THE FOLLOWING IS AN ARTICLE FROM LAST MONTHS WEATHERWEALTH MEMBERSHIP

A SQUEEZE IN COMMODITIES & AN UPDATED LOOK AT ENERGY AND SOUTH AMERICAN WEATHER FOR CROPS

JANUARY 18th, 2022

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A SQUEEZE IN COMMODITIES & AN UPDATED LOOK AT ENERGY AND SOUTH AMERICAN WEATHER FOR CROPS

JANUARY  18th, 2022

IN THIS REPORT:

WHAT IS A SQUEEZE IN COMMODITIES?

DEVELOPING AN ETF COMMODITY STRATEGY

COMMODITY INDEX MAKES NEW HIGHS BUT WEATHER FOR CORN AND BEANS MORE BEARISH IN THE SHORT-TERM

CASE STUDY OF COLD MID WINTERS AND WHY NATURAL GAS PRICES DO NOT ALWAYS RALLY

GRAIN WEATHER UPDATE–ARGENTINA DROUGHT EASING VS. WEATHER PROBLEMS FOR U.S. WHEAT

RECORD LOW PARAŃA RIVER LEVELS, COFFEE AND SUGAR WEATHER

WEATHER WEALTH TRADE IDEAS (BOTTOM OF THE PAGE):

WHAT IS A SQUEEZE IN COMMODITIES?

 

A squeeze in commodities occurs when there are not enough supplies of a product and global demand remains high. Hence, commercial companies (food companies, grain exporters, natural gas distributors, etc. ) panic and buy an excessive amount of futures contracts in order not to be “squeezed” out: or unable to acquire adequate supplies to fill the needs of customers. When this happens, something we call “backwardation” occurs.

Backwardation is a term used to describe a commodities market when the spot rates are higher than the future price of that certain commodity. In other words, there is a downward sloping forward curve relative to the spot rate set for the maturity of the commodity. “Contango” is the term for a market’s forward price curve that rises above the spot level.

 

In this example (above) the cash market of the nearby contract is above the futures prices. When there is a squeeze, this means that nearby supplies are incredibly tight, and commercial companies have to buy futures in order to avoid the risk of not being able to acquire the actual commodity.

So, which commodities were in a squeeze during 2021? In other words, which ones were in short supplies with incredibly near-term demand?

Wheat: During last summer, global droughts reduced supplies to the lowest in more than 10 years. Bread companies, grain exporters, etc. were not only worried about not being able to receive wheat from farmers to meet demand needs, but inflationary, hoarding concerns were evident because of COVID-19.

Coffee: This market has been incredibly volatile as of late, as the global market tries to figure out how much of a short-term squeeze it is due to the poor 2021 Brazil crop, vs. some improvement in global weather. However, it was really the Vietnam Robusta coffee (lower quality instant coffee) that has been in a short squeeze in part due to container and shipping issues out of Vietnam.

Natural Gas: Last summer’s record U.S. heat, the western drought that meant a switch from hydropower to natural gas usage and tight European supplies, meaning strong U.S. exports of Liquid Natural Gas (LNG), created this huge squeeze. Two Gulf hurricanes last September and worries about a cold early winter also created panic.

 

Lumber: Had probably the biggest squeeze in 2021 because of the housing boom and lack of available supplies, in part due to COVID and the inability to transport supplies.

Source: https://www.visualcapitalist.com/the-periodic-table-of-commodity-returns-2012-2021/

So where might the potential squeezes occur now and potentially in the future?

  1. Heating oil is having a bit of a supply squeeze due to short supplies and extreme cold eastern U.S. weather. This has been my highest confidence commodity trade over the last few weeks (see past reports), especially spreading it against gasoline for protection and risk management.
  2. It is possible that Arabica coffee futures might have a squeeze again due to stocks falling. However, once the Brazil harvest begins in June-August, unless there are harvest delays, wet weather issues to the Colombia crop or a freeze scare in Brazil, that squeeze should pass. Hence, coffee prices could go into a longer term down trend. The question is all about the timing, of course.
  3. Corn, Wheat & Soybeans: No question stocks are quite tight, but right now there is no major squeeze or panic by commercial firms such as Cargill, Bunge, ADM, etc. However, as we get deeper into winter and next spring or summer, any weather-crop issue would later cause some panic.
  4. Metals for the global Green economy: While I often do not advise in metals as they are not weather related, of course, I am following Green Stocks and how a warming planet and the need to reduce carbon and emissions is creating great trading opportunities.

The video below is about the tin market and what a squeeze is.

 

 

 

A POTENTIAL ETF PORTFOLIO FOR YOU TO INVEST IN

 

Here is a sample portfolio with about a 75% allocation and the rest in cash for now

I’m not highly confident that long natural gas will work. Yet, given the extreme cold, you can have a conservative long position. Still, I feel most confident about the heating oil market. Also, I am most bullish on wheat now and a variety of ETFs in metals (both rare earth and “traditional” like silver, tin, etc.)

BOIL (5%): Regarding this aggressive long natural gas ETF, I am only recommending a small allocation. This is due to market action in natural gas and given that inventories are above the 5-year average. Remember, if it was November or December and we had extreme cold, there would be more panic by producers. But, given the record warm December, even with a few weeks of cold weather, producers know stocks will be sufficient without major short supply. Yes, some terminals in the cash market like in New York City and Chicago will see their spot natural gas contracts spike from demand, however, it may not translate to the future market.

USO (10%): Crude oil is not about the weather, of course, but the longer-term charts appear healthy. If there was an active heating oil ETF, I would have recommended this trade a few weeks ago, but there is not. Heating oil has soared about 5-10% in the last few weeks. My advice would have been for a 20% allocation, 1-2 weeks ago before the huge price rally.

This is what heating oil has done vs. gasoline due to driving shutdowns and extreme cold U.S. weather. This chart was as of a week ago and this spread I recommended on my Best Weather Spider, etc. continues to soar. It is up more than $5,000 a contract in two weeks.

 

WEAT (15%): The “squeeze” and panic in the wheat market ended two months ago as commercial grain firms and most countries like China, “filled most of their supply needs”. Since then, big crops in Argentina and Australia hitting the market has eased the squeeze resulting in a strong 15% sell-off in wheat futures. The short-term charts look terrible and we are not really in a weather market again till spring and summer. However, if this drought in the southern Plains continues in March-May, wheat prices have a chance to rally back.

The tricky thing about the wheat market is that I have to analyze, not only the weather and crops in four countries but what the dollar is doing and the outside markets. Last summer, we had droughts in three countries, and buying wheat was quite easy and very profitable.

CORN (5%): It is not just South American weather that is driving this market but ethanol demand. Domestic demand for ethanol was 14.5 billion gallons in 2021 based on the amount of gasoline consumed. With U.S. ethanol production expected to exceed 15 billion gallons this year, exports will have to make up the difference, domestic ethanol demand is expected to remain high. If it were not for the fact of Argentina’s weather improving into February, I would have been more bullish corn. However, the ETHANOL situation and the chances for some summer 2022 Midwest weather problems, means a conservative long position is warranted.

The weather in Argentina is turning more bearish for now

 

BAL (10%): Cotton prices are all about inflation, China demand, and the outside markets; not the weather. However, the long-term charts look bullish and the Texas drought will be a factor come summer, not now.

 

METALS (30%): A transition to a lower carbon greener economy; take a look at these ETFs longer term.

 

 

 

 

COMMODITY INDEX MAKES NEW HIGHS

The strongest inflation rate in 40 years is inducing the petroleum complex, cotton, and metals to surge again. This should cause the Fed to raise interest rates several times over the next two years. However, history shows that rising interest rates usually take two years to have a major effect on inflation. You combine this with global extreme weather due to La Niña and the possibility of some bullish Ag markets deeper into 2022 and the trend in commodities should continue higher; not for all markets but certainly for some of them.

 

WHY NATURAL GAS PRICES DO NOT ALWAYS RALLY ON COLD WEATHER (CASE STUDY 2014-2015)

 

Following the record warm December, U.S. natural gas stocks are slightly above the 5-year average. In order for a “squeeze” to occur in nat gas, (in which natural gas distributors and producers “panic” and buy futures), we normally. have to see stocks below the 5-year average. This is why natural gas prices have not taken off in the cold January.

What happened last week? Speculative commodity traders, along with every investor and their dog, got excited about the extreme cold and snow hitting much of the country. What did that cause? Commercial hedgers stepped in and sold into it. In other words, supplies are adequate to absorb a few weeks of cold weather. It is the heating oil market that has tight supplies.

The charts below show the following:

  1. A similar cold January/February (2014) in which natgas prices soared as we had a supply squeeze and a supply deficit.
  2. In contrast, a cold late January/February (2015) did not result in a rally in natural gas. Everyone was sitting around confused as to why not. Notice in Jan/Feb ’15 that inventories were close to the 5-year average; like today (no panic from a lack of supplies.)

 

Natural gas storage supplies: Notice in January 2014 that there was a supply squeeze with stocks well below the 5-year average. In contrast, look at January 2015 when there were no tight supplies.

CHARTS ABOVE: The top chart shows the price spike to $6.50 in March 2014 due to the very cold winter and supplies well below the 5-year average. Notice, however, even with a very cold February 2015, prices fell as low as $2 !!

The natural gas market knows it is cold and will stay cold but has built-in higher prices based on expectations of strong EIA draws in the next few weeks. There will not be a supply squeeze unless all of February and March are cold. Is that possible? Stay tuned for my forecasts updates and more medium-term outlooks in the weeks ahead. For us to get above $5 we need major draws in supplies, not only the next few weeks but into February and March as well. This is possible but based on the 2015 scenarios above perhaps not likely.

I expect cold weather to continue into early February.

 

GRAIN WEATHER UPDATE

Below, I discuss the SOI index and look at current soybean and corn crop conditions in South America. Additionally, there are maps about improved weather for corn and soybeans for the next 2 weeks. I also illustrate weather problems for wheat in the U.S. This addresses cold weather for the soft-red crop and the drought expanding in the southern Plains.

 

CORN AND SOYBEANS:

Of course, Brazil and Argentina are huge agricultural countries, and their respective weather and crop conditions vary widely between them.

There are three major weather concerns for South American grains

1) The recent drought in Argentina is forecast to lower corn and soybean production by at least 3-5 MMT;

2) The drought from Paraná to Rio Grande Do Sul is worsening. It can have a huge impact on soybean production if things don’t improve later this month and especially in February; and

3) It has been too wet in northern Brazil where white mold may be present in soybean fields. It has to dry out, otherwise, further reductions in the soybean crop will occur in the north.

Source of Charts: Michael Cordonnier: Soybeans and corn report

 

 

Notice the tables above and the fact that Argentina‘s soybean crop is only in 31% good condition and estimates are falling for both Brazil and Argentina corn and soybean crops. This would normally be extremely bullish for corn and soybeans. It is especially so, given the extreme heat in Argentina and southern Brazil this last week. Some readings were over 100°F. However, the map below shows above normal rainfall for much of Argentina this week and likely next week. Ditto for parts of southern Brazil. This is why soybeans sold off some 40¢ (and corn about 15¢) since I mentioned this would happen a week+ ago.

Notice the green and blue with rainfall as much as 150-300% of normal in key dry areas this next week or so. Also drying (red) in the north is more favorable for soybeans right now hit with mold from wet weather. But, what will happen in February? Could it turn hot and dry again? Stay tuned for future reports.

 

WHEAT:

The medium to the long-term trend in wheat is still bullish unless the spring and summer feature good global weather. Here is the list of two U.S. crop areas where some market attention may begin to develop in wheat. However, once again, it is the spring and summer weather from Canada to the U.S. and Russia that mostly dictate wheat prices.

 

WILL RECORD LOW WATER LEVELS IN PARAŃA EFFECT COFFEE OR SUGAR PRICES?

“Paraná” means ‘like the sea’ in the Tupi-Guarani language spoken by indigenous people. At 4,880 kilometers (3,030 miles), it is the second-longest river in South America. It transports approximately 80% of Argentina’s agricultural exports.

(Source: Michael Cordonnier)

 

However, I see the weather situation improving for most of Brazil’s coffee crop following disease issues in the north and dryness last year in the south.

For sugar, while the weather has improved for São Paulo, the continuing drought in Paraná could cause some renewed concerns about the sugar crop.

 

 

 

 

WEATHER WEALTH

 

NATURAL GAS: While stocks are still large for natural gas (read report above), if cold weather continues, not only for the rest of January but February, as well, this should at least put the “breaks” in a major skid in prices. Yet, I am suspect of any major move up in natural gas prices based on my study above (confusing).

A week or two ago I became a bit more bullish on natural gas, but again, this market has been extremely volatile. Due to a lack of a squeeze situation, we are not seeing bull spreads (long Feb or March vs. short May or June) work. My bias is to have a conservative long position in March natural gas, risking last week’s lows and perhaps a small position long the ETF BOIL. The other idea is to sell the March $3.80 put option. Although there is low volume in the put, you should be able to sell this for about 12-13¢ ($1,250 a contract if prices stay above this level the next month)

HEATING OIL: My best trade the last few weeks, being long Feb heating oil and short Feb gasoline is up more than $5,000-$6,000 a contract. Otherwise, if you read between the lines of my reports and Best Weather Spider being upped to a +3 in heating oil a week ago, you are long either Feb or March futures outright with nice profits. Raise stops this next week to preserve profits. I do not want to see one lose and the potential is still there later for higher prices.

COFFEE: This market is waiting for new crop reports by many firms these next few weeks. Dry weather is needed in far northern Brazil and rains in southern Brazil. The weather looks improved for the next week or so, but there are so many outside factors.

I had two winning trades in option strangles much of the last few months but recommended exiting them with profits. My bias is to sell out of the money call options. While stocks are tight, possibly causing a supply squeeze at any time, the Omicron variant and improved Brazil weather keep me from being too bullish.

SUGAR: Seasonally prices go lower into February and I have been bearish due to the big crops in Thailand and India the last few months. However, with energy prices soaring and some renewed dryness concerns in Paraná (a smaller producer than São Paulo, which is in good condition), this market may be oversold for now. Nevertheless, I am not convinced about any move back to 20¢ anytime soon.

SOYBEANS AND CORN: While I mentioned 3 weeks ago buying May corn or selling puts, my confidence is only moderate right now due to improving Argentina weather. I also became more bearish soybeans near the top on my forecast for improved South American weather, two weeks ago. While I did not come right out and say short soybeans, those of you who are experienced traders, hopefully, took roughly 80¢ on long futures ($4,000 a contract) or shorted call options and bought puts to protect profits in futures.

WHEAT: My Best Weather Spider (go back and see past reports) went from basically neutral wheat the last month or so to bullish last week at a (+2). Here is last week’s Spider. I like long July wheat at these price levels, a small position long the ETF WEAT and short May wheat puts some 30-50¢ away as advised a week or so ago. Wheat prices have fallen more than I expected the last month or so, though I did point out many times that weather was not a major factor till spring in this market and big Southern Hemispheric crops might pressure the market.

 

COCOA: The market has rallied sharply on renewed demand. While there is some dry weather for West Africa, it is not a major factor right now. I will look into this more later this week or next week, but I have no high confidence recommendation in this market for the moment and am too busy with the energy market and grains.

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