Using COT data to find
most powerful signal of when to buy a commodity is when
the commercial entities are near record long or have
near record high positions in the futures market signaling
that a major bottom is at hand. This information on
commercial activity, as well as on speculative fund
activity, is provided every Friday afternoon by the
Commodity Futures Trading Commission (CFTC) in the regulator’s
Commitment of Traders Report (COT).
up for Futures' weekly Market Pulse e-newsletter, which
explains the COT report, here.)
of the commercial entities as the insiders in a publicly
traded company. When the CEO, vice presidents and directors
are buying large quantities of stock in the open market,
they are signaling that the people who know more about
the company than anyone else believe that the stock
is a good value. While it is not exactly an apples to
apples comparison, it is analogous to commercial entities
entities in a commodity market represent the producers
and the end users of the chosen commodity. Take coffee
as an example. The producers in this case would be the
Brazilian and Colombian farmers and the end users would
be the coffee roasters like Starbucks or Procter &
Gamble, the maker of Folgers and Nestle. The commercial
entities know more about the economics of the coffee
market than anyone else in the world. They are best
equipped to make judgments as to when coffee is cheap
and when it is expensive.
Fred and Ginger
entities make decisions based upon their own business
economics while speculative funds make decisions based
upon potential for investment profit. The waltz that
these entities dance with each other is equal and opposite
in that when coffee prices have been falling and prices
are cheap, speculators are short while the commercials
are long. Speculators typically care about following
the price trend. Commercials simply are looking for
good economic value.
example, if coffee is trading well below the cost of
production, farmers are more likely to store as much
coffee as they possibly can instead of locking in losses.
They will only sell what they must to pay bills. This
has the effect of being long the futures market. Conversely,
if coffee prices are trading so low that the profit
margins for a coffee roaster like Starbucks are attractive,
Starbucks will stockpile coffee in an attempt to lock
in favorable long-term profit margins. This also has
the effect of being long coffee futures. So, when farmers
do not want to sell and the commercials want to buy
as much as possible, you have a looming scarcity building
in the market at prevailing prices.
opposite is true when coffee prices are too high. When
Starbucks is unable to make a profit when paying high
prices for coffee, they will operate hand-to-mouth to
try to buy time for when prices become attractive again.
Typically, when coffee is bought at prices that are
too high, a Starbucks will sell short so that it may
recoup lost profit margins when prices do fall back
down. This effectively creates a large short position.
farmers see prices that are attractive and profitable
to their operations, they will sell as much as possible
to lock in these profits and store as little as possible.
This effectively builds short positions on behalf of
the farmer. So, with farmers being willing aggressive
sellers of coffee and the commercials buying as little
as possible and operating hand-to-mouth, a looming oversupply
in the market builds.
short, if you buy when the commercials are near a net
record long/high position and you sell when commercials
are near a record short position, you are more apt to
be on the right side of the value commodity investor’s
profit food chain.
further illustrate this analysis, we will take a closer
look at oats and milk. Oats is a market that has recently
exploded higher and milk has yet to do so. In going
over both markets, you can see how profits could have
been achieved in the oats market and how an opportunity
to profit in milk still exists using this commercial
there’s another powerful metric that, when synchronized
with the above discussed near record net long/high commercial
position framework, helps identify a deep value bottom.
It also helps in the timing of when such undervaluation
will be recalibrated to the upside. The metric is the
relative value of a particular agricultural commodity
with the continuous commodity index (CCI).
a particular agricultural commodity is historically
cheap in relation to the broad price level of the 17
most-traded commodities in the world, which is captured
by the CCI through an equal-weighted format and concurrently
is exhibiting near historical commercial net long/high
positions, a rare investment opportunity has likely
the buy alert criteria:
Near record long/high commercial net positions have
historically cheap relative value against the CCI.
1991, the oats market has seen four conditions where
commercial net long positions were near historical highs
and where the relative value of oats prices against
the CCI were near historical lows. Those years were
1995, 2001, 2004 and just recently in 2010. The average
percentage move in oats prices subsequent to this rare
duel condition was 154%. In mid-July prices had already
exploded higher by close to 40% since the recent bullish
signal of the commercials near record long position
and of the near record low relative value conditions
again this duel indicator model for identifying major
bottoms and rather timely price surges has demonstrated
its predictive value in the oats market. If history
is any guide, the oats market has far more upside before
the current bull market subsides. The minimum move expected
based upon historical price performance would be a 100%
move from the recent lows near $2 per bu. This would
project a minimum top close to $4 over the next 12 months.
though the oats market still has plenty of upside left,
the object of using this duel commercial/relative value
trigger is to be able to buy near the bottom and participate
in the early part of the move, which tends to be the
most explosive and where some of the greatest returns
reside. The milk market looks like a textbook opportunity
to take advantage of this effective commercial/relative
value trigger before the explosive early part of the
move takes place.
1996, the milk market has seen four conditions where
near record net long commercial positions have coexisted
with near record low milk prices relative to the CCI.
Those years were 2000, 2003, 2006 and now in 2010. The
average percentage move higher in milk prices subsequent
to these duel buy triggers occurring was 86%.
current spot milk prices hovering near $13.50 per 100
lbs., a typical rally from such a bullish condition
based upon history would take prices to $25 over the
next 12 months. The predictive value of this duel commercial/relative
value system has been remarkable in the milk market
over the last 14 years. If history is any guide, prices
can spike at any moment and will likely do so in violent
Timing and direction
commercial net position activity within the context
of a relative value framework has proven to be an effective
and predictive tool in not only identifying major bottoms
but also in identifying the right timing for such a
move to take place. The same predictive trends of this
duel system can also be seen in every agricultural market
that trades. This is not an isolated system for just
a few markets but for the entire agricultural complex.
other important aspect to understand is that such a
bullish condition is typically only seen on average
twice a decade. Thus this is a rare occurrence that
when identified must be acted upon with a high degree
of urgency. It is not that money cannot be made at other
times, but it just means that the best ratio of risk
to reward exists only a few times every decade.
simple approach does not diminish the importance of
understanding the supply/demand fundamentals of a particular
market nor the technical picture of the recent price
activity. To be a good commodity investor, you need
to use all the tools available to make the best overall
investment decision. But using the commercial/relative
value trigger mechanism can help refine the price point
of initial entry as well as the timing to maximize profits.
operators stay in business by knowing when to buy and
when to sell to maintain profitability. History strongly
suggests that investors would do well to heed their
predictive warnings to maximize commodity investor profits.
Hackett, commodities broker and author of the Hackett
Money Flow report newsletter (www.hackettadvisors.com),
is a nationally recognized agricultural commodities
expert with more than 15 years of money management experience.