still considered relatively cheap. If the dollar continues to decline and inflation begins to exert more upward pressure on all commodity markets, OJ is likely to see some benefit. On top of the inflationary impact, supply is shrinking in the wake of low prices and disease problems in Florida. And we could be seeing a general shift towards stronger in demand. This leaves OJ as a potential “buy and hold” market into 2010.

Brazil is responsible for about 55% of the world’s OJ production and the US about 35%. Key consumers include the US, which uses about 38% of the world total, and the EU-27, which also consumes about 38%. Given the sharp rally in the Euro of the past year, this alone would be a good reason to consider investing in OJ. Declining production in the US in recent years has left Brazil as the dominant world exporter. The US is a distant second at only 10% of the world export market and has actually become a net importer. In the past decade, demand for juice in the US has declined due to stronger soda consumption and plenty of competition from beverages that contain a small percentage of various fruit juices and a large amount of water and sugar. A major push to tax sugar drinks to help lower obesity rates in the US, along with a shift to healthier diets, could cause a shift to stronger demand for pure orange juice in the future. In addition, ideas that juice will help boost immune systems for children may help raise consumption this fall, as the country braces for the first flu season with H1N1 virus. Looking at orange juice sales from key US retail outlets in the US, as provided by the Florida Department of Citrus, the latest 4-week period ending August 29th orange juice sales totals were 3.8% higher than the same 4-week total a year ago. Retail prices were down 8.2% for the same period.

From a supply point of view, the market will face the first key report of the year on October 9th, when the USDA releases its first estimate for the 2009/10 US orange production. Traders will be focusing on the Florida production number primarily. Last week, the USDA indicated that commercial citrus acreage in Florida has fallen 1.3% (568,814 acres) from last year, as growers have been fighting citrus greening (an insect-borne bacterial disease which first appeared in 2005) and also citrus canker. Brazil’s production has stabilized near 350-360 million boxes over the past ten years. US production last year was 162.1 million boxes. Even though the Florida acreage number is lower than last year, the decline is not as steep as previously expected. Before last week’s update, estimates were ranging from 141 to 154 million boxes. After the update, traders were revising their estimates higher.

The lack of a hurricane threat to the Florida crop this year and speculative long liquidation selling drove the market down sharply to the September 11th lows. The fact that the market was able to hold above this level after the recent acreage report could be seen as a positive development. The market is approaching a season where production is expected to fall, and demand might be on the rise for the first time in a long time. Funds still hold a hefty net long position of 9,300 contracts, so the market should remain vulnerable to choppy and volatile trade ahead of and just after the October 9th production report.

Below is an excerpt from our most recent Newsletter. To receive access to this story, with trade strategies, and our daily coverage of 16 markets, visit futures-research.com for your free 2 week trial!

We are short term bearish crude oil prices but bullish on where they might be toward the end of 2009. In the short term, slackening seasonal refinery demand will probably result in another expansion of the annual US crude stocks surplus at the EIA. Historically, refiners gear down refinery activity under the guise of slack seasonal product demand and because of a rotation from summer to winter fuel needs. This year it would appear that an already low US refinery operating rate is set to become even lower in the weeks ahead. If the US refinery rate does fall markedly in the coming weeks, it could put as much as 20% of US energy refinery capacity “on idle.” While we think that much of the impetus behind the operating slide will be seasonal in nature, the significant cushion of distillate fuel and crude oil stocks crude slow the output rate even more. US distillate stocks recently were sitting as many as 40 million barrels above year ago levels, and crude oil stocks were seeing a year-over-year surplus of 32 million barrels, which would seem to suggest that the energy markets are facing a burdensome supply situation ahead.

Another important factor determining where the refinery operating rate might be headed is the profitability of the refinery effort (or the crack margin). A look at the general profitability of refinery products suggests that while the incentive to refine oil into products might be markedly improved from the low levels that were seen at the beginning of this year, comparative returns are still well below what they were a year ago. We suspect that product prices will have to fall (which might result in the crack margin falling back below $10 per barrel) before supplies are cleaned up and the refiners have the incentive to expand output.

As it stands now the “reformers” and the media have little to no interest in investigating the prospect that managed profit margins in the US refinery industry is periodically sparking sharp run-ups in energy prices. Therefore, expect the US refinery rate to fall more than normal, which in turn should set the table for a mid-winter product shortage in the face of the anticipated colder than normal winter ahead.

While we doubt that November crude oil prices will see a full return back below the seemingly important pivot price zone on the charts around $62.50, we suspect that the crude oil market will have the capacity to fall below the $66.00 level in the aftermath of sagging seasonal demand and especially in the wake of the next US monthly unemployment report. With the cushion of supply in the energy sector considered particularly burdensome this year, it is possible that many refiners will be forced to aggressively reduce product supplies. That could initially pump up the amount of excess crude oil supply and should in turn drive down crude oil prices.

While we are decidedly bearish toward crude in the weeks ahead, a significant slide in the US Dollar, evidence of an unfolding US recovery and a colder than normal winter could see December crude oil back above $77.00 before the end of the year.

It would appear that a downtrend pattern in the Dollar has become entrenched and that the reason behind that slide is varied and highly debatable. Clearly, many sellers of the Dollar think that US interest rates are destined to remain low until there is clear-cut evidence of a recovery in the US economy, and that in turn seems to suggest that investors can get higher yields in other currencies. Others think that unrestrained borrowing and the soaring budget deficit are behind the slide in the Dollar, and that in turn would seem to leave the prospect of a sustained, long term downside action in the Dollar ahead.

With the Obama Administration recently suggesting to the G20 that a new world economic order was needed and in a UN speech suggesting that world superpowers can’t be allowed to dictate to lesser powers, it would seem that the Dollar is destined to see its prestige stripped even more. Maybe US officials are paving the way for a decline in the Dollar in hopes of securing a quicker recovery in the world’s largest economy, and as long as other central banks stand by, it is possible that the Dollar will continue to fall. In short, given both internal and external factors, we suspect that the December Dollar Index is poised to fall all the way back down to the early 2008 lows, below the 72.00 level. In the event that the Dollar sees consistent declines, it is possible that certain commodity prices will gain an added measure of strength. If the US does manage to hold interest rates down until the US and global recoveries are well underway and a falling Dollar accentuates upward price action in a host of critical commodities, it could facilitate inflationary conditions.

Clearly, investors worldwide have already begun to factor in some form of inflation in the wake of the worst economic debacle in 50 years, as money is flocking toward classic inflation measures like gold and silver. In addition to record spec and fund long position readings in gold futures contracts, investors are also piling into gold and silver derivative instruments. That historically large investment flow seems to be justified by the combination of factors facing the markets. The US can hardly afford to see escalating interest rates as it takes on copious amount of new debt. Furthermore, some players are suggesting that a “Sub-prime II” debacle is waiting in the wings in the form of commercial real estate commitments or off resets on some residential variable rate loans.

Therefore, it is clear that keeping rates low is a situation that benefits the government and a large portion of the US economy, and that is probably enough to keep the Fed looking away from the initial inflationary signs in the economy. In the end, those commodities with favorable or decent fundamentals are destined to catch an aggressive lift in prices, while those commodities with neutral or slightly bearish fundamentals might see selling interest tempered.