- 1998: Volume 7, No. 6 What's Hot and What's Not

The financial markets stayed hot due to global economic uncertainty but most of the agricultural markets, with the exception of hogs, cooled off.

What's Hot

Stock Market—The stock market came roaring back in response to two Federal Reserve Board rate cuts, the second one a "surprise" move between FOMC policy meetings which indicated that the Fed had adopted an accommodative stance and would most likely err on the side of lower rates to make sure that global financial markets stabilized and that the U.S. economy continued to grow at a moderate pace. However, although the stock investing public views lower interest rates as an economic cure all, even Fed Chairman Greenspan no doubt would caution that's not the case. While lower interest rates should take the edge off of the global economic decline, problems in Asia and Latin and South America aren't tied to high interest rates; e.g., Japanese interest rates have been under one percent for years, but Japan still can't get out of recession. In addition to ongoing problems in Asia, about two-thirds of U.S. businesses in a recent survey planned to cut back on spending in 1999 which practically ensures a weaker economy. We have a feeling that the stock market is setting up for a big disappointment. Also, history buffs would point out the similarity between the current rally and the "reprieve" rally in 1929 which was followed by a massive collapse. For Elliott Wave aficionados, the current comeback can be labeled a "wave two" up correction in a five-wave bear market, with the powerful and usually catastrophic wave three collapse yet to come. We'd be very cautious about jumping back on board the stock market and feel its prudent to brace for further declines.

T-bonds—Bonds have been hot on the downside, first due to hedge fund liquidation of Treasury positions involved in "carry play", i.e., borrowing in a cheap currency (the yen) and investing in a high yield currency (the dollar), then on shedding of safe haven longs due to the rebound in global equity markets on ideas the worst of the global economic crisis is over. However, bonds are down to a level that is attracting institutional interest (both U.S. and foreign) and are likely to rebound, particularly since the U.S. economy is still expected to slow significantly next year and the Fed is likely to keep easing monetary policy. Bonds would also quickly regain safe haven status if stocks run into trouble again.

Currencies—After exploding to the upside, the Japanese yen leveled off into a trading range, indicating that the unwinding of dollar/yen carry plays (see above) is over. At this point, it's tough to guess which fundamental rationale will become dominant; the bearish outlook for Japan's economy to remain weak during 1999, or bullish hopes that Japan is finally getting serious about turning things around, evidenced by a significant banking reform plan. It's a coin toss but, technically, a close outside of the current trading range is likely to signal the direction of the next major move.

Lean Hogs—Hogs have been in a major bear market since last year, pressured by ample pork supplies, a situation that's expected to continue through the middle of next year. Amazingly, even though cash prices hit the lowest level in nearly 28 years and producers are losing big money, the recent pig crop report indicated continued expansion in hog output. That's due to the proliferation of "corporate" operations which won't reduce hog production for fear of losing market share. There's been a lot of hoopla over U.S. pork donations to Russia, but that just won't make a dent in U.S. supplies or make up for lost Asian business. There is some light at the end of the tunnel; more breeding stock is showing up in the slaughter mix, setting the stage for reduced hog output down the road. In addition, although the animal rights people will cringe, there are indications producers are liquidating significant numbers of baby (feeder) pigs to avoid turning out a money losing adult. However, lower prices are favored near-term as producers liquidate hog stock.

Markets That Might Get Hot

Heating Oil—Buying heating oil is a popular trade this time of year in hopes of a seasonal bull market or price spikes during the winter. However, the ingredients don't appear to be in place for a sustained up move. For starters, supplies at the start of the peak demand season are huge. American Petroleum Institute distillate stocks of 147 million barrels are well above the "normal" range of 130 to 140, providing a cushion for all but the coldest of winters. In addition, the current forecast calls for the La Nina weather phenomenon (the evil twin of El Niño) to bring periods of both above and below normal temperatures to the northern Midwest resulting in an "average" winter. Of course, anything can happen with the weather or in the Middle East (Iraq's been causing trouble again), but the upside prospects in heating oil don't appear good.

Natural Gas—This market is in a similar situation to heating oil; supplies at the start of the peak demand season are ample and winter temperatures are expected to average out to normal, although anything can happen when it comes to the weather. However, on the plus side, natural gas is an extremely volatile market increasing the chance of price spikes if and when Arctic weather hits. However, timing will be key since it will be tough to withstand the downdrafts when the weather warms up.

Soybeans—Even though traders are currently fixated on U.S. grain and soy donations to Russia, that's an insignificant factor compared to weather in South America. Even though U.S. soybean stocks are projected to remain ample through the entire 1998-99 season by the USDA, there's the potential for significant rallies if crop problems develop in South America, which appear more likely this growing season since La Nina tends to bring below normal precipitation and above normal temps to northern Argentina and southern Brazil (South America's bread basket) during the January-March period. Unfortunately, the current La Nina is a bit anorexic and needs to gain some heft before becoming a major factor.

Coffee—This market had been stuck in a range until hurricane Mitch destroyed much of Central America and with it the high quality coffee demanded by U.S. consumers. Concrete damage estimates won't be available for months, but coffee prices have already gained 22 percent in anticipation of lower supplies. And there's certainly the potential for further explosive gains since what's left of the crop can't be harvested, processed or shipped.

Gold—We can't get excited about the bullish arguments of better gold demand due to an improving global economy (a notion sparked by strong recoveries in global equity markets) and tighter supplies from production cutbacks next year, feeling that the bearish fundamentals of low inflation in the U.S. and Europe, deflation in Asia, the likelihood of further European central bank gold sales after European Monetary Union early next year, and forecasts of a slower global economy next year are much more compelling. But the "hot money" has been getting into the market and those who want to cast their lot with the hedge fund gurus could try an "investment" in gold.