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The nearby orange juice contract made another sweeping move to new highs to start the month of March. This is the latest in a series of moves dating back to lows established in mid-February 2009. The reason for this is a powerful one-two punch of increased consumer sales in the US, which shows up the accompanying chart, along with reduced production in Florida after this winter’s freeze. In February, the USDA pegged the Florida crop at 129 million boxes, down 6 million from the previous month. If production is cut another 2-3 million boxes by the USDA this week, it would take production to the lowest level in more than 20 years. The broad turn in demand is just as significant. As of January 23, 2010, sales in US retail outlets were at the highest level since January 20, 2007. This looks like a turn in an 8-10 year downtrend in sales of OJ, which may be based on a very deep shift in eating and health habits among US adults.

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A number of international brokerage firms are touting copper as a 2010 bull market candidate. In the base metals trade, seeing recommendations from either British or Australian sources seems to give many traders even more confidence in the bull market predictions, perhaps because those two countries have had a history of heavy corporate involvement in base metals mining. Nonetheless, the copper market seems to be able to track economic activity in the developing world, and it has sometimes been able to discount periodic negative impacts from the developed or OECD countries.

Certainly global industrial activity will find it difficult to spring back to pre-sub prime levels, but seeing the Chinese buying more automobiles than the US in the month of January could be a sign that the developing world is capable of making up for an anemic recovery in the US and Europe. It should also be noted that infrastructure spending was a major component of many global stimulus projects, with the majority of the US spending not even getting into the market until later this year. Therefore, what demand might be lost from classic economic activity might be regained through big government projects.

From a shorter term perspective we suspect that some mining activity remains curtailed because miners have only recently seen prices return to the 2006-2008 consolidation high zones and the cost of mining has increased because of higher energy prices, the potential for wage re-negotiations and because local governments are demanding higher taxes or more stringent environmental practices. While $3.00 copper pricing might have been very lucrative prior to 2006, copper miners might eventually need prices above $4.00 to be confident in expanding their production. The general pattern of LME daily stock changes over the last two months has favored the “build” side of the equation, but recent daily declines seem to be breaking that pattern, and that in turn could be a hint that the copper market is set begin to tightening again (see chart).

In short we think that copper has signaled a value zone in the nearby contract above the $3.00 level and that copper prices for December delivery might have an upside capacity of $3.75 to $3.80 in the event that recovery prospects for the developed world improve.

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Despite all the obvious ineptitude in the U.S. it would appear that the Federal Reserve is under by very astute leadership. Congress had to rant against Chairman Bernanke in his reconfirmation process because even the politically-blinded mainstream media was having trouble keeping the blame from falling on entrenched members of Congress who provided Ginnie and Fannie the unrestricted right to mortgage the future of America to the hilt. So far, little blame has been levied against Americans who borrowed beyond their needs for homes, cars and flat screen TVs. On the other hand, the Fed has been given the task of securing a recovery from “a deep economic wound” and has also been given the added burden of containing inflation in the process.

It is our opinion the Fed is already masterfully controlling the situation with a mechanical discount rate hike that should only impact the banks. It also seems as if the Fed is singing the mantra of leaving rates low to insure the recovery, but at the same time they are heavily in the media with hawkish dialogue that is serving to temper inflationary expectations. What the Fed really wants is to keep rates low to those who need them and in turn give some pause to those who are betting on rising inflationary pressures.

Dovish
February 24, 2010 Fed Chairman Ben Bernanke told Congress that the central bank has “promoted economic recovery through sharp reductions in its target for the federal funds rate and through purchases of securities. The economy continues to require the support of accommodative monetary policies.”

February 26, 2010 Chicago Federal Reserve Bank President Charles Evans told CNBC: “I still think it’s going to be an extended period of time that interest rates are going to be low.”

Hawkish
February 26, 2010 Kansas City Fed President Thomas Hoenig (on C-SPAN): “One of the issues that I have dealt with is how do we bring interest rates back to a more long-term sustainable level from their extremely low and obviously unsustainable levels…I think we should be going back to a more normal level sooner rather than later.”

March 2, 2010 Kansas City Federal Reserve Bank President Thomas Hoenig told CNBC: “When you have zero rates that go on indefinitely, you are inviting future problems. We know that zero is non-sustainable…the market already knows that.”

It is also possible that recent equity market gains are the result of ideas that politics are leveling out and that the chance for extreme change is being reduced. The fact that the Dollar was seen as a flight to quality instrument in the recent Euro zone debt debacle suggests that the US is still seen as a safe environment. While we don’t have the benefit of knowing the results of the February monthly Non farm payroll report as of this writing, we get the sense that any slightly disappointing readings will be discounted and even that worse than expected readings could be discounted too because of the possibility that severe weather had an impact on the data.

In short, the equity markets and many physical commodity markets have mostly shaken off a series of global tightening moves, a rising Dollar and what continues to be a disappointing recovery pace. We have to wonder how high prices would be if the recovery was thought to be entrenched, the initial rate hikes were thought to be past and Washington wasn’t trying to modify the entire American economic system every two hours. In short, the bull market mentality in commodities lives on even in the face of significant headwinds.

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What happened on February 16th? With commodity and equity markets forging a distinct upside burst, one almost got the impression that some form of robust recovery was back in place. However, while we suspect that the US economy is still progressing toward self-sustainable growth, we also doubt that the economy has achieved that status yet. It is also possible that news of a 30 day grace period for Greece debt issues provided an across the board showing of optimism. However, news that a key Midwest Democratic Senator (Evan Bayh) would not seek re-election also seemed to have noted repercussions. In addition to another seat from the majority being called into question, the widely respected Senator also suggested that Washington was broken, and that would seem to challenge all incumbents in the next election. Since the Democrats hold historical majorities in both governing bodies, it would seem like the latest news is worse for the Democrats. In fact, even the President was ridiculed by portions of his party and by liberal media talk show hosts that voted for him, and that in turn could force a move back toward the center.

If the power block in Washington is dissipating, that could mean that extreme change that has been feared by the markets won’t materialize. While it might be too simplistic, we think that stocks and physical commodities were dented in January and early February and US Treasuries futures were lifted as a result of fears that US banks would be unable to trade, and we think the reversal of those fears provided some of the relief gains posted in many markets on February 16th. While Congress is being taken to task for choosing politics over common sense in many policy initiatives, the White House has also take heat for what small businesses say are unfair changes. Seeing that Washington even tossed around the idea of eliminating the mortgage interest deduction to high income Americans is a classic example of Washington looking for revenues without considering the market ramifications. With sagging US real estate values, ongoing foreclosure problems, fears of problems in commercial real estate defaults swirling in the background and very serious European debt concerns still in place, it just doesn’t make economic sense for the US government to kill any portion of the US real estate market. In fact, removing new buyers from the US real estate market before the economy has gained momentum would probably be revenue negative to the budget. In an overly pessimistic view, we suspect that a move toward political gridlock in Washington might actually create enough clarity for business and consumer confidence to begin to improve.

We think that traders should view the February 16th action as foreshadow to the eventual trend in US physical commodity prices. But, given the ongoing uncertainty toward the recovery pace and the potential for a derailment of said recovery, traders have to be sure to buy physical commodities after periods of noted weakness. A temporary shift to using technically-orientated overbought and oversold indicators might be an effective trading tool until the US economy exhibits a stronger a pattern of growth.

Continued gains in physical commodity markets will probably come from demand-driven views, but as the end of February approaches, supply side issues have the upper hand in many markets. Given our near term bearish/long term bullish views, we advocate short futures versus long multiple call position plays in markets like cattle, corn, sugar, orange juice, gold and silver.

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While the soybean complex may be inundated with too much supply, the focus of attention for the corn market over the near term will be on longer term demand factors and of course on the outlook for planted acreage. In its baseline projections issued in late 2009 in preparation for the budget process, the USDA put corn planted area for the 2010/11 season at 88 million acres, up from 86.5 million this past season. This estimate will be updated in the USDA Outlook Forum for February 18-19 (released after this writing), but there is a general market opinion that corn planted area will increase by 2-4 million acres over that number, with some estimates even higher. Traders seemed to dismiss the preliminary baseline projections from the USDA, but we should point out that while there are more than 2 million acres coming out of the Conservation Reserve Program and winter wheat plantings were low, the baseline projections for the 8 major row crops are projected at just 247.1 million acres, down from 248.9 million last year and from 253.1 million acres in 2008. If the baseline numbers are close to correct, the trade may be overestimating total plantings for the coming season.

The enclosed table shows several “what-ifs” for the corn outlook for the 2010/11 season if we assume that producers will plant 4 million more acres this spring than they did last year. We have also assumed a slight increase in usage for the coming year due to the surge in ethanol production and reassuring reports from the EPA last month that helped to confirm that corn-based ethanol growth is likely to continue over the next several years. In November, the US used 362.4 million bushels of corn to produce ethanol. In order to reach the new USDA forecast of 4.3 billion bushels, the US needs to average 361.2 million bushels each month to reach the new projection. Given the recent trend, the USDA may be in a position to increase this forecast again in future reports.

If we assume a trend-line yield for the coming season at 161 bushels per acre, US ending stocks for the coming season are likely to decline to 1.702 billion bushels, compared to 1.719 billion this year and 1.673 billion last year. A record yield would drive ending stocks to just over 2 billion bushels. However, if we were to assume a yield that is the average of the previous five years (152.4) then ending stocks slip under 1 billion bushels, and the stocks/usage ratio would fall to just 7.4%, the second lowest in history. If we were to plug in the same yield as we had in 2005, ending stocks drop to 616 million bushels and the stocks/usage ratio to a record low. A yield level such as that would be only 8% below trend.

In its February Supply/Demand report, the USDA estimated world ending stocks for the 2009/10 season at 134.04 million tonnes, down from 145.88 million tonnes last year. This put the stocks/usage ratio at just 16.6%, the third lowest in 35 years.

There are plenty of factors which could keep grain markets under pressure over the near term, but our analysis suggests that corn prices are not likely to see a long, drawn out bearish trend. It also suggests that any sign of a weather issue that might reduce yield should be taken as a sign of a potential very tight situation ahead. Aggressive traders might assume a 388 to 351 trading range for May corn over the near term.

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While we cannot rule out ongoing gains in crude oil directly ahead, we have to believe that prices have recently gotten a little rich relative to what near term supply and demand fundamentals would indicate. From a technical perspective, crude oil has also been showing signs of being technically overbought, with open interest consistently posting readings above 1.32 million contracts and the recent COT positioning report showing a combined Non-Commercial/Non-reportable net long reading of 139,000 contracts. In fact, if one were consider that since the report’s mark-off date May crude managed to extend the rally by another $4.00 per barrel, crude oil has likely seen its spec long position grow even larger and is probably close to a moderately overbought standing. Even though we expect to eventually see nearby crude oil prices in 2010 reach highs in excess of $90 and perhaps even $100 per barrel, we currently see a slower than expected US recovery pace, residual Euro zone debt issues, periodic tightening threats by China and persistent strength in the Dollar as problematic to energy prices gains.

However, our biggest concerns are weak gasoline demand readings and burdensome supplies. Despite seeing very low US refinery operating activity, US gasoline stocks have not shown any sign of tightening. One might explain away the burdensome stocks situation as being a result of the slack seasonal demand window that will be rectified as we progress toward the summer driving season. In the meantime, we suggest that traders look to implement short futures and long multiple call strategies in an effort to capitalize on a potential corrective slide in the near term but ultimately in the hopes of catching the next wave higher in energy prices off the combination of growth and seasonal demand. We currently see May Crude oil prices as being prematurely strong and in need of a correction back down to levels below $75.00.

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A change seemed to come over the markets in mid January. In addition to a slackening of US economic readings, the commodity markets were also presented with a series of credit-tightening moves by the Chinese and persistent strength in the US Dollar. With the added burden of a large upward adjustment in grain supply in the January USDA Supply and Demand report, the overall attitude toward most physical commodity markets was punctured. In looking around at the general consensus of fundamental opinions in the grain markets, one certainly sees what would appear to be a very bearish view toward prices. Given the large U.S. crops, a very large South American soybean crop and talk of more 2010 acres available for corn and soybeans, the bear camp would seem to have all the marbles early in the crop year. Ultimately we think that demand will serve to chew through supply in many markets, but given the head start of burdensome supply of corn and soybeans and a less than stellar economic outlook currently, the bear camp should have the advantage in the coming weeks.

We would suggest that the February 5th Non-Farm payroll number, to be released after this writing, will be a very important reading on the state of the recovery. Traders looking back to physical commodity price action on February 1st and 2nd have to acknowledge a tightening, positive correlation between commodities and equities, and we think that it clearly highlights a “need” to see forward progression in the U.S. economy for certain commodity prices to find support. While markets like sugar, orange juice, lumber, the Yen and platinum might be able to fade a near term, outside market downward bias ahead, markets like soybeans, silver, hogs and gold might be in for additional losses into the end of February.

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Since the first half of December, open interest in wheat has headed straight up with only a handful of very minor corrections. This has come regardless of which way the market was headed, although the biggest gains in open interest have occurred since the start of this year when wheat started moving straight down. The question now is whether this added open interest consists mainly of index funds getting long, trend-following funds getting short or a combination of the two. One reason this matters is that trend-followers are getting heavily short. In fact, they are within 8200 contracts of their all-time record net short position of over 69,000 contracts that was established in September, 2009. If the trend-followers continue to press the market and this comes in conjunction with general liquidation selling by index funds, it would be enough to push the May wheat contract below the early October lows at 472 and possibly as low as 438.

A sell-off in the dollar could be enough to forestall this bearish scenario for a few weeks, but the combination of weak export demand for US soft red winter wheat and the possibility of ongoing liquidation weakness in the grains and equities would seem to tip the scales in favor of continued declines in wheat. Keep in mind that cumulative export sales for the 2009/10 season are still behind the pace to reach the USDA projection for the entire season. This suggests that export demand is even weaker than the current USDA forecast, which happens to be at the lowest level in nearly 40 years.

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Optimism in the copper market had been running exceptionally high since the start of the year on expectations for industrial metal demand to recover in tandem with an improvement in the global economy. A good portion of the gains in copper leading up to the January high was based on expectations that China’s voracious copper demand would remain robust this year, while rising investor risk appetite tied to the weak Dollar also provided significant price support. But there have been a few fundamental, economic and political shifts over the last month that have changed the mood. We see a strong enough change in sentiment to suggest more of last year’s premium will be pulled out of the market and leave May futures vulnerable to an eventual test of the $2.85 price level.

Perhaps the biggest factor impacting the trend change in copper has been China’s move to tighten bank liquidity, that has escalated concerns that copper demand will soften as China’s economy cools. As there seems to be growing speculation that China will have to tighten interest rates even more aggressively during the year, the market is beginning to price in a lower demand outlook from Asia, and that could end up being a longer-term weight on the copper market. With most of the economic news in January coming in soft, it still doesn’t appear that the pace of recovery in the US economy, at least in the key copper industries of construction, transportation and machinery, will be strong enough this year to support copper prices at these inflated levels.

With the copper market in the midst of scaling back demand expectations, we suspect that it will feel a strong impact from high supplies. Copper warehouse stocks at the LME have seen a steady rise over the last several months, recently reaching a one-year high. This also raises doubts over actual copper demand. The Dollar is currently in a fairly convincing uptrend, being supported by a variety of factors, and this could be another bearish influence for copper over the near term. We also think traders shouldn’t underestimate the bearish impact from the harsh political regulatory climate. The government’s move toward imposing tighter position limits and the Obama Administration’s push to restrict proprietary trading by banks could certainly change the investment landscape and would likely have a negative impact on copper prices as well.

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At least as of this writing, there appears to be a slight macroeconomic letdown facing the markets. While it would seem like the US is continuing to fight its way back toward growth, the pace of that return might be somewhat less than what was built into most commodity markets in early January. Even the global recovery effort seems to be a little disappointing, especially with China applying a number indirect tightening moves over the last three weeks. However, we think the tightening moves are eventually going to be a very positive development, as they should reduce the threat of runaway inflation that could bring forth overly aggressive policy action. While many well-known analysts have recently fretted over the prospect that the Chinese economy is simply a bubble poised to pop or that growth in China isn’t entrenched, we think it’s a telling sign that the Chinese authorities are confident enough in their forward progress to step up and purposely slow economic activity.

As for commodity prices, many of them also seem to have gotten slightly ahead of the curve with global growth expectations clearly running ahead of reality in the first 15 days of January. With the added influence of a bounce in the US Dollar off the January lows, even the currency market’s influence has turned a little negative. However, in the end there is no reason to think that the established uptrend pattern in commodities is destined to end, and from our perspective there doesn’t appear to be a sign that the investment interest for commodities is going to wane.

Certainly there is some disappointment on the pace of the improvement in US payrolls, but one has to look at most events of the last 45 days as generally indicative of a migration away from the truly historic financial threats facing the US. While some might discount the news of the $51 billion annual profit posted by the US Federal Reserve in 2009 as a drop in the bucket for US debt, it should also be noted that US Treasury supply has been taken down very easily in periodic auctions and that the most recent capital flows report showed that foreigners remained very keen to invest in the US. With US banks healing quickly off very advantageous yield curve windfalls, they could soon become flush with enough cash to begin to take on more loan risk. Therefore, we assume a short term corrective view on most physical commodity markets, but the length and the duration of the slide might not be as significant as the bears would hope. Clearly the grain markers are given an added measure of vulnerability by the surprise upward adjustment in US corn yields and the widespread expectation of massive soybean supply from South America, but it is also clear that demand is going to remain strong and that lofty ending stocks forecasts will eventually be seen as overly optimistic. Going into the end of January we give the bears a distinct edge, but in markets like sugar, orange juice, copper, and unleaded gasoline noted near-term liquidation should be viewed an opportunity to buy into an ongoing bull trend.