- 1997: Volume 6, No. 1 What's Hot and What's Not

The list of "hot" markets continued to grow as foreign currencies fell sharply and several ag markets embarked on what appear to be major trends. In addition, the old standbys, stocks and bonds, continued to make big moves. After consolidating for more than a month, the stock market jumped out to new all-time highs, shrugging off a sharp decline in T-bonds. The D-mark and Swiss franc, which had been in choppy downtrends, accelerated to the downside while the previously red hot British pound ran out of steam to the up side. The bull move in energy markets began to cool off, but volatile price action probably isn't over; and things are likely to turn "hot" again, this time on the downside due to warmer weather. Finally, the cattle and coffee markets showed signs of life while the hog market appears to have the potential for a big move.

Energy Markets

After trending sharply higher since summer, the petroleum markets have run into trouble. Even though the supply/demand profile for crude oil is expected to remain tight through all of 1997 (Iraqi sales and higher non-OPEC production will be absorbed by rising crude oil demand), heating oil prices rallied sharply several times, but never got above 6800, and those price spikes were mainly caused by short squeezes at contract expiration. This winter, heating oil prices rallied to 7350, however, supplies are currently equal those of a year ago and temperatures aren't nearly as cold (i.e., demand isn't nearly as strong). And since the speculative crowd is loaded up on the long side, something's got to give. Already the heating oil market appears to be topping out and should drag unleaded gasoline and crude oil down with it. There's still a chance for price spikes on outbreaks of Arctic cold, but rallies are likely to be short lived. The upside seems limited but there's plenty of downside potential; heating oil bottomed last summer around 4900.

Soybeans

As we mentioned in the last issue, all of the bullish soybean fundamentals (tight stocks and near record demand) remained in play, leaving little room to accommodate crop problems in South America, so it didn't take much in the way of hot, dry weather in southern Brazil, along with bullish USDA reports, to trigger a sharp rally. The USDA was full of bullish surprises, cutting the 1996 crop 31 million bushels to 2382 million, estimating December 1 soybean stocks at a much smaller than expected 1823 million bushels, and reducing 1996-97 season carry-over stocks to a rock bottom 155 million bushels, resulting in a historically and dangerously low stocks-to-use ratio. Southern Brazil suffered through two weeks of hot, dry weather but only a small portion of Brazil's soybean crop was actually threatened, and any damage should be more than offset by record production in neighboring areas where growing conditions have been ideal. Also, significant rainfall occurred this weekend. However, the market remained strong, indicating that the balance has tipped to the bull side. The speculative crowd appears to have embraced the argument that big South American production will be needed just to keep up with torrid demand. That means any further crop problems in Brazil or Argentina could trigger explosive rallies in soybeans and soymeal.

Copper

This market finally broke out to the upside of a massive consolidation range in response to good demand, evidenced by a strong cash market. Signs of a stronger U.S. economy (particularly solid housing numbers) also provided support. The bullish action was all the more impressive-occurring despite a large rise in London Metal Exchange stocks. However, much of the increase came from Comex withdrawals (more of the old "shell game") and from Chinese supplies, which for months had been expected to enter LME storage. As mentioned before, the bullish near-term factors take precedence over the long-term bearish outlook for surplus copper mine production this year and next, at least until something comes along to change the speculative sentiment. Technically, the upside target is 110.00.

British Pound

The pound had a good run to the upside but finally faltered due to slower UK economic numbers and down tick in inflation which reduced the need for a Bank of England rate hike. A strong surge in the U.S. dollar and expectations for the ruling Conservative Party to lose the next general election (likely to be held in May) also put a crimp in the pound. Since UK rate hike expectations won't disappear entirely, and since there are growing concerns over the D-mark and European Monetary Union (EMU), the British pound should remain firm relative to European currencies but probably level off versus the dollar.

D-mark/Swiss Franc/Japanese Yen

Weak German and Swiss economies and the potential for lower interest rates in those countries triggered major declines in the D-mark and Swiss franc. In addition, as mentioned above, the D-mark carries the added baggage of EMU and is expected to converge with the weaker EMU currencies. No less an authority than Bundesbank President Tietmeyer reportedly admitted the D-mark would lose value ahead of EMU, scheduled for 1999. It's also becoming apparent that European countries might be unable to make structural changes necessary to compete with the US, UK and Asia economies (e.g. pare down expensive social programs, entitlements and change restrictive labor laws) which should keep EU currencies weak relative to the dollar, possibly for years. The Japanese yen continued to slump even though it appears Japanese officials are seriously concerned with the extreme weakness and want it to stabilize. However, short of massive intervention, there's not much they can do since any interest rate hike is out of the question due to the weak Japanese economy and collapsing Japanese stock market. It's too early to say that currencies are back to the trend-happy "good old days," but they're beginning to act like it.

T-bonds

This market remained hot, reversing to the down side in response to signs of a strong fourth quarter economy. The crowd is now worried about a Fed rate hike even though the Fed is likely to keep monetary policy unchanged as long as inflation stays under control. Fed officials have commented that they don't understand why inflation has remained subdued despite rising wage pressures, higher energy and food costs, and a somewhat stronger economy, but mentioned they don't want to react hastily with a rate hike. In addition, since government studies indicate the CPI overstates inflation by more that one percent annually, the Fed could even tolerate an uptick in the CPI without raising rates. That might not stop traders from building further rate hike expectation into the market; and if first quarter economic numbers remain strong, bonds might head back down to major support in the 105.00 area. On signs of a slower first quarter economy, bonds are likely to cool off and settle into a trading range.

Stock Market

After consolidating for about six weeks, the March S&P broke out to new highs, signaling another major up leg in this amazing bull market. Basically, the long-standing bullish rationale of moderate economic growth, low inflation, and relatively low interest rates remains intact. We agree with the warnings that stocks are overvalued (e.g., many mutual fund managers complain they can't find any stocks they really want to buy, but are "forced" to be fully invested since that's what the public wants). But until something comes along to knock the investing public out of a bullish comfort zone, higher prices are favored.

Coffee

A combination of tight deliverable stocks in the US, reports of frost damage in northern Mexico, Colombian port strike, and the potential for the Association of Coffee Producing Countries to agree on tighter export retention at a meeting this week combined to push coffee prices sharply higher. To round out the bullish fundamental story, next season's Brazilian coffee crop is expected to be down significantly. The only problem with jumping on board the bullish band wagon right now is that prices are nearing major 130 - 135 resistance at the upper end of a massive trading range on the price chart. However, a close above there would confirm the start of a major bull market.

Markets That Might Get Hot

Lean Hogs

After exploding to new highs in response to the surprisingly bullish December 1 quarterly pig crop report, the hog market fell sharply, partly on skepticism that hog numbers were as low as the USDA indicated (down four percent) and also due to weakness in the cash market from slower demand. However, taking the report at face value, and assuming demand remains good over the long term, pork supplies should be relatively tight for most of this year. In fact, some experts are forecasting record high cash hog prices this summer. There's a good chance lean hogs will embark on a major uptrend and score new contract highs.

Live Cattle

Cattle prices have been in a broad trading range for months but are currently flirting with an upside breakout. On the bear side of the fundamental argument is rising supply due to higher placements on feed. On the bull side are lower slaughter weights and good demand. Packers have been forced to "pull cattle ahead," i.e., buy lighter, under-finished cattle; and that's likely to continue. In addition, it's been a relatively tough winter for livestock in the Great Plains and Midwest, with extreme cold slowing weight gains and causing above normal losses. Like hogs, assuming demand remains good, this market has the potential to move substantially higher over the long term.