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Given our view that many commodity prices are poised to rise sharply for the coming four quarters, we think that commodity traders should attempt to capitalize on these anticipated trends with some longer term “investment type plays”. As mentioned endlessly in the press recently, the sustaining of low interest rates and the presence of what seems to be a perpetually sliding US Dollar are widely expected to entrench a very favorable environment for physical commodities. While the influx of funds into some commodity markets has recently ramped up and there are concerns that the influx might be temporarily restrained by regulatory changes, we are already seeing signs that funds and large traders might be considering holdings of actual physical commodity supplies as a way to “get around” the attempt to limit “investment” in commodities. In the event that cash commodity prices gain or outperform futures prices and the regulators try to limit the entry of the “big players” into the futures market, it is possible that classic long commodity futures plays might not only come into vogue but they might even represent the cheapest entry into an already established uptrend. Given the potential for further start and stop action from the economic recovery front and the prospect of increased price volatility, it might be more effective for commodity investors to utilize somewhat out of the money long dated bull call spreads in markets that still appear to have significant upside potential.
Over the last several issues of this newsletter we have touted the potential for a strong continuation of gains in sugar, silver and orange juice. We have also recently talked about a series of commodities that effectively missed out on a large portion of the initial run up in prices in 2009. It might pay to screen those commodity markets with either net spec short positioning or minimal net spec long positioning, as those markets might be major benefactors of “reallocation” by the funds. In other words, as the large commodity funds are faced with position limits in markets like crude oil, it is possible that natural gas or the energy product markets will begin to see an influx of investment. Furthermore, markets that have either net spec short positioning or minimal net spec long positioning might also come into favor. Those markets include milk, natural gas, lumber, oats, Minneapolis wheat, Chicago wheat and feeder cattle. In an attempt to defeat the need to predict timing, the need to weather volatility and lastly to reduce the cost of participating in a long term commodity play, we think that long dated, somewhat out of the money bull call spreads are the way to go.
Because out of the money, long dated options are judged to have a low probability of coming into the money, using them in our strategies can reduce the entry cost. But at the same time this probably means that investment selections should be restricted to those markets with significant upside potential or that seem to offer historic price potentials.
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DISCLAIMER: This report includes information from sources believed to be reliable and accurate as of the date of this publication, but no independent verification has been made and we do not guarantee its accuracy or completeness. Opinions expressed are subject to change without notice. This report should not be construed as a request to engage in any transaction involving the purchase or sale of a futures contract and/or commodity option thereon. The risk of loss in trading futures contracts or commodity options can be substantial, and investors should carefully consider the inherent risks of such an investment in light of their financial condition. Any reproduction or retransmission of this report without the express written consent of The Hightower Report is strictly prohibited.
