- 1997: Volume 6, No. 2 What's Hot and What's Not

Energy Markets

Over the past month, heating oil led the charge to the downside, dragging crude oil and unleaded gasoline with it. However, the situation is changing again. Due to relatively low gasoline supplies, unleaded has grabbed hold and is likely to lead the complex higher again. This time, however, price action is likely to be more dicey due to the negative seasonals still working against heating oil.

According to the latest American Petroleum Institute and Department of Energy stats, gasoline stocks are running about 2.5 percent below last year's relatively tight level. While the peak demand season is still months away (it officially begins on June 1) and there's plenty of time for refiners to turn production around (i.e., switch from maximizing distillate production to gasoline), the speculative crowd traditionally begins to jump on this seasonal trade just about now, evidenced by the recent sharp price bounce. Last year, spot month unleaded spiked to the 7,800 level in spring before falling sharply during the summer. Since stocks are currently below a year ago, it can be argued that a similar price spike is possible, perhaps in the same time frame.

Heating oil, on the other hand, is likely to remain a drag on the petroleum complex. Since distillate stocks are higher than a year ago and the winter has been much warmer, prices could easily slip to the 4,500 to 5,000 level where this market bottomed last summer. Even a strong rally in unleaded might not help much.

Crude oil will be caught in the middle of the bullish supply situation for gasoline and bearish supply outlook for heating oil, probably resulting in a choppy uptrend. As mentioned before, support should come from forecasts for a tight world supply/demand balance which is only likely to result in minor stock rebuilding. And it goes without saying there's always the potential for supply concerns to surface should tensions rise in the Middle East. From a trading standpoint, crude oil is likely to be supported by major support in the 1,900 to 2,000 range. And continued strength in unleaded gasoline could easily generate a rally to major resistance around 2,400 to 2,500.

Soybeans

The soy complex continued to move sharply higher until this week when an unchanged USDA carryover estimate proved a major disappointment to the bull camp, triggering the first significant correction in six weeks (after a non-stop $1.30 per bushel rally). The USDA offset an increase in the crush rate (which is running at a record pace) with small cuts in exports and residual. The USDA is looking for a record 18 percent drop in U.S. soybean exports during the second half of the marketing year, however, many pundits are skeptical of that; despite stiff competition from a record crop in South America, strong global demand could keep U.S. exports at a relatively strong pace. In addition, a 140 million bushel carryover is still very tight, resulting in a dangerously low stocks-to-use ratio, which is what matters to the market. If anything is going to be bearish, it's likely to be the March 31 planting intentions report; acreage could be as high as 66 million, which would equate to a massive 2.5 million bushel crop, assuming good yields, of course. However, the crop is far from "in the bin" so prices are likely to stay strong, maintaining a hefty weather premium. Bottom line, nothing can go wrong with the U.S. crop, and since there are always some weather scares, it might not be long before cries of "beans in the teens" are heard.

Copper

This market has been very strong but suffered a significant pullback recently, indicating at least a near-term top. The bullish fundamentals of good demand and relatively tight stocks remained in play (evidenced by a firm cash market). In addition, it looks like London Metals Exchange stocks have peaked and will trend lower. On the bear side of the ledger remains the long-term outlook for increasing mine production to outstrip consumption. That's still not on the radar screen as far as most traders are concerned, but it's sure to become a bearish rationale should this market run into trouble. It's too early to call an end to the bull phase, but due to the potential "three drives to a top" formation, bulls should be extra cautious.

Currencies

The bull move in the dollar began to slow, partly due to the recent G-7 pronouncement that the dollar had reached a level accurately reflecting"current fundamentals" and should stabilize. Of course, that's probably wishful thinking since forex levels are mostly a matter of opinion, and Fed chairman Greenspan undermined the G-7 jawboning in favor of a steady dollar by strongly hinting that the Fed would make a preemptive rate hike to keep inflation under control. Since the U.S. economy is likely to outperform Germany, Japan, et al over the long-term, and interest rate differentials should remain squarely in favor of the U.S. (i.e., steady to rising U.S. rates versus steady to lower rates elsewhere), capital flows are likely to continue moving into the U.S. and the dollar should continue to gain on the D-mark, Swiss franc and Japanese yen. The only exceptions are the potential for yen strength over the near-term due to repatriation of the yen ahead of Japan's March 31 fiscal year-end and for the British pound to remain relatively strong due to the outlook for higher U.K. rates.

T-bonds

T-bonds continued to make big moves, it's just that they've been in various directions, which is okay if you like whipsaw markets. After falling in early January in response to signs of a strong economy and attendant rate hike expectations, bonds exploded to the upside in response to signs of a slower economy and ideas the Fed would keep rates unchanged. However, over the past four weeks, bonds have fallen precipitously in response to (you guessed it) signs of a stronger economy and hints from Fed Chairman Greenspan that a preemptive rate hike is on the way to keep inflation in check. The net result is a wide trading range based merely on changing sentiment on Fed policy. This time, however, Greenspan's comments on a rate hike are likely to keep a lid on bonds and probably produce lower prices eventually.

Stock Market

There's really nothing new. Stocks remained strong since nothing has surfaced to shake investor confidence in the market. Even the sharp decline in bonds had little impact since a preemptive "anti-inflation" rate hike, strongly hinted by Fed Chairman Greenspan, can be rationalized as bullish for stocks; it could merely reinforce the long-standing bull market mantra of moderate, sustainable economic growth with low inflation and relatively low interest rates. Until something comes along to knock the mutual fund investing public out of their bullish comfort zone, higher stock prices are likely.

Coffee

The coffee market remained hottest of the hot, jumping sharply higher in a ballistic supply rationing phase. All of the old bullish fundamentals of tight near-term supplies and crop worries (this season's output is below expectations and next year's crop is likely to be even lower) remain in play. On top of that, the Ivory Coast recently said it will begin immediate eradication of illegally planted coffee in protected forest areas, further tightening supplies. Ouch. Of course, on the other side of the coin is the potential for demand to slip as price increases reach the retail level. But with Brazil's frost season just around the corner, this market is likely to stay firm.

Cocoa

This market turned hot, rallying moderately at first due to dryness in the Ivory Coast (which is likely to cut mid-crop production), then accelerating in anticipation of a squeeze in the London market (where a big commercial firm is rumored to hold the bulk of deliverable supplies), finally exploding higher on news that the Ivory Coast would begin immediate eradication of illegally planted cocoa in protected forest areas. Ivory Coast officials had no estimate on the amount of cocoa that would be lost, but said the 1996-97 crop would be as low as 950,000 tons compared to the record 1.2 million the previous season. Over the long-term, it's tough to expect a prolonged bull move in cocoa due to surplus stocks from previous years of overproduction. However, higher prices are still favored near-term.

Markets That Might Get Hot

Precious Metals

The silver market jumped to life, breaking a long-standing downtrend before falling back this week. Gold followed, supported by a potential mine strike in Russia. Whether those bullish feints signaled the start of something big remains to be seen. From a fundamental standpoint, there was nothing to indicate any significant increase in silver demand. In addition, a Russian mine strike would mainly affect platinum and palladium output, not gold. Also, there's no sign of inflation, despite constant concern voiced by the Fed. However, for those gold and silver bugs out there, call option premiums are still relatively cheap, so it's probably worth a shot at the long side, particularly in silver, which is capable of massive rallies on the technicals alone.

Lean Hogs

A weak cash market and ample hog marketing triggered a sharp break in lean hogs. Either the December pig crop report was wrong and there are more hogs out there, in which case cash prices are likely to stay on the defensive until demand turns around, or farmers are still in the process of liquidating hog numbers, in which case the March 27 pig crop could be a humdinger of a bullish report. The crowd expects that report to show the start of an expansion phase in hog numbers, however, we'd argue that farmers don't switch marketing plans that quickly (they were still liquidating hogs in December) and that a declining hog/corn ratio (i.e., slipping profit margins) and relatively high corn prices will prevent expansion. Basically, why take the trouble to process expensive corn through a cheap hog when you can make an easy profit by selling $3 corn? Trading-wise, if the March pig crop report is bullish, look out above.