With the US Dollar seeing a two-month slide and US Treasuries only able to manage a two month consolidation below contract highs, it would also appear that some flight to quality interests are already pulling away from the US Dollar and US Treasuries. While we don’t see the US credit rating called into question anytime soon, in the event that the numbers remain soft and the next non farm payroll report shows another big loss, the onus could be on Washington to do something other than extend unemployment benefits. While Harvard and other politically correct institutions of higher learning might be able to produce studies that ferret out some abstract stimulus effect from extending payments to the unemployed, to get “self perpetuating” growth might require some tried and true classic stimulus efforts.

While China and other important world entities have signaled their ongoing interest in US Treasuries, it is not a given that another round of deficit spending from the US will go off uncontested. Therefore, we see the potential for even more slowing ahead and a major political/economic decision might have to be made by Congress and the President in the coming month. While physical commodities like oil and metals are sure to be dramatically impacted by the recovery/no recovery situation, we think the tell-tale markets will be the US Dollar and perhaps the US Treasuries.


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For much of the past three years, the copper market has been a very solid leading indicator of where the economy was heading. While some might suggest that the mid July rally points to a possible recovery ahead, it is more likely that the market reached an undervalued level below $2.80 and it needed a corrective bounce. The subsequent rally from the sub $2.80 low to the $3.10 area was accomplished at least partially on the back of a gradual tightening of supply at the exchanges, but it was also partially forged off speculation of a recovery in the wake of a reduction in European contagion fears. In looking at daily and weekly changes in world copper exchange stocks, the LME has shown a very definitive pattern of daily declines. The Shanghai exchange has also seen a tightening of supply. Since March 3rd when LME copper stocks began to decline in earnest, that exchange has lost approximately 131,650 tons of copper and saw declines on 87 out of 97 days.

Some might even suggest that changes in Shanghai copper stocks are even more critical to world copper prices, as China has become a dominating demand force in the market. Therefore seeing Shanghai copper stocks drop in 8 of the last 10 weekly readings for a total decline of 60,902 tons would seem to suggest that China is still growing or that China has for some reason decided to reduce its buffer stock of copper. It should also be noted that the International Copper Study Group last week put the world copper market in a 60,000 ton deficit in the month of April, and that highlights a market that has remained tight even in the face of some rather slow economic activity. In the end, we would suggest that copper is a commodity market that should sense the end of the slowing first and in turn see the biggest reaction to a return to positive growth expectations.

However, with December copper recently climbing back above $3.10 and those prices sitting more than 10 cents off the early July lows, we would caution traders to buy copper cheap and avoid paying up near the upper end of the last two months’ trading range. In our opinion, the copper market is likely to encounter another disappointment in the lead-up to and through the next US Unemployment Report, and the realization of a sluggish US economy is certainly capable of knocking December copper back down to the $2.89 level. While the US and European economies might not be able to return to the robust growth seen prior to the sub-prime crisis, seeing the US and Euro zone become less of a drag on global demand could make a late July or early August correction in copper a chance to get in on what could be a pretty solid uptrend through the end of this year.   

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The impact of the sub-prime crisis continues to serve as a drag on the global economy into the 3rd quarter of 2010. As suggested in our last newsletter, the evidence of slowing in the US economy has become more prevalent throughout a wide range of statistics over the last month and that in turn has created a fresh drag on physical commodity prices.

We also suggested in prior publications that a number of physical commodities like soybeans, sugar, crude oil, RBOB, heating oil and natural gas are pretty flush with supply right now. Fears on the demand side are, therefore, something that should be expected to weigh on price structures.

Ordinarily we would have expected some response from the government to recent evidence of slowing but our Congress gets a full week off for the 4th of July, perhaps so they can take advantage of their superior health care benefits and be fully rested when they get back. Complicating the move toward additional stimulus measures are international concerns toward deficit spending and apparent fundamental differences within the government on what type of stimulus measures actually work.

While the jury is still out on whether extending unemployment benefits is a stimulus, those benefits were included in the original record stimulus package and it doesn’t seem as if the country is garnering a sustained benefit from that spending. However, given that the Democrats have a solid majority and also the White House, we suspect that a noted portion of any additional stimulus will be directed by the California and Nevada Congressional contingents toward unemployment benefits extensions.

We have to wonder if key members of the G20 won’t begin to complain that the US is using borrowed money for suspect programs. Therefore, the international response to an upcoming US stimulus push might serve to reduce the flight-to-quality status of the US Dollar and the US Treasury markets. While we aren’t expecting an all out discussion of a downgrade of the US debt rating, it is possible that money won’t be as aggressive in flowing toward US financial assets.

In the event that the President dares to dream big and Congress puts together another massive pork barrel package, it is possible that global market players might attempt to shape US policy by their investment flows. While China recently suggested that would not abandon US Treasuries, they reportedly held in excess of $900 billion at the end of April. Therefore, they do have the power to influence US policy decisions. We see the prospect of the Dollar weakening ahead but we doubt that factor alone will be capable of turning off a pattern of weakness in physical commodities.

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The USDA will issue its July Supply/Demand report on Friday, just after this writing and the report is likely to show a tight ending stocks forecast for the end of the 2009/10 season which would lead to smaller beginning stocks for the upcoming crop season. In the process of pricing in both a near-perfect start to the crop season and improving crop conditions in May and June, December 2010 corn pushed to a life-of-contract low ahead of the key USDA reports on June 30th.

The USDA Planted Acreage and June 1st Grain Stocks reports were considered very bullish, and prices have already jumped as much as 13.5% in just 4 trading sessions. This suggests that a major low could be in place. The corn market seems to be in a position to move higher over the near-term, and it seems to have some of the key characteristics to attract interest from large money managers and fund traders as a “buy and hold” commodity.

Planted acreage was revised lower to 87.87 million acres, as compared with 88.8 million acres on the March report and expectations of a 400,000 to 600,000 acre increase from that March forecast. This was below the low end of the range of trade expectations. June 1st stocks came in at 4.31 billion bushels, which was roughly 290 million bushels below trade expectations. The stocks number implies much better than expected demand for corn during the past quarter, and this suggests another significant revision lower for 2009/10 ending stocks. In the long run, the 2009 crop was probably overestimated. However, there is still talk that the lower quality of the 2009 crop meant that it took more corn to produce the same amount of ethanol and to feed animals to the same weight. With lower beginning stocks and lower plantings for the 2010/11 season, the ending stocks forecast is likely to tighten.

However, yield is also likely to be revised higher. Even if we revise yield to a record 168 bu/acre, when we plug both the lower beginning stocks and lower acreage numbers, ending stocks come in at just 1.526 billion bushels. If yield is a lesser record at 166 bu/acre, ending stocks slip to 1.365 billion bushels with a tight 10.2% stocks/usage. If we see late season heat and some dryness from mid-July through mid-August, some of the later planted corn crop could see unfavorable conditions for pollination and this could clip yield enough to cause a significant tightness in the corn supply outlook. The development of above normal heat recently, with more heat expected in the long term forecast, may trim yield forecasts as this is occurring as the corn crop starts to pollinate in key growing areas.

Nighttime lows will also be watched closely. If they remain above 80 degrees, this can seriously hamper the pollination process. Traders noted that plant populations have increased in corn fields in recent years and that this increased concentration of vegetation raises the temperature in corn field above that of the surrounding air. This could cause added stress and lessen the ability of the crop to cool down at night which is necessary for an optimal pollination. For example, if actual average yield comes in at 161 bushels/acre, still the second highest on record, ending stocks slip under 1 billion bushels and stocks/usage drops to just 7.2%. Stocks/usage has been under 10% only two other times since 1973 and this would suggest a December corn price of near 5.25 to 5.65 into late August.

Crop conditions have deteriorated in the past two weeks due to too much rain, especially in Iowa. The good-to-excellent corn rating dropped to 71% as of July 4th versus 73% the previous week and 75% two weeks earlier. However, Iowa conditions fell to 65% from 72% last week and this is a growing concern for the market. However, pollination weather looks near ideal for the corn crop until or unless extreme heat moves back over the Midwest for the July 17th to 24th timeframe. Many weather models are showing this feature and this could clip the yields for some of the late planted crop. Silking stands at 19% as of July 4th, well ahead of last year’s 8% at this point. This is also ahead of the 5-year average of 12%. Silking is the best indicator of the start of pollination although the corn plant starts to shed pollen slightly before silking and it continues to shed pollen for several days thereafter. Weather conditions are critical during this period since the plant will not shed its pollen if conditions are wet or too hot. The reason that pollination is critical is that each silk that is pollinated produces a kernel on the ear of corn. If there is uneven pollination, there will be fewer kernels which means fewer bushels per acre regardless of how favorable late season weather may be.

The Commitments-of-Traders report for the week ending June 29th showed heavy net selling by funds. Trend-following (managed) funds were net sellers of a whopping 50,221 contracts to switch their net position back to the short side at 39,426 contracts. The reporting period ended on the day that the December contract posted its recent low at 343 1/4, just ahead of lthe USDA’s Acreage and Quarterly Stocks reports. Therefore, trend-following funds may have gotten themselves trapped on the short side ahead of the USDA’s reports, and that could provide a foundation for significant fund buying ahead if weather is even mildly stressful and prices continue to advance. For example, if trend-following funds simply return to the 4-year mid point of their position in corn, this would be a switch from the current net short position of near 40,000 contracts to a net long of 120,000 to 160,000 contracts.

Other factors which could support the corn market in coming weeks are the China production outlook and the recent collapse in the US dollar. If the dollar sees increased pressure ahead, commodity markets in general could be well supported. Major corn growing areas in North East China have received substantial rain over the past weekend but conditions are still looking variable depending on location. Parts of the north China Plains are still showing excessive heat. If China’s crop comes in smaller than expected, imports could be significant. The rains were very welcome as dry conditions and above normal temperatures in that region in recent weeks had raised fears of a drought. Some areas are still seeing temperatures of 95 to 105 degrees in the China plains which may impact yield.

Keep in mind, a near record yield of 164 bushels per acre will leave the stocks/usage at only 9%, the second tightest since 1973 and a level which might spark aggressive pricing from end users.

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We had some very bad US data again today, but Treasuries weren’t been able to extend sharply to the upside, which leads us to believe that we might be near a major inflection point. While the Euro zone situation isn’t fully solved by any measure, we think their debt contagion has been moved to the back burner and that the slowing of the US economy and its soaring deficit problem might become the media’s new obsession. With the battle lines drawn in the recent G20 meeting, the US is already setting the stage for divergent policy decisions. Perhaps the US leadership was already aware of the vulnerable status of the US economy, but since Washington won’t do standard textbook stimulus efforts the US might be in for a return-to-recession status.

The world has already bid Treasuries into the stratosphere due to their flight to quality status and because of evidence of US slowing. But today the Treasury rally seemed to run out of gas, and the US Dollar appears to have finally caved in. This suggests to us that world sentiment is changing and that further slowing in the US could mean a flight from the US Dollar and from US Treasuries. While gold was down sharply today, the world might have little choice but going to gold because of the almost total absence of a sturdy currency.

It would appear that the US will now be forced to provide more quantitative easing or perhaps even another stimulus package. Since the current US Administration would rather shoot itself in the foot than to utilize standard economic principles in their easing programs, it is possible that US Treasuries and the US Dollar are poised to go from the “penthouse” to the “outhouse.” In our opinion the Democrats won’t/can’t change their principles of only helping those who don’t have a job, are not wealthy and don’t work on Wall Street. This means the Democrats are going to be faced with market action ahead that could insure a house cleaning in the November elections.

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With crude oil prices rising back toward the $80.00 per barrel level in the face of an uncertain global economic track, it would appear that the world’s “petroleum oil supply and demand balance” is tighter than most pundits would like to admit. Arguments that US oil prices are too high because of burdensome domestic crude supply would carry some weight if it weren’t for significant increases in oil use from developing countries like China. In other words, the world oil supply and demand balance has remained tight through a severe global recession and looks to be on a track to tighten even more significantly in the face of a recovery.

However, in the wake of the Gulf oil disaster, it would seem like petroleum supply has received another black eye, and that has opened up the door for a historic change in US energy policy. While few expect the 6-month moratorium on deep water activity to be extended permanently, the severity of the environmental damage taking place could prompt an aggressive stance by the Administration, especially as we go into a national election. And with a daily operating cost for deep water rigs in some cases exceeding $1 million dollars per day, it is possible that many operators will pull up anchor and move to less certain production areas outside the dictate of the US government.

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Below is an excerpt from the Commodity Outlook:

An unfortunate thing happened on the way to the “recovery.” The Euro zone crisis managed to entrench itself in the headlines, and that in turn kept consumer and investor sentiment off balance. While many economists had predicted a long, slow recovery process in the wake of the sub-prime mess, events like the early-May US equity market debacle could string the recovery process out even further. About the only positive from the May event was a sharp decline in energy prices. But under the current set of conditions, a little extra disposable income is hardly going to be the spark that reignites the recovery fire.

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The agricultural markets could be somewhat vulnerable to bearish outside market forces if the turmoil in European debt issue remains a negative force for financial markets. Weakness in world equity markets and the surge higher in the US Dollar could slow world demand, and some agricultural markets seem more vulnerable than others to short-term weakness if speculators were to exit long-held long positions in those commodities. A look at the Commitments of Traders Supplemental Report provides a hint as to which markets could be especially vulnerable to selling pressures if financial market anxiety worsens. Trend-following fund traders or hedge funds (non-commercial, no-CIT Traders) hold large net long positions in live cattle, sugar, cotton and corn. If traders move to the sidelines, these markets could fall under a short-term long liquidation trend.

Sugar already saw a clear and decisive downtrend since March, but trend-following funds still hold a net long position of nearly 64,000 contracts. A resumption of the downtrend could attract increased long liquidation selling. The bears continue to unwrap the sugar market, but it may need more downside in order to lay a firm foundation for any meaningful rally attempts. The latest COT report also showed non-commercial traders (traditionally funds) continued to hold a net long position of 122,593 contracts. While this is a 43% reduction from March 2008 extremes, it continues to reflect a market composition worthy of lower prices in search of value. Rally attempts so far have been feeble and short-lived. October sugar saw a two-cent short covering rally in May that made a push for the March/April lows of 16.00, which appeared sufficient to work off extremely oversold conditions. This left sugar in a rally or bust situation that has so far been a bust for the bulls and has left the market vulnerable to another leg down. So far, there have been two waves down from the January 2010 highs at 22.78 with a good chance for number three. The next area of support comes in at the May spike lows from 14.20 to 13.67. We expect these levels to become violated and are looking for a further downside extension that takes sugar to downside objective of 11.50 prior to expiration.

A lack of support from outside markets and fears of bigger supply ahead could help keep the trend down over the short-term. With the larger supply and good weather outlook, any shift to bearish outside market forces leaves the market vulnerable to increased long liquidation selling from fund traders. The Brazil Cane Industry Association indicated that the center-south sugar production from the start of the season through May 16th reached 4.43 million tonnes, up 38.7% from last year. Ethanol production reached 3.78 billion liters, up 21.1% from a year ago. Many traders look for total sugar production from Brazil for the 2010/11 season to be up 16-20% from last year, as expanded acreage, much improved weather and an early start to the crushing season help boost production. Russia imported a record 1.4 million tonnes of raw sugar in May, but traders see virtually no imports for June or July, as import tariffs jump to $200/tonne this month from $50 last month. Traders see tightness in China for the second half of the year, with talk of a production deficit for the second year in a row. This may help the market forge a low into the summer, but for now the outlook for India to shift from a major importer to an exporter for the coming season and the record crop from Brazil could spark another leg down. The lack of a weather issue so far from key growers India and China along with expectations of a bumper harvest from Brazil could keep the short-term trend in the spot market weak.

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The energy complex saw an aggressive liquidation wave in the month of May, and that wasn’t surprising considering that at the May high crude oil was trading $18 per barrel above the February lows. In retrospect, the washout was justified from both fundamental and technical perspectives. In addition to a mountain of physical supply sitting inside the US, the market was picking up on the prospect of reduced global demand. With the COT reports at times this spring showing speculators holding a massive net long position in crude oil, even the technical condition of the market was screaming for a correction. Surprisingly, crude oil market seemed to get around news of a slight slowdown in the Chinese purchasing managers reading, even though the prospect of strong Asian demand was helping to discount the ultra-high level of crude oil supplies on hand in Cushing, Oklahoma. With gasoline stocks failing to continue a pattern of declines seen earlier in the year and demand not ramping up as expected in the wake of positive views on the economy, there were just too many negatives for the market to ignore as it went into the May debacle.

With the probe below $67.50 in July crude oil and in the face of periodic bouts of deflation, we suspect that many US refiners will begin to ratchet down their activity, which could ultimately bring about a very solid low in prices. In the meantime, to avoid a retest of the May lows, it  would probably require evidence of rising weekly gasoline demand and a pattern of falling refinery operating rates. In other words, to see a bull market mentality return to the energy complex, we probably need to see some proof of tightening US gasoline stocks. Last year US gasoline stocks saw a decline of roughly 15 million barrels in the April through June time frame. It could take that size decline and perhaps even more to fully restart the bull market action in the energy complex.

It is possible that RBOB pricing will begin to garner some support from a seasonal pick-up in demand, and that demand pattern might also serve to cushion gasoline prices against the residual slowing fears that look to be propagated by the ongoing travails inside the Euro zone. Still, it might take a temporary return to the late May low of $1.8888 in July RBOB to put gasoline prices back into a deflated/cheap condition. Talk of stronger summer air travel this year and fairly active US trucking activity would seem to suggest that the product markets have a much better fundamental outlook than crude oil, which might see its physical supply condition worsen markedly in the face of scaled back US refinery activity. Therefore, we see RBOB pricing gaining on crude oil, and we see RBOB managing to gain on heating oil toward the end of June. For those that look at spread strategies, we think that RBOB will hold up better than crude oil on any near term weakness, and we expect RBOB to spring higher than crude in the event that the entire energy complex rebounds off of improving global psychology.

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Unfortunately the Euro zone debt crisis and the US Gulf oil spill both remain uncontained as of this writing. In our previous two issues of this newsletter, we were hopeful that an ongoing global recovery and/or the prospect of global inflation would serve to offset markets that were oversupplied. However, a number of markets are facing significant oversupply conditions, and many physical commodity prices aren’t likely to tolerate even a modest slowing of the global economy. With the massive slide in equity prices into the May 6th and 7th timeframe accompanied by a severe bout of broad-based physical commodity price weakness, the forward view on the global economy is probably set to deteriorate. While temporary declines in Consumer Sentiment and Consumer Confidence readings don’t mean an end to recovery prospects, seeing that mentality hang over the market for weeks will probably result in weaker retail sales, a setback in hiring and perhaps less forward buying of commodities.

Just to add insult to injury, the “powers that be” want to blame the sharp dive in stock prices in early May on excess speculation, when in fact global economic conditions probably justified a 1,000 point break in the Dow. US, Euro zone and UK officials are just upset that unfettered deficit borrowing is not going to be allowed by the markets! In reality the markets were saying that there is a limit to global borrowing and that economic principles are going to be respected sooner or later. Certainly the Euro zone and the UK have already started to move toward government austerity programs, but seeing a large portion of the developed world pull back on government spending has to pull down economic activity, or at least make it more difficult to recover. Given the amount of debt on the books and the amount of additional debt that might be assumed ahead, one gets the impression that the markets are being presented with a boom or bust scenario. With the prospect of a decade-long Japanese style deflationary spiral ahead, it would seem like policy makers are indeed beginning to see inflation as the only way out of the conundrum. In the Euro zone one might even question the capacity to foster inflation given all the baggage in that area.

In looking forward, we assume that some additional deflationary selling will be seen in oversupplied markets like crude oil, soybeans, wheat, cocoa, RBOB, platinum, copper and silver. However, we still have faith that the Euro zone situation will be contained and that the bump in the road for the commodity bull market could run its course prior to the end of May. Some traders like to say that commodity markets can’t go straight up. Others suggest that commodity prices were getting too expensive around the May highs. But in the wake of the sharp May washout, there should eventually be an opportunity to buy “cheap”.

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