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COMMODITY PHILOSOPHY

When it comes to agricultural commodities there are some realities and considerations that hedgers (farmers and end users) and investors should focus on in making the best financial decisions they can. Let’s break them down into four groups.


LONG-TERM INVESTMENT

I do not believe in day trading or excessive trading. Trading is for gamblers, not investors. Trading will almost assuredly damage your long-term investment results. If you are a hedger (farmer or end user) or investor, you are making a decision to buy or sell with the idea of getting the best return on your investment. If you are a farmer your investment is the crop sitting in the bin or the crop that is sitting out there in the field or the live stock that still needs to be fed before it comes to market. If you are an investor it is simply the money backing the investment that is searching for a good rate of return.

By the very fact that futures and options contain finite months of ownership before expiration does necessitate a more proactive approach (especially for options) when compared to stocks for example. The key here is that most farmers lose money in their hedging accounts every year because advisors have convinced them that futures and options are insurance products not investment products. I emphatically disagree.

Farmers and investors have plenty of insurance and the last thing they need is more of it. If you use futures and options as insurance products then you are likely to receive insurance type performance. In most years you will lose the entire premium (investment) and every once in a while you will get a large payoff (return).

I believe futures and options are investment products. If one makes investment decisions on when to deploy such products and when to cash them in, returns on the farm and for investors should be greatly improved. So the focus here is not to do a whole bunch of transactions with options and futures that generate large commissions. The focus here is to do a few sensible transactions that generate a better outcome with a long term plan in mind. I want to get compensated for my advice, not for how many trades you do.

With futures, I believe in having a 1 to 2 year horizon and establishing positional trades for those who want to invest in the agricultural commodity markets by going long or short. The key to successfully investing in agricultural futures is to understand your risk tolerance so that you can weather the volatility that will inevitably ensue during the time of your investment. Failure to correctly assess your appropriate risk tolerance is a recipe for substandard investment performance.

FUNDAMENTALS

This is where most advisors spend a majority of their time. In my opinion, it is of little benefit to the hedger or investor in making a good financial decision. Don’ t get me wrong, one must have a fundamental framework from which the foundation of a decision can be made. But to spend too much time and to rely too much on fundamental numbers is fraught with frustrating results. The reason is simply this: the current fundamentals everybody knows, so by definition the current fundamentals have little or no advantage to the hedger or investor. Remember, when a piece of information becomes known to all it loses it value to the hedger or investor who has it. What really matters is what the fundamentals ARE GOING TO BE. The reality is that no one ever knows. In order to get the future fundamentals right, one has to correctly assess weather, acreage, exports, fund behavior, yield prospects around the globe and global liquidity factors. Although one may be able to get some of these issues right some of the time, it is virtually impossible for one to get all of them right all of the time. So time would be better spent trying to know what you can ascertain and spend less time trying to know the unknowable.

That is why we rely on a series of fundamental indicators that have been time tested and highly correlated to future price behavior. Some of the unique indicators we use involve relative value, cash differentials and futures spreads just to name of few.

TECHNICALS

Technical indicators have been around for a very long time and advisors have been applying them to stocks, bonds and commodities as an aid to help in the decision making process for as long as there have been markets. The problem is that there are very few proprietary technical indicators anymore. The standard ones everyone knows about already. So once again, by definition if everyone is using a particular technical indicator then that indicator becomes less and less effective over time. Standard technical indicators such as Relative Strength Index, Bollinger Bands, Stochastics, and the MACD Momentum Indicator are but a few of the more popular ones out there. They all do a very similar job.

All these technical indicators are very good a telling you one thing. They are very good at telling you when a market is running at full speed either in the up or in the down direction. What they are woefully inadequate at predicting is how long a market is going to run at full speed. In the last year there have been extended overbought and oversold readings from these indicators in most agricultural commodity markets that have lasted months at a time! In the Grain Markets it was not uncommon to see the markets move up or down a dollar per bushel or more between the beginning and the end of an overbought or oversold condition. Those that made financial decisions based solely on technical indicators got run over by the market quite often. I could mention similar instances in other Ag commodities (cotton, sugar etc.) over the last year.

We prefer to rely on longer term logarithmic price channels to give us better and much more correlated signals for bottoms and tops in agricultural markets.

There must be more to making a good financial decision than simply relying on technical indicators.

MONEY FLOW

I know of very few advisors who focus at all on the money flowing in and out of Agricultural markets as a basis from which to help guide hedgers and investors into making sound financial decisions. Many mention it in a passing sentence but I have not seen many give it the priority that I believe it deserves. What is money flow anyway?

It is the net measure of the net buyers and net sellers in any given market at any given moment in time. In commodity markets we have three distinct constituencies: Large Speculative Funds, Commercial hedgers and Index Funds. The interaction of supply and demand between these groups sets prices each and every day.

If there was a way to measure what these groups were doing and to then translate that into a working tool to adequately measure the forces of supply and demand, you would have one very exciting tool at your disposal.

Fortunately for us, the CFTC (Commodity Futures Trading Commission) tracks this every week and gives us the raw numbers on Friday afternoon as to the Speculators, Hedgers and Indexers positions as of the close of trading the prior Tuesday. It is called the Commitment of Traders Report.

I have developed an indicator that can help you decipher this raw data into a simple and easily followed indicator to help you make educated financial decisions on when to buy and when to sell based upon your particular orientation.

I believe that a keen focus on money flow wrapped around a firm appreciation for basic technical conditions and a broad understanding of fundamentals gives the hedger and investor the greatest ability to make the best financial decisions consistently.

Following the forces of supply and demand is simple, logical and effective. It simply makes good business sense to understand and measure the Money Flow that is affecting the markets into which you are selling or buying.

Download a free copy of our white paper which discusses the Smart Money indicator in more detail.

You can also download a free sample of the Hackett Money Flow Commodity report.

The annual subscription to the Hackett Money Flow Commodity Report is $300/year and can be paid by credit card or check.

Begin your subscription today!

I look forward to helping farmers (hedgers and end users) and investors use this money flow tool to maximize desired decision outcomes.

If you would like to set up an account with us please call us at 561-573-3766 or e-mail us at Shawn@hackettadvisors.com. You may also fill out an online application directly with R.J. O'Brien.


President, Hackett Financial Advisors, Inc.

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