The Hightower Report

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After being on the verge of making a new 8-month low against the Dollar, the June Yen proceeded to have a monumentally large rally during the market turbulence of May 6th, far exceeding the size of any other currency move that day. This rally was so severe that the June Yen’s low and high prices for 2010 were achieved within 13 hours of each other. Even though most of those gains were given back within a day or so, the Yen has continued to find strong safe-haven support whenever there has been any sort of flare-up of EU sovereign debt problems. The most recent example of this was on May 19th, when the announcement of a unilateral German short sale ban created a risk aversion shock to financial markets worldwide. While it is definitely too early to think that the European crisis has been completely resolved, the 750 billion Euro crisis prevention plan developed earlier this month has meant that no other EU nation has as yet reached the crisis stage that Greece reached a few weeks ago. It is also important to remember that the Japanese government has made it clear that they are looking for a much weaker Yen, mainly to assist the recovery of their deflationary economy.

Recent Japanese economic data has provided some signs of revival, but there are still key numbers which remain solidly weak. The latest edition of the key Tankan survey continues to be negative, while both Japanese CPI and PPI have been lower for the past few months, illustrating how entrenched deflation has become with the Japanese economy. Although very low interest rates in Japan may hamper any monetary policy moves that the Bank of Japan may consider, it is likely that any sort of stimulative action undertaken will result in a much larger Japanese money supply. It is unlikely that recent plans for deficit reduction in Japan will find much support, as an aging population and a reluctance to embrace immigration as a measure to increase the Japanese workforce have made reviving the economy the main priority. If events outside Japan start to calm down, it is more likely than not that the June Yen will make another run at the lows from earlier in the month. An extension of the recent safe-haven rally due to EU tensions may provide enough of a price boost to the June Yen for us to approach the short side.

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Signs of better demand ahead due to the expanding global economy and ideas that China will eventually import feed grain are factors which could quickly bring about a need for the corn market to build a weather premium. The market may be in the process of bottoming out this spring and about to begin a demand-led rally into the early summer. Traders seem to have already priced in a conservative demand outlook for the rest of this year and next year and a relatively large crop for this summer.

While many other commodity markets have moved well away from the depression-type pricing that was seen in the wake of the sub-prime crisis, December corn was up only 15 cents from the 2009 lows as of April 27th. The fast start to this year’s planting pace has allowed the market to become complacent about the possibility of a tight supply situation developing if we were to see less than perfect weather for the coming growing season.

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The build in distillate stocks in the EIA numbers this week is keeping storage levels at record high levels for this time of the year. With June heating oil prices trading close to the highs for the year in the wake of these bearish numbers, Congress and those pushing for speculative limits on futures trading will probably think they have found another “smoking gun.”

But these higher prices are really signaling the threat of even tighter energy supplies ahead and the inability of the world to meet its growing demand for energy “products.” This comes from growing individual transportation needs, particularly in the developing world, and the lack of expansion in global refining capacity. In other words, the market is sending a message that some don’t want to hear!

As we point out in our recent special report Natural Gas: Positioning for a Major Bottom, the market will soon be forced to turn to natural gas for individual transportation needs, and that will more than likely result in natural gas prices finally joining the historical commodity price explosion.

The pundits are sure to doubt the validity of the natural gas price rally, as supplies are also flush. But world needs more energy output, and all sources are destined to become more expensive.



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The stock market is still facing a number of big picture negatives and because of those negatives, signs of recovery, favorable earnings and even the promise of low rates for an extended period of time won’t be given much credence. In other words, the bears have a “cause” and the positives will likely be discounted, or ignored in the short term. Nothing of significant seems to have changed overnight with the EU seemingly set to let events take their own course and that could result in the next country coming under attack. Favorable confidence readings and the first year over year house price rise in years from a private survey was totally lost in the Euro shuffle. With the added negative sentiment flowing from heated and hateful Congressional testimony, the bear camp clearly has an environment to their favor. Ordinarily we would expect the US equity market to get a lift from the type of statement we expect to see from the FOMC early this afternoon, but in the current environment, the positives are going to have limited or no impact. We suspect that prices are set to work lower early this morning, but if there is the slightly fresh negative from the Euro zone, or the credit rating agencies on the Euro zone problem, the selling could intensify again.

S&P 500: With the European debt crisis showing no sign of coming under control and commodity prices serving to unhinge natural resource and oil sector shares, the S&P would seem to remain vulnerable to more selling pressure. In our book the failure to forge an exhaustion washout and recovery attempt in the action yesterday, suggests that the selling hasn’t run its course yet. We also don’t see the development yet that can effectively truncate or shut off the negative speculation against other EU debt issues. Initial support is seen at 1176.80 but that level clearly won’t hold and that would put the next downside target at the April 8th low of 1171.30.

DOW: After the big range down extension and no recovery effort at all into the close yesterday, the path of least resistance remains down. In looking ahead it would seem like the debt situation is seemingly cemented into a front row seat. Critical support in the June Mini Dow is seen at 10,915 today but we can’t rule out a further decline to 10,875 in the coming trading sessions. To even think about turning the trend away from the downside today would require a close back above up trend channel support line of 10,941 today.

NASDAQ: The June Nasdaq seems to have found some measure of support around the 2000 level, with the bull/bear line today seen at 2002.75 into the close. While the market might see a fleeting bounce off the US Fed’s promise to leave rates low, any bounce off that issue might simply be seen as an opportunity to get short at a slightly higher level on the charts. Keep in mind, the Nasdaq was one of the more overbought markets in the stock index sector in the last COT report. If the 2000 level fails to hold today that would set up the next downside target of 1985.50, which is only the mid April low!

TODAY’S MARKET IDEAS: The EU is leaving its fate with the markets and the markets are registering their disdain for a total lack of budgetary restraint. We would be very surprised to see the sell-off in stocks end today.

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The corn market seems to have already “priced in” a conservative demand outlook for the rest of this year and next year and a relatively large crop for this summer. While many other commodity markets have moved well away from depression-type pricing, December corn is up just 30 cents from the 2009 lows. Traders see the early weather conditions as ideal and current ending stock projections as ample. With the fast start to this year’s planting, the market seems to have become complacent regarding the possibility of a tight supply situation if we see “less than perfect” weather for the coming year. The market saw a spike higher on April 7th on rumors of China buying corn, but the market quickly retreated when the buying could not be confirmed. However, just the thought of China shifting from an exporter to an importer may have been enough to turn the psychology of the market from bearish to bullish. We believe China will be an importer of corn sooner or later and that the odds of it happening this season are improving significantly. Demand estimates are likely to be revised higher for US exports, US corn used to produce ethanol and even for livestock feed, as profitability for livestock producers is soaring.

On top of demand issues, we feel that the market may be basing its yield expectations on the strong pattern of the past two years under what have been “ideal” growing conditions. A return to a more normal weather pattern might lower yield expectations and result in a tighter supply. If there are any weather or demand issues that surface which suggest that prices are just too cheap or that supply will tighten, the technical set-up for the market is such that corn prices could quickly turn around much more bullish.

Keep in mind that the last Commitment of Traders report showed a near-record net short position of 62,000 contracts held by trend-following fund traders. Any turn higher in the minor trend will be enough to spark short-covering from this group of traders.

Index fund traders have exhibited a steady buying trend, moving from a net long position of around 225,000 contracts as of early 2009 (which was the depth of the recession) to a record high of 459,000 contracts recently. There are many types of index funds, and corn seems to be included in most of them. It is a food, fuel, feed and industrial commodity. Index fund participants tend to be long term investors and are unlikely to exit their positions until there is a general perception that inflation has peaked. If anything, corn is likely to attract increased buying from fund traders in the future with the proposed corn-only ETFs likely to attract new investment money ahead.

A review of the new crop supply/demand situation may be in order. The enclosed table shows the current outlook for ending stocks given various yield scenarios for the 2010/11 season. Many traders see trendline yield this year near 160.5 bushels per acre. If we plug in the USDA prospective plantings report estimates and some conservative usage estimates, we start the season with 1.899 billion bushels and end the season with 1.693 billion. However, the University of Illinois makes a very strong argument that recent years have seen better than normal weather (with a lack of heat in July and above normal precipitation in June and July) and that if we see normal weather for the Midwest this year the average yield will be closer to 157 bu/acre. At this level, ending stocks would slip to just 1.4 billion bushels with a stocks/usage of just 10.6%, the second lowest in the last 14 years. If we assume a yield of 153.3 bushels per acre (the average of the past five years), it would leave ending stocks at just 1.1 billion bushels and a stocks/usage of just 8.3%, the second lowest since 1973. We are not predicting lower yields; we are just trying to point out that a high yield will be necessary this year to avoid a tight situation. None of the estimates above call for exceptionally poor weather, just slightly under trend.

As of April 18th last year the corn crop was only 5% planted, but excellent weather this year has boosted planting progress to 19% complete. The 10-year average for that week is 10%. The record pace was set in 2004, and that was the only other year besides last year in which yield managed to exceed 160 bushels per acre. Studies on yield, however, do not show much of a correlation between early plantings and yield. June and July precipitation and the temperature that occurs during pollination are the dominant factors. In 2004, the weather was excellent for the entire season, and the December 2004 corn contract posted a contract high on April 8th at 341 1/2 before posting a contract low at 191 on December 2nd.

Signs of better demand ahead due to the expanding global economy and ideas that China will eventually import feedgrain are factors which could quickly bring about a need for the market to build a weather premium. In the last 13 years, China has been a net exporter of corn with amount ranging from 5 to 15 million tonnes (197-591 million bushels) common. With poor weather for planting corn this spring, a drought in the southwest of China and the possibility of expanding corn usage for the coming season due to more corn usage for high fructose corn syrup, starches and expanding livestock production, China may shift to being a net importer for the coming season.

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The global economy continues to resemble the “Energizer Bunny” as it has managed to keep on ticking despite a series of anxiety issues. However, the evidence of forward motion is quite compelling with various economic readings flashing positives, corporate earnings showing an improvement in revenues and profits and ongoing evidence that China continues to be a strong engine of growth.

In addition to favorable retail sales readings and the initial positive US Non-farm payroll reading, other developments have caught our eye. Perhaps one of the more subtle ones is news that the Colonial Pipeline has recently seen a string of days where a number of requests for shipment of gasoline and distillate products were rejected because of capacity constraints. Another rather telling sign is that Chinese oil demand rose more than 12% in March, and according to PetroChina that resulted in a seventh straight month of double-digit energy demand growth. When one also notes that in March Chinese copper concentrate imports were 17% above year ago levels and up 27% from the prior month, it is clear that the Chinese economy is not hitting the skids, contrary to predicted by many Wall Street analysts last month.

Within the US we would like to point out the stellar performance at UPS, which recently managed impressive earnings and revenues. With many pundits suggesting that consumers were still wounded and that high energy costs were going to make it hard for companies to perform, the UPS results seem to suggest that the consumer is O.K. and that many companies can deal with the high oil prices. In fact, many transportation companies have implemented fuel service charges. From our own experiences we have seen fuel charges on trash pickup, lawn services, etc. have generally remained in place since the $140 crude oil days. In other words, the economy is recovering and there appears to be a bit of pricing capacity returning.

As for the valuation of equity prices, the pundits have been calling for a “correction” for a large portion of the last four months. Into the April high reversal, those calls were given added credence by the resurgence of EU debt fears and the Goldman lawsuit. However, as we have said a number of times since the beginning of 2009, the equity market gains off the 2009 lows were largely the return of a tide of investment that was forced out of the market in the darkest hours of the sub-prime crisis. Again, the bears are suggesting that the stellar gains in stocks (using the 2009 lows as a starting point) are signaling more growth than can be justified by conditions. Our view is that panic and expectations for a “depression” were factored into the S&P from September 22, 2008 through March 6, 2009 and that the most of the stock market gains have come from scared money flowing back into place.

We also see the Lehman gap area from October 3rd through October 6th, 2008 as merely the top of the total disaster zone, and until the nearby S&P rises back above the late September 2008 range of 1237 to 1250, we don’t think that the market is pricing in anything more than modest growth. From an overbought-oversold perspective, the stock index futures are not overdone, as the COT S&P spec positioning as of April 13th registered a net long of only 1,810 contracts.

From a longer-term perspective, it should be noted that a US military report recently predicted that the world oil surplus could be gone by 2012 and that the world might also see a global energy shortage by 2015. That would seem to suggest that global energy demand is likely to continue to support oil and a long list of physical commodity prices. In our mind, seeing nearby crude oil prices manage a sustained rise above the $90.00 level will begin to rekindle energy-related buying interest in markets like sugar, natural gas, corn and soybean oil. Make no mistake about it; certain physical commodities are facing negative supply side issues, but demand and investment interest are showing signs of tempering the supply side threats.

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While we think that crude oil and gasoline prices were technically short-term overbought around the April highs, we also think energy prices might have been a touch overvalued from a fundamental perspective. However, global energy demand is recovering and big physical supply excesses appear to be getting worked off. In fact, US EIA crude oil stocks have now fallen below year ago levels, and EIA gasoline stocks have seen their year-over-year surplus narrowed, with weekly declines in six of the last nine weeks after peaking earlier in the year.

Another interesting development is that US gasoline imports are in the midst of a decline, and with the US refinery operating rate still sitting below the 5 year average as we approach the end of April, refineries don’t appear to have much room for error as the summer driving season approaches. Traders should make no mistake about it; gasoline stocks are not to be considered tight at this time. However, they might be poised to tighten.

It is also possible that improving economic data and an ongoing pattern of rapidly expanding auto sales in developing countries (General Motors recently reported record auto sales in Argentina, Brazil, China and India) point to a turnaround in the global economy and the stronger gasoline consumption. (In the month of March China once again bought more cars than the US. This is becoming a pattern!) No doubt a continued world recovery is necessary for further gains in US gasoline prices, but we suggest that periodic big-picture anxiety events that result in sharp setbacks in crude and gasoline prices should be seen as opportunities to get long. Unfortunately, to reduce the magnitude of an effective stop point on a long futures position, it might require traders to wait for a break in July RBOB down to the $2.2510 area.



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From a long-term technical perspective, the rice market is in much the same position as corn and wheat. All three markets hit all-time highs in 2008 (wheat first, then rice, then corn), and all three markets saw massive sell-offs that lasted into late 2009, with trailing weakness lasting well into 2010. All three markets are likely to see major bottoms in 2010. The question is, when and at what level?

An initial signal that we are heading toward a bottom in rice can be seen on the Commitments of Traders report, which shows a major turnaround in terms of who is holding long positions in the futures market in Chicago. In a nutshell, non-commercial and non-reportable traders, who are mostly made up of speculators, went from being heavily net long at the tail end of 2009 to nearly even in mid-March of this year. Non-commercial traders were actually net short 47 contracts as of March 30th. Commercials were on the other side of that change, going from heavily net short to near even. This suggests that specs were buying rice on the way down and that they have largely thrown in the towel.

Of course, the rice futures market in Chicago is not a true bellwether the way soybean or corn futures are, so a shift by commercials does not indicate a wholesale shift of ownership into stronger hands around the world. So what is happening in terms of supply, demand and inventory in Asia? This year’s world ending stocks are expected to stay above the 2007/08 levels that helped to trigger the 2008 rally to new all-time highs. However, ending stocks are only projected to be up by 12.3% over 2007/08 at the end of the current marketing year, and they are actually expected to post a small decline from last year. In other words, world rice stocks are far from ample by historic standards at just over 60% of 2000 levels. This may start to generate a shift in attitudes in Asia back in the direction of inventory building.

This shift starts with India, where last year’s late start to the summer monsoon season resulted in lost production in a variety of crops, including rice. That in turn has triggered a surge in food inflation that the government is determined to curb. For example, India had been signaling in recent months that it would resume wheat exports this year after a multi-year hiatus, but they have recently reversed course and indicated that they now have no plans to do so. They have even gone so far as to approve an indefinite extension of tax-free wheat imports that had been scheduled to expire on March 31st. This was accompanied by proposed legislation intended to make cheap food grains, including rice, available to the poor. India’s rice stocks as of April 1st were pegged at 26.7 million tonnes against a government target of 12.2 million tonnes. However, because of inflationary concerns, India is likely to try to hold onto their stocks, and exports are likely to remain low, which means that “free” world ending stocks may be a bit tighter than the world total.

Vietnam also announced within the past few weeks that it is increasing its domestic rice reserves by 500,000 tonnes to 1.5 million. There is also a severe drought occurring that is to the west of China’s biggest rice-producing areas. And while it is not believed to be directly affecting their rice output at this time, it is easy to see how the inventory-building mentality could start to spread to other food staples, like rice.

The market saw a sharp break following the March 31st USDA Grain Stocks and Prospective Plantings reports, but while traders called the news bearish, there was a total lack of new selling, and July futures saw a 4-day surge off of those lows. Turning higher on perceived bearish news could be a sign of the near-term low.

The monthly usage data would suggest that US ending stocks could tighten ahead, and the surge away from the 12.50 level for July rice could be a sign that the market has found real value. If there was a decline in open interest on the rally we would assume that the rally was just short-covering, but this was not the case; open interest continued to push higher. In addition, there was significant divergence with the Relative Strength Indicator at the various March lows, and this would suggest a loss in downside momentum.

With the US crop about 15-20% planted, the focus of attention may shift to weather in the US and demand for rice from Thailand and Vietnam. Given the recent move to what we would consider a “value zone,” it will not take much in the way of positive fundamental news to see a more significant rally in the weeks ahead.

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The natural gas market is finally beginning to show fundamental and technical signs of a major bottoming. While it might be folly to rely on swift enactment of policy by the U.S. government that would serve to expand the use of natural gas in the energy supply chain, the relative price advantage of natural gas versus many petroleum inputs looks to facilitate an increase in demand. Recently the BTU price of natural gas reached 16 month lows versus crude oil, and that should begin to get the attention of users and maybe even someone in Washington who is willing to look beyond the tip of their nose.

Clearly, the natural gas market is being weighed down by supply, but a bull market has to begin somewhere, and seeing the EIA revise its 2010 US electricity demand upward by 1.9% is certainly a start. Throughout most of the declines in natural gas prices from early 2008 to the 2009 low, the trade was seemingly factoring in a sustained lull in industrial usage. The slide from the 2008 high price of $13.69 per MMbtu to the 2009 low of $2.40 was blamed on fears of a recession or even a depression. Now that a depression has been averted and the recession is seemingly lifting, we suspect that the trade will have to move to reinsert some premium back into natural gas prices.

The latest weekly EIA report indicated that natural gas in storage was below to year ago levels, and the recent Commitments of Traders report showed speculators holding a net short position of 50,365 contracts. While US natural gas rigs in operation have risen off the 2009 low levels, they are still running at nearly half of their peak levels. Therefore, while natural gas stock levels are to be considered flush, it is possible that increased cyclical demand could be joined by “new” demand from petroleum users who are looking for a cheaper fuel alternative.

Colorado State University’s hurricane forecast team is calling for four of the expected eight hurricanes this coming season to be classified as “major” storms, which could serve to spook out some position shorts. With hurricane threats tamped down over the last two seasons, the energy markets might not be overly concerned with the “potential threat” of weather at this time. However, if there are some signs of storm activity in May, attitudes could begin to change. As the accompanying chart of tropical storm frequency indicates, some minor activity has historically occurred during the month of May. While we are barely half-way through the month of April as if this writing, the natural gas trade has already seen enough fundamental change and enough momentum in the overall economy to begin to have some respect for weather-related threats. In the meantime, we think that corrective action back down to the $4.00 level in the June natural gas contract should be considered a long term buying opportunity, especially if the spec net short positioning expands beyond the 65,000 contract level.

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The global economy continues to recover, even if the recovery pace appears suspect to some and is still being questioned entirely by others. Financial uncertainty resulting from the U.S. debt, real estate and the health care reform effort appear at least under some semblance of control, and that has already emboldened consumers, purchasing managers and potential employers. In addition to a notable Non farm payroll gain for the month of March, the market has also seen weekly chain store sales figures jump, and that in turn prompted some analysts to suggest that consumers were almost giddy. And while the pace of economic activity in the Euro zone remains very troubling, the Chinese economy looks to be holding in a positive growth track. Just last week the Chinese announced that their large oil refinery installations were expected to run at record throughput levels in the month of April!

With crude oil, platinum, palladium, pork, copper and rice prices all showing impressive gains over the last two months, we get the impression that the global economy is easily strong enough to lift physical commodity prices with partially supportive fundamentals. Perhaps the biggest threat to existing bull markets in the commodity sector are the likelihood of periodic rate hikes threats and residual strength in the US Dollar. But ultimately we doubt that rate hikes will derail those markets that are already showing up-trending patterns. In our opinion, traders are likely to be presented with 3 or 4 separate rate hikes in the next 45 days, with the mostly likely coming from Australia, Canada and China.

However, we also suspect that the US will be presented with another minor pulse up in the discount rate with the Fed loudly attempting to play down the idea that rates are set to rise quickly. After the grilling by Congress and the press, the US Federal Reserve is probably moving toward a posture where they begin to err on the side of battling inflation, even if classic inflation isn’t a visible problem.

We think that commodities will remain popular among “global investors” and that many prices have yet to reach back to what we would categorize as “fair value.” An offshoot of a continued recovery in the global economy and of the ongoing interest in commodities could be an extension of upside gains in the Canadian Dollar.

Seeing crude oil prices venture back to the vicinity of $90.00 per barrel in the face of somewhat flush crude and gasoline stock levels is indicative a how important global energy demand is to the oil price structure. An uninformed member of Congress or a “talking head” from the media would probably point to a recent minor downward revision of global energy demand “GROWTH” from the EIA as evidence of overextended pricing in crude oil. But the reality is that the EIA still expects global energy demand in 2010 to increase by 1.5 million barrels per day over the 2009 levels. Some energy bears have tossed around the idea that the energy complex “peaked” just prior to the sub-prime debacle, and while that might hold for the U.S. market that certainly doesn’t look to hold for global demand!

We expect residual strength in energy prices to begin to lift certain commodity markets, while continued recovery evidence should also serve to lift other commodity markets. However, we don’t expect a straight up-trend ahead, as the markets are likely to see a certain amount of choppy activity due to periodic rate hike fears and bouts of selling due to periodic strength in the U.S. dollar.