Friday, May 27, 2011

The Chinese Puzzle Box

by Sean Brodrick

I’m wrestling with a puzzle, and maybe you are, too. Is the China growth story still intact, or is it running off the rails? What does this mean for my investments? And if China is in trouble, what should I be buying — and selling — now?

To be sure, we’ve heard premature reports of China’s doom for years. Frankly, I think people who talk about China’s economy imploding should have their heads examined. There are 1.3 billion people in China, and they are making an enormous transition from third-world lifestyles to living like big, fat, Americans. 

Even if China slows down, the Chinese will still be ramping up consumption for decades.

The problem is that potential slow-down. If the market has priced in exponential growth, a slow-down is enough to deflate A) commodity prices and B) stocks of companies that are designed around exponential growth in China.

Here are some of the warning signs that have the market rattled:
  • Goldman Sachs just lowered its estimate of China’s gross domestic product growth, saying it will rise 9.4% in 2011, less than a previous call of 10%. Royal Bank of Canada lowered its China growth estimate to 9.5%. Both estimates are way down from China’s 10.3% growth in 2010.
  • A preliminary purchasing managers index for Chinese manufacturing came in at 51.1, the lowest since July 2010. And industrial production rose by 13.4% in April, slower than the 14.8% gain in March.
  • On May 12, the central bank raised banks’ reserve requirement for the fifth time this year. China’s central bank is doing this as part of a concerted effort to fight inflation, which is currently a major policy concern for Beijing. China’s Consumer Price Index was 5.3% in April, slightly down from March’s 32-month high of 5.4%. This stubbornly high inflation leads some experts to predict the central bank isn’t through raising reserve requirements, which would hobble economic growth.
  • And China’s central bank could also raise its benchmark interest rate — again — to fight inflation. RBC forecasts that the People’s Bank of China will need to raise interest rates by an additional half a percentage point by the end of the third quarter. That would suck more “hot money” out of the economy.
So you can see why people are concerned. But maybe those concerns are overblown. After all, a reading of 51.1 in the PMI is consistent with growth of 13% in Chinese industrial production and 9% in Chinese GDP.
Is China a Canary in the Coal Mine for the Rest of the World?

If a slowdown in China is taking place, it’s not happening in a vacuum. In the United States, first-quarter GDP came in at a disappointing 1.8%, and preliminary data for April and May suggest that is continuing into the second quarter. 

The Philadelphia Fed manufacturing index of business activity fell to a seven-month low of 3.9 from 18.5 in April and March’s 27-month high of 43.4.

The end of quantitative easing — in which the Fed threw money at banks, who in turn threw it at the stock market — should weigh on stock prices if not the actual economy. And the ongoing stalemate over raising the U.S. debt limit hangs like the sword of Damocles over the global economy.

Meanwhile, European economic data continues to disappoint as member countries, including Greece, Spain, Italy, Portugal and Ireland wrestle with their debt crises.

And the Japanese economy shrank at a 3.7% annual rate in the January-March period, even worse than was expected. By the way, it turns out three of the nuclear reactors at Japan’s stricken Fukushima Daiichi nuclear power plant are believed to have suffered meltdowns. I’m wondering how long before we see larger-scale evacuations in that area.

Doctor Copper Says the Chinese Economy Is Feeling Poorly

Copper is an economic bellwether due to its many uses in industry and commerce. It’s called “Doctor Copper” because it takes the temperature of the global economy.

Copper can be a particularly good indicator of the Chinese economy because China uses 40% of the world’s copper. The bad news is China imported 595,963 tons of refined copper in the first quarter, 21% less than the same period a year ago.

Now, that may just be the Chinese messing with us — they’ve manipulated the copper market in the past to get better prices. But take a look at a chart of copper — you can see the price is really starting to break down:

We’ll see if support around $3.69 holds. If it does, this is only a short-term correction. If it doesn’t, well …

Why This Might Be Just a Correction
New Oil Price Estimates
2011 2012
Goldman Sachs $120 $140
Morgan Stanley $120 $130
JP Morgan $130

Here’s the thing that has turned the whole China problem into a puzzle for me. The same big banks that are downgrading China’s economy are also raising their estimates for global oil prices.

Goldman Sachs, Morgan Stanley and JP Morgan are all RAISING their estimates of where oil prices will end this year.

The banks issued their forecasts on Brent Crude, an international benchmark. Goldman raised its Brent crude price forecast for 2011 and 2012 on expectation fuel demand growth will sap global inventories and strain OPEC’s spare capacity. The bank raised its year-end Brent forecast to $120 per barrel from $105, and its 2012 forecast to $140 from $120.

Meanwhile, Morgan Stanley raised its Brent crude price forecast for 2011 and 2012, citing an improvement in demand coupled with a loss of Libyan output. The brokerage raised its 2011 Brent crude price forecast to $120 per barrel from $100 a barrel, and its 2012 forecast to $130 from $105. JP Morgan raised its 2011 forecast as well, to $130.

I find it very puzzling that the big banks are raising oil prices while simultaneously lowering forecasts on China’s growth.

And in fact, one part of China that is still full of red-hot growth is its oil demand. China’s implied oil demand hit its third highest monthly level EVER in April.

And there are other areas of the Chinese economy that are also growing rapidly.

China’s Gold Demand Continues to Soar

The Chinese are buying more gold than ever … and buying more gold for investment than anyone. In fact, China’s investment demand for gold more than doubled to 90.9 metric tonnes in the first three months of the year, outpacing India’s modest rise to 85.6 tonnes, according to data from the World Gold Council. That means China now accounts for 25% of gold investment demand, compared with India’s 23%.

A big driver behind this is that rising inflation in China that I mentioned earlier. China’s citizens, fearing that inflation will eat away at their savings, are buying a lot more gold.

But if the Chinese economy was really slowing down, wouldn’t China’s consumers have less money to spend, and therefore buy less gold? So China’s gold demand story doesn’t fit with the narrative of a slowing economy.

Chinese Silver Imports Are Rising

China imported 3475.4 metric tonnes of silver bullion in 2010, a whopping fourfold increase from 2009’s imports of just 876.8 tonnes. This year, China’s lust for gold keeps rising. China’s demand for silver bullion in April was 339.4 metric tonnes. This compares to 302.09 metric tonnes in April 2010 or an increase of over 12% from the same month last year.

Silver is an industrial metal as well as a precious metal. If China is really slowing down, shouldn’t its silver imports be falling off a cliff?

Solving the Puzzle

We hear predictions of China’s slowdown — and some of the data seems to back that up — but we also see China’s purchases of hard assets including oil, gold and silver booming.

I think the lesson here is to be cautious and selective about how you invest in China. If China is in the market for hard assets, you might want to buy them first.

And if you want a different way to invest in Chinese assets, consider that China will increase investment in water conservation projects this decade to $615 billion, up from $163 billion in the previous 10 years, according to reports in the Xinhua news service.

The plan will allow the nation to fight droughts and floods, which have increasingly affected many regions across the nation, Xinhua said, citing Minister of Water Resources Chen Lei.

Two stocks that are positioned to profit from this investment wave are Veolia Environment (VE on the NYSE) and Insituform Technologies (INSU on the NASDAQ).

Both firms are involved in water infrastructure and transportation, and both have exposure to China.

Top 10 Reasons to Take Friday Off From Trading

The unofficial start of Summer happens for traders at 4:00pm today (that is junior traders). You have all heard the sell in May and go way stuff so I will not bore you with that but here are the Top 10 other reasons to start the long weekend early.

10. Trading volume is pathetic to begin with and worse after 12:00.

9. You can get to $COST before they run out of Hamburger and Hotdog buns. Pick up a flag while you are there.

8. The $SPY, $IWM, $QQQ and $DIA are all moving sideways and have been since early April. You think that is going to change the day before a long weekend?
new e1306445285417 stocks
7. After all the partying you did last weekend leading up to the now delayed Rapture you could use the rest.

6. You can place electronic limit and stop loss/limit orders now, its 2011.

5. Celebrate the 70th Anniversary of the sinking of the Bismarck.

4. The only stock over $1 and with more than 100,000 share trading volume that is reporting earnings is Mentor Graphics (ticker:$MENT). Nice chart but see #5 above. Here are the levels so you can place orders now. Over 15 it can run to resistance at 16 or 16.50 higher. Under 14 it is a good short with support at 12 to 12.50.
ment e1306445742956 stocks
3. The Bond Market is ‘Officially’ calling it a half day closing at 2:00pm. What does that even mean for a market that trades via the phone or IM?

2. If you are going in only to buy $LNKD puts when you see the current 70-80% volatility rise to over 100% on demand you won’t pull the trigger anyway.

1. Admit it you have been have been in vacation mode since Wednesday and just reading this to see if there was one idea you have not tried on your boss already.

Enjoy your Holiday but remember why we celebrate it. Find a veteran, shake their hand and say Thank you!

See the original article >>

Bullish Consolidation for Agricultural ETF

From its Feb high at 58.25 through today's action, the iPath DJ-UBS Grains TR Sub-Idx ETN (NYSE: JJG) has carved out a high-level bullish consolidation area atop its powerful 7-month uptrend.

When I analyze the Feb-May period via my hourly work, I can make a compelling argument that the consolidation period is complete. Moreover, the price structure is starting a new upleg that will thrust prices above key resistance at 55.85-56.50 towards a projected optimal target of 60.00/30 and possibly an overshoot target zone of 63.60-64.40 thereafter.

At this juncture, only a decline that breaks and sustains beneath 53.35 will begin to compromise the timing of the anticipated upside breakout.

See the original article >>

Coffee price rally could find fresh legs, says VM


Flagging coffee futures could yet revive to a fresh record high, VM Group said, as it cut its estimate for the production surplus, and took another swipe at Starbucks for blaming speculators for elevated prices.
It was "difficult to avoid the conclusion" that coffee markets will in 2011-12 witness more of the supply squeezes, "record tightness and extreme price volatility" which has characterised the current season, the analysis group said.
The comments came as VM, which undertakes commodities research for ABN Amro, cut its estimate for the world surplus in production of arabica beans, the type traded in New York, by 900,000 bags to 5.6m bags for 2010-11.
For 2011-12, an off season in Brazil's cycle of higher and lower production years, the arabica surplus will come in below 700,000 bags.
While prices have retreated from the 34-year highs above 300 cents a pound reached in April, "the bullish outlook remains not only intact but, if we are correct in our estimates for 2011-12, reinforced", VM said.
"The next 'target' might be 318 cents a pound – the price spot arabica that was reached in New York in May 1997."
Starbucks 'pushing demand'
The group's revision to its forecast for the arabica surplus reflected lower hopes for production, dented by the impact of La Nina weather conditions on parts of South America, while consumption has remained steadfast despite higher prices.
Indeed, while Starbucks has consistently blamed speculators for high prices, VM noted that the coffee shop giant "is doing everything it can to push demand.
"Starbucks plans to more than triple its cafes in mainland China, from 450 currently to 1,500 by 2015.
"In any case, the idea that supply is comfortably ahead of demand on a global basis does not ring true."
Data from US regulators shows speculators halving their net long position in New York coffee futures since August, to some 20,500 lots, even as prices have appreciated by nearly 50%.
Robusta forecast
VM also cut its forecast for the world surplus in robusta coffee - the variety traded in London and which is generally viewed as of lower quality than arabica – by 290,000 bags to 4.9m bags, reflecting damage caused by La Nina rains in Indonesia.
The surplus in 2011-12 was pegged at 4.1m bags, although this "could be significantly eroded" if high prices for arabica coffee force roasters to switch beans.
Arabica for July delivery stood 0.3% higher at 266.40 cents a pound in New York at 10:40 GMT.
London robusta beans for July were 0.2% lower at $2,596 a tonne.

See the original article >>

International cotton prices fall

by Zarina Ergasheva

The international cotton prices have sharply fallen. According to some media outlets, the price of one ton of cotton fell from US$5,200 in March to US$3,900 in late April.

Specialists from the Ministry of Energy and Industries (MoEI) consider that the international cotton prices fell as considerable cotton stocks were made following flurry in the cotton market. “International exerts expect this price to keep till the new cotton harvest,” said the source, “Many countries have increased areas under cotton and experts forecast cotton harvest will increase this.”

International media outlets reported in early May that according to International Cotton Advisory Committee (ICAC), after seven consecutive months of increase, cotton prices fell in April 2011 due to significant slowing in demand. The Cotlook A Index reached a record of $2.44 on March 8, 2011, but was down to $1.73 per pound on April 28. These prices remain very high by historical standards.

ICAC pointed out that very high cotton prices, problems of credit access, and the fact that cotton yarn prices did not increase as fast as cotton prices and started yielding ground in mid-March 2011, are all affecting mill use. Global cotton use is expected to reach 25.1 million tons in 2010/11, almost unchanged from 2009/10. A slowing of spinning operations and an increased switch to chemical fibers are curtailing demand for cotton and are reducing its share of world fiber use.

Production is expected to increase by 11% to a record of 27.6 million tons in 2011/12. Increased cotton supplies will feed demand in 2011/12, but high prices and competition from chemical fibers are expected to limit growth in mill use to 3%. World cotton production is projected to exceed mill use in 2011/12, which would result in ending stocks recovering to 10.1 million tons. The world ending stocks-to-use ratio, forecast to reach an all-time low of 33% this season, could rebound to 39% in 2011/12. This would remain lower than the 10-year average of 49% prevailing before 2009/10.

Daily News & Analysis (DNA) reported on May 9 that cotton prices, which were on an upsurge, have fallen 20% in the last one month, easing margin pressures on Indian textile companies and raising prospects of price cuts for end-consumers. Textile firms now expect to sustained margins, if not improved profitability. The decline in prices in India, the world’s second-largest cotton producer after China, is primarily on account of improved production and a supply-glut in the overseas markets. Significantly, this price decline has reduced cotton yarn prices benefiting companies using yarn to make garments.

We will recall that Tajikistan has allocated 210,000 hectares to cotton cultivation this year, but farmers have managed to plant cotton only on 203,100 hectares. Specialists from the Ministry of Agriculture (MoA) say farmers plan to yield some 400,000 tons of raw cotton this year.

In 2010, farmers planted cotton on 160,400 hectares and yielded some 330,000 tons of raw cotton.

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Copper, iron ore and coal to lead commodities

by Commodity Online

Copper, iron ore and coal is expected to create a bullish undertone for commodities thanks to insatiable appetite for commodities from developing nations such as India and China.

The rising demand and the supply demand mismatch turn copper into a top contender for leading the commodities pack up in the coming years. The red metal already faces a market deficit and it is expected to widen further when economies emerge out of their protective cocoons as recovery gathers momentum.

Iron ore also has claimed a position among the favourites following the rising demand for steel and the new pricing structure the market has now adopted. The benefit to the energy sector is obvious enough to be over looked, and coal is a major source of it. Countries like China, which relies on coal for more than 70 percent of its energy needs, are sure to bolster prices of coal in the coming days.

Standard Chartered Plc predicts gold, copper, coal and iron ore to be in the forefront of the commodities price rally in the few years to come.

Goldman Sachs also sees raw materials price to climb in the coming days, along with Deutsche Bank and Barclay’s capital, all of which advocate the strength in commodities to stick.

However, rising commodities prices punt up global food prices adding to the inflationary situation, which lead countries such as China, Brazil and India etc to hike interest rates.

The Standard & Poor’s GSCI 24 commodities index beat stocks, bonds and currencies in the last five months, which is the longest winning streak in last 14 years, reports showed. But the index has been on the downside of the late due to the subsequent fall back of commodities market.

The development expectations from India and China are sure to dominate the future path for commodities. India is expected raise the demand for metals by 80 percent in the coming years to complement her investments in infrastructure. Coal demand, on the other hand, is seen at 2 billion tonnes in the coming years, reports showed.

Nevertheless, more immediate concerns dog the commodities markets currently. Slowing growth in the US, debt troubles in the European Union and rising inflation and the apparent real estate bubble in China, all of which present the market with enough and more hurdles.

China's Soybean Buying Makes Short-Term Dip

China's demand for U.S. soybeans eased recently as South American supplies hit export markets, but the long-term trend in Chinese buying is still strong.

“China has been out of the U.S. market for about two months,” says Mike Hogan, Market360 director at Stewart-Peterson, Inc., West Bend, Wis.
U.S. soybean export sales as of April 14 had reached 97% of USDA's projection for 2010-11 and gained to 97.9% as of May 12. “So in one full month we did not add 1%,” says Hogan. “That's a horribly slow pace.”
The weekly volume of soybean export inspections had been running from around 30 million bushels to more than 40 million bushels early in 2011. The pace dropped to 5 million to 8 million bushels in recent weeks.
Hogan notes that China bought early this year and cites two factors in reduced Chinese demand:
  • South American supplies became available and the Chinese economy slowed from nearly 10% inflation two months ago to about half that last month.
  • Reduced inflation usually means business is slowing.

Swine Industry Drives Soy Demand

China likes to buy and process beans to keep the value added in crushing into meal and oil. USDA's Foreign Agricultural Service says that rising incomes in China indicate strong demand for soybean oil. “Demand for soy meal is likely to grow as the hog sector recovers from earlier reductions caused by diseases and low prices,” says FAS.
Even though Chinese buying eased recently, growth in China's poultry and pork production, which drive soybean demand, appear to be on track.
Assuming that China's economy continues to grow at its current rate and creates jobs, people will continue to move from the country to cities, says Paul Burke, director of global marketing and industry relations at the U.S. Soybean Export Council in St. Louis. “Based on that outlook, one would be able to make an easy assumption that China will continue to need to increase its imports of soybeans for processing to produce soybean meal to supply the animal agriculture industry in China,” says Burke.
The world's largest swine herd is in China. About half that herd still is fed table scraps or other products, rather than formulated feeds that use soybean meal. The Soybean Export Council cites statistics from China showing that the commercialized share of the swine industry grew from 23% in 1998 to 56% in 2008, and was still trending higher.
During the same years, China's imports of U.S. soybeans soared from about 2 million metric tons to 18 million.
“There is a lot of room for continued growth in the Chinese feed and livestock industry,” says Burke.

Short-term Exports Off

Despite those long-term prospects, USDA analysts this month reduced their estimates for U.S. soybean exports in 2010-11 because export shipments had slowed and Chinese demand had eased. July and November futures retreated from their April highs but partially recovered since mid-May.
USDA projects U.S. total exports in 2011-12 at 41.9 million metric tons, up less than 1 million from exports to date and outstanding sales for this season. Exports from Brazil and Argentina likely will climb on big crops.
China will account for 60% of global soybean imports in 2011-12, up from 59% this year and 42% in 2006-07, says FAS. China's share of global crush likewise gained from 18 percent in 2006-07 to 25 percent this year and a projected 26 percent in 2011-12.
“Global trade is projected at a record spurred by strong demand in China and ample exportable supplies in South America,” says FAS.
The soybean shipping season from South American has been lengthening over the years as production increased. “It takes longer to export larger crops,” says one analyst. However, a longer shipping season doesn't necessarily bring a longer period of competition for sales. South American soybeans “can get bought so quickly that by the time the U.S. crop is available, South America is all sold out.”

New-crop Markets

China's economy will be a key factor for new-crop soybean markets, says Hogan, noting that the Chinese have been reluctant buyers for 2011-12. One factor affecting new-crop demand is that the market expects delayed U.S. planting will cause some shift from corn to soybeans.
For producers looking at marketing their 2011 crop, Hogan offers this suggestion: “A $12 November bean put would assure you of a relatively good price at this time,” he says, noting the premium on the put is about 24.25 cents. And, he adds, “We've had $12 beans only a handful of times in 25 or 30 years of trading.”

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Economics of Prevented Planting in Corn

by Gary Schnitkey

Farmers will be able to take prevented planting payments once the “final planting date” is reached in late May or early June. In this article, net returns from taking a prevented planting are compared to expected net returns from planting corn and soybeans. Examples suggest prevented planting have returns competitive with planting corn or soybeans. Hence, farmers could have large incentives to take prevented planting payments once the final planting date has been reached. Number of acres on which prevented planting are taken will depend on 1) weather and 2) expected commodity prices at harvest-time.

Net returns from prevented planting

Farmers can take prevented planting payments when 1) the final planting date has been reached, 2) the crop has not been planted for insurable reasons, and 3) the farmer has purchased one of the plans within the COMBO product (RP, RP with exclusion, or YP). Final planting dates are county specific. Common final planting dates are May 25th, May 31st, or June 5th, although some counties will differ from those dates (See Prevented Planting Provision in Crop Insurance for more details on prevented planting). When considering prevented planting, farmers should consult with crop insurance agents to assure that all requirements are met and to make sure that prevented planting can be taken on the desired number of acres as historical plantings may limit prevented planting acres.

Unless prevented planting buy-up coverage has been purchased, prevented planting payments equal 60 percent of the minimum guarantee for crop insurance. As an example, take a farm with an 150 bushel Actual Production History (APH) yield that purchased a Revenue Protection (RP) policy with an 80 percent coverage level. The projected price in 2011 is $6.01 per bushel for corn. The prevented planting payment equals $433 per acre (150 bushel APH yield x $6.01 projected price x 80% coverage level x 60% prevented planting factor). 

Higher coverage levels have higher prevented planting payments. Panel A of Table 1 shows an illustration of prevented planting for the above example with a 150 bushel APH yield. Prevented planting payments are $406 per acre for a 75 percent coverage level, $433 per acre for 80 percent coverage level and $460 per acre for 85 percent coverage level. As the coverage level of the crop insurance product increases, there is more incentive to take the prevented planting payment.


Net returns from prevented planting are compared to expected net returns from planting corn and soybeans. As illustrated in Panel A of Table 1, net returns from prevented planting equal the prevented planting payment minus weed control costs and crop insurance premiums. Weed control costs are estimated at $15 per acre. 

Crop insurance premium costs must be paid for prevent planting and can vary from premium costs for corn when enterprise units have been selected. Enterprise units have planting requirements that must be met, otherwise farmers will be charged based on basic units, which have higher premiums than enterprise units. The example in Table 1 assumes that planting requirements are met and insurance premiums represent enterprise units.
Expected net returns from planting corn or soybeans
Panel B of Table 1 shows estimates of net returns from planting corn and soybeans. In arriving at these estimates, expected yields and expected prices are used. The example uses expected yields of 120 bushels for corn and 45 bushels for soybeans. These expected yields will become lower over time. To aid comparisons, yields to breakeven with taking the corn prevented planting payment are shown at the bottom of Panel A. Breakeven yields for corn are 121 bushels for a 75 percent coverage level policy, 124 bushels for an 80 percent coverage level, and 126 bushels for an 85 percent coverage level policy. 

Expected prices represent harvest-time prices. The $6.40 corn price and $13.30 soybean price are near cash bids for harvest delivery in the third week of May. Higher expected prices lead to more of an economic incentive to plant.

In calculating net returns, costs that have not already been incurred should be subtracted from revenue. In the example, costs are $395 per acre for corn and $263 per acre for soybeans. If a cost has been incurred and cannot be recovered, then it should be excluded. Take as an example nitrogen fertilizer that has been applied. This cost has been incurred and should be excluded from corn costs.

In the above example, corn has net returns of $373 per acre and soybeans have net returns of $363 per acre. These expected returns for planting are below the net returns from prevented planting ($382 per acre for 75 percent coverage level, $401 for 80 percent coverage level, and $466 for 85 percent coverage level). This suggests that taking the prevented planting payment has the highest return for this situation.

Considerations other than net returns

Planting either corn or soybeans has more risks than taking the prevented planting payment because expected yields and expected prices are not known. Theory suggests expected net returns from corn and soybeans should exceed net returns from prevented planting to compensate the farmer for bearing risk.

If corn is planted, there will be an insurance guarantee; however, the guarantee will decrease by 1 percent per day for each day after the final planting date, reaching 60 percent of the original guarantee when 25 days have passed from the final planting date. The decreasing guarantee increases risk the more days after the final planting date. Hence, the lowering guarantee, as well as lowering expected yields, will create more incentives to take prevented planting the later prospective planting takes place.

The above prevented planting example assumes that a crop is not planted on prevented planting acres. Farmers can plant a crop after 25 days have passed from the final planting date. More details on these provisions are provided the May 19th FarmdocDaily entry entitled Prevented Planting Provision in Crop Insurance, 

What is different this year from previous years?

The 2008 Farm Bill introduced higher subsides for enterprise units. These higher subsidies encouraged farmers to purchase enterprise units and increase coverage level. In 2008, 46 percent of acres using revenue crop insurance products for corn were insured with 75 percent of higher coverage levels. Use increased from 46 percent in 2008 to 65 percent in 2010. It is likely more acres were insured with higher coverage levels in 2011.

Higher coverage levels can lead to more incentives to take prevented planting payments, as prevented planting payments are larger with higher coverage levels. As a result, more acres could go into prevented planting in 2011 as compared to previous years.

Factors impacting number of prevented planting acres

From this point on, prevented planting acres will be impacted by two factors:
1. Weather. Dry weather in the eastern Corn Belt of upper Midwest would allow farmers to plant corn.

2. Expectations of harvest-time commodity prices. Higher commodity prices will increase expected returns from planting, leading to more incentives to plant. Hence, increases in Chicago Mercantile Exchange (CME) futures likely would lead to increases in planted acres and vice versa.

For farmers who have purchased the COMBO product with high coverage levels, taking a prevented planting payment will be a viable alternative compared to planting corn and soybeans. Weather and expected prices will impact the number of prevented planting acres.

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Wheat prices soar as IGC forecasts harvest deficit


The world will not, after all, balance its books in wheat next season, despite weaker prospects for consumption by biofuels plants highlighted by the mothballing of Europe's biggest bioethanol plant.
The International Grains Council cut its forecast for world wheat consumption in 2011-12 by 3m tonnes, to 669m tonnes, reflecting in part lower expectations for use by biofuels users such as the UK's Ensus site, which is being mothballed because of high grain prices.
Wheat prices as of 18:00 GMT
Minneapolis: $10.61 a bushel, +4.0%
Paris: E252.75 a tonne, (closed)
London: £198.50 a tonne, +2.7% (closed)
Kansas: $9.52 a bushel, +2.6%
Chicago: $8.21 a bushel, +3.1%
Prices for July contracts on US exchanges, and November lots on European ones
"Use [of wheat] for ethanol is growing less quickly than expected, including in the European Union, while greater use of alternative feeds, including barley, is expected to cut the feeding of wheat in Russia," the influential group said.
However, it lowered its estimate for production even more, by 5m tonnes, to 667m tonnes, reflecting "overly dry conditions in the southern US, much of Europe, and parts of the former Soviet Union".
"The outlook for wheat crops has been affected by unfavourable weather in a number of countries."
'Panic buying'
The warning places the intergovernmental group among the growing band of forecasters to ditch expectations of a rise, or even stasis, in global wheat stocks in 2011-12, although inventories are set to remain at an ample level.
IGC 2011-12 wheat estimates, change on last, (yr-on-yr change)
Production: 667m tonnes, -5m tonnes, (+2.8%)
Consumption: 669m tonnes, -3m tonnes, (+1.2%)
Trade: 127m tonnes, +1m tonnes, (+4.1%)
Carryover stocks: 185m tonnes, -1m tonnes, (-0.5%)
The grain's stocks-to-use ratio, a metric of the availability of a crop, and therefore of its price potential, will come in at 27.7% on IGC estimates, well above the 21.3% level in 2007-08 which helped fuel the last spike in prices.
And it came as, thanks to weather scares, wheat futures posted a second day of strong gains, notably in Minneapolis, which trades spring wheat, which US and Canadian farmers are struggling to plant amidst overly damp conditions.
Minneapolis wheat for July soared to $10.78 a bushel at one point, the highest for a spot contract since July 2008.
"Some panic buying is finally surfacing because of the continued delays in the Northern Plains," Darrell Holaday at US broker Country Futures said.
In Europe, grain institute Arvalis raised its estimate of drought damage to France's soft wheat crop, the region's biggest, to "more than 10%" from "far more than 5%".
Total grains
The IGC edged is forecast for consumption of corn by US bioethanol plants in 2011-12 lower too meaning that, while the estimate for production of overall grains was cut by 5m tonnes, inventories were seen higher than before, at 338m tonnes.
Stocks are expected to end this season at 348m tonnes.
Total grain stocks held by major exporters – a metric which exclude those held by countries such as China which are rarely traded, and so have less of an impact on prices – were pegged at 111m tonnes, an eight-year low but 3m tonnes above the previous forecast.

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Sovereign Debt Default Risk

by Bespoke Investment Group

Below is a table showing default risk as measured by 5-year credit default swap prices for nearly 60 countries worldwide. As shown, default risk for Greece is by far the highest of any country shown, and 5-year CDS prices for the country are up 40% so far in 2011. Venezuela has the second highest CDS prices, but they're only up 6% year to date. Portugal and Ireland are the 3rd and 4th riskiest countries.

The countries that investors believe are least at risk of default are currently Norway, Sweden, Finland, and Denmark. The US used to be the least at risk of default, but CDS prices here have ticked up 20% so far in 2011. US default risk is still low relative to the rest of the world, but any tick higher is something we don't want to see.


by Cullen Roche

The most recent World Gold Council’s quarterly report showed a continuing boom in gold demand from China. China has been the single most important component in the 10 year commodity boom and their demand for gold is no exception. In fact, this makes a great deal of sense. You see, many of the hyperinflationary concerns that we often hear about in the USA are real viable threats in China. China really is printing loads of money. They really do have a high inflation problem. China really is a command economy. Add in the strong fundamental underpinnings in the Chinese growth story and you have a pretty solid thesis leading to increased gold demand.

In the report, they list 7 reasons why gold demand is likely to remain strong in China:
1) Gold investment is rooted in Chinese culture.
2) Impending inflationary fears in emerging markets.
3) China Central Bank is positive on gold.
4) Limited domestic investment channels.
5) Advisory from top Chinese economic scholars.
6) Increase in asset allocation to gold by institutional investors.
7) Potential increase in gold demand from a growing middle class.

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By Charles Rotblut

What diversification options are there beyond stocks, bonds and commodities? A member recently asked me this question. Here is an expanded version of the answer I sent him.

Not all stocks and bonds move in sync with one another, and making sure your holdings in both are properly diversified is the best place to start. If you have never given thought to your stock and bond allocations, you need to adjust these before moving on to other asset classes. Even if you have paid attention to your allocations in the past, review your portfolio annually (or every six months) to ensure the percentage invested in these two asset classes makes sense given your goals and tolerance for risk. (AAII members have access to asset allocation models that show suggested diversification strategies.)

Stocks – Simply splitting your holdings between U.S. large-cap, U.S. small-cap, developed international market and emerging market stocks gives diversification benefits. Though correlations (the extent to which different assets move in sync with one another) become closer during financial crises, they move apart during periods of recovery. Over the long term, each of these stock categories will generate different types of returns.

Bonds – Though the outlook for interest rates is uncertain, bonds continue to play an important role in your portfolio, since they provide both income and return on capital. Diversification can be achieved by holding a variety of U.S. government, corporate and foreign bonds. If you are worried about inflation, shorten the duration of your holdings, which will reduce the sensitivity of the portfolio to interest rate changes. (My bond funds have average durations of between four and five years.)

REITs – Real estate investment trusts provide a stream of income as well property ownership. They are sensitive to interest rate changes, but are more correlated with stocks than bonds. Keep in mind that if you own a house, you are already invested in residential real estate. If you have a mortgage, you’re investing in residential real estate on margin. Thus, a REIT focused on commercial real estate may make more sense.

Master Limited Partnerships – MLPs are mostly involved in the oil and natural gas pipeline business. They have a unique structure that results in them paying relatively high yields, but MLPs tend to be more correlated with stocks. MLPs come with potential tax issues and their distributions must be monitored when they are held within an IRA.

Preferred Stock – This is a hybrid security that offers a stream of dividend payments and limited voting rights, but is sensitive to interest rates and should be monitored for credit quality. This is why preferred stocks share return characteristics with both stocks and bonds. In a portfolio, they would be funded with some money that would otherwise be allocated to stocks and some money that would otherwise be allocated to bonds.

Annuities – These are contracts that return a stream of income over a certain period of time. The advantage is that they can guarantee you a minimum level of return. The disadvantage is that they can be complicated, have high comparative costs and offer limited upside, especially compared to the potential returns realized by investing in stocks. When used properly, annuities can offer financial security and can offset part of your bond holdings.

Precious Metals – Gold’s value has historically been inversely correlated to currency valuations over long periods of time. Over shorter periods, it is influenced by shifts in sentiment. Precious metals are a hedge for your portfolio that is unlikely to create wealth unless your timing is really good. An ETF can remove many of the headaches (including the threat of theft) associated with buying and storing gold and other precious metals. Arguments can be made to use both stock and bond dollars to buy precious metals; if pushed, I would suggest allocating to gold from your stock holdings given the lack of cash flow.

Commodities – A basket of commodities, including precious metals, energy (e.g., oil) and agricultural goods (e.g., wheat) provides a hedge against inflation. It also lowers the volatility of a portfolio holding only stocks. Commodities are subject to sharp swings in volatility. Futures contracts are used to invest in these (accessible via mutual funds and ETFs), but come with an additional level of risk and complication. If used, 10% to 15% of the money invested in stocks should be shifted to commodities.

Hedge Fund Strategies – A growing number of mutual funds and ETFs follow strategies designed to mimic those used by hedge funds. These can provide different returns than you would otherwise get in a more traditional investment. The downsides are that you will be paying higher fees, the strategies can be complex, and they are risky by themselves. The suggested allocations discussed at a Morningstar conference on alternative investments that I attended on Tuesday ranged from 0% to 25% of portfolio dollars (funded from both stock and bond allocations), with 15% used as a benchmark. One fund manager said that anyone who does not fully understand the strategy being used should avoid hedge funds and any investments that mimic them. This is good advice that applies to any investment offering.

Currencies – Foreign currencies can help protect your portfolio against fluctuations in the U.S. dollar. They are volatile, and an individual investor is pitted against traders with access to economists and offices staffed 24 hours a day. (Foreign currency exposure can also be obtained by investing in foreign bonds.) From an allocation standpoint, use portfolio dollars from both stocks and bonds if you are holding a currency fund for an extended of period of time and from stocks if you are going to trade currencies actively (which I do not recommend).

The Role of Cash

The one asset class not mentioned above is cash. Cash and its equivalents (money market funds, CDs, Treasury bills, etc.) give you both safety and flexibility. The primary advantage of holding onto cash is having the ability to pay for unexpected expenses and take advantage of new, attractive investment opportunities when they appear. The downside is that inflation erodes your purchasing power. (Remember when putting $5 in the gas tank actually allowed you to drive somewhere?)


By Comstock Partners

Our comment of two weeks ago outlined the major headwinds likely to impact both the economy and stock market over the period ahead, while last week’s comment discussed the actual economic slowdown that was already happening. Events of the past week have confirmed these views.

The Chicago Fed’s National Activity Index of 85 coincident indicators for April dropped to minus 0.45, its lowest level since last August. The index has now been below zero for five of the last eight months, as is the three-month moving average. This means that the economy was probably growing below trend in the first quarter, and possibly the second as well.

First quarter revised GDP growth was not revised upward as the consensus expected, but remained at the originally reported 1.8%. Moreover the underlying data deteriorated as consumer spending growth was revised down to 2.2% from 2.7% and inventory accumulation was revised up by $9 billion. Furthermore, major firms have been reducing their second quarter GDP growth estimates to well below 3%. Recall that toward the end of 2010 most pundits were looking for 4% growth in the quarters ahead.

Initial weekly unemployment claims, reported today, rose to 424,000 and have now remained well above 400,000 for the seventh straight week after a period of coming in below that level. This does not bode well for upcoming monthly payroll employment.

The ECRI Weekly Leading Index was down again last week, the fourth decline in the last six weeks, and the lowest since the week of January 15th. A slowdown in this indicator generally suggests a period of tepid growth in the period ahead.

The May numbers for both the Richmond and Kansas City Fed indexes fell sharply, confirming the previously reported results for the Philly Fed and the Empire State Manufacturing Survey. This strong unanimity strongly suggests that industrial production is still extremely sluggish in May. These results are consistent with the April decline in core capital goods orders of 2.6%. Similarly, shipments dropped 1.7%.

Keep in mind that this has happened during a period during which QE2 poured reserves into the financial system, the stock market rallied and fiscal policy was boosted by the reduction in payroll withholding. With all of that we have an economy that is growing below trend and fading rapidly. Now QE2 is ending within weeks, fiscal policy is about to tighten and housing prices are still falling with lots of additional supply still coming.

The stock market has now stalled for over three months and appears to be in the process making a top. The S&P 500 reached an intra-day high of 1344 on February 18th, backed off and then broke out to a new high of 1370 on May 2nd. It has since declined to well below the 1344 mark, a strong indication that the breakout has failed and that a new decline may be underway. This would be similar to the pattern of 2010, when the market dropped 17% following the end of QE1. That time the market was saved by the initiation of QE2. The Fed, however, is running out of ammunition, and we doubt that a QE3, if ever implemented, would be that effective.

Options Trading Manipulation: Two Charged with Manipulating Oil Prices

by johnu

Options Trading Pair Accused of Manipulating Oil Prices

(Calgary Herald)
Earlier this week, the US futures regulator sued two veteran oil traders along with their employers, the Arcadia Energy Suisse SA and Parnon Energy Inc. (both owned by by Norwegian shipping magnate, John Fredriksen), for allegedly booking $50 million in profits through the manipulation of oil prices in 2008.

The Commodity Futures Trading Commission has accused the pair of options trading employees at Parnon and Arcadia of carrying out a cross-market options trading trading scheme between January and April of 2008. The options trading scheme involved the accumulation and sell-off of a substantial position in physical crude oil in order to manipulate futures prices.

Specifically, trading activities involved the interplay between physical oil storage held in Cushing, Oklahoma, along with the delivery point for the US benchmark futures contract plus the derivatives market. Apparently, the pair would try to boost prices by purchasing commercial supplies of crude around Cushing as well as force prices lower by dumping crude in order to depress prices and then to profit on short options trading positions.

However, the charges appear to not be related to crude oil’s recordbreaking spike to almost $150 a barrel back in 2008.

Options Trading Tip: The Advantages of Spread Trading


An options trading spread is an options trading strategy that involves the purchase of one option and the simultaneous sale of another. Given this very broad of a definition for an options trading spread, there is a huge number options trading strategies that can be undertaken.

More importantly, options trading investors should note the following three advantages of a bull call spread verse just buying a call option outright:
  • Less Risk. Given that an options trading spread involves the buying and selling of options, the premium received from the short option will help to offset options trading costs. Hence, this will also reduce options trading risk associated with the trade.
  • Lower Theta Risk. When an options trading investor purchases an option, they will acquire a negative Theta position. Moreover and has time passes, this type of options trading position will loose value. On the other hand and when an options trading investor is selling an option, they are actually profiting over time. Hence, entering a spread trade can reduce one’s exposure to time decay by as much as half.
  • Lower Volatility Risk. Options values will increase when implied volatility rises but decrease when implied volatility falls. However, spread trades can be used to minimize volatility to some degree.
In other words, spread trades can be used to lower the amount of money an options trading investor risks and limit his or her exposure to both time decay and implied volatility.

Options Trading Bulls Charge Up on Tesla


5189224326 36589158f4 m optionsOptions trading investors are taking up positions to benefit from the rise in shares of Tesla Motors Inc. after the car company announced that it will sell a batch of stock in order to fund a new “crossover” model.

Specifically, options trading investors are purchasing bullish calls that grant them the right to buy shares for $30 by June expiration. In addition, options trading investors are targeting calls with a $30 strike that will expire in July.

The announcement sparked unusually heavy options trading for Tesla’s options and about 18,000 calls versus about 4,700 puts exchanged hands. In fact, overall options trading volume in Tesla’s options were the second-highest since the company had its IPO.

Oil price manipulation

The Commodity Futures Trading Commission on Tuesday filed a civil enforcement action alleging that Nicholas Wildgoose and James Dyer, who worked as traders for Arcadia Petroleum Ltd. and its affiliates, profited by manipulating the price of oil and oil futures in early 2008. I was interested to take a look at the details of the CFTC allegations.

Let me begin by providing a little background. Cushing, Oklahoma has an important network of pipelines and storage facilities that allow it to serve as a major trading hub for crude oil. There exists a physical market in which you can arrange to buy or sell oil for delivery in Cushing. Yesterday (the 25th calendar day of May) was the last day you could have scheduled a pipeline to deliver physical oil to Cushing some time in June. Economists might describe an agreement reached in May to receive oil some time in June as a forward contract.

There are also separate arrangements known as futures contracts, such as the well-known light sweet crude contract traded on NYMEX. Whereas a forward contract is an agreement between two particular parties accompanied by a stand-by letter of credit from a bank ensuring the buyer’s ability to pay, a futures contract is intermediated by an exchange that insists on maintenance of a continually adjusted margin account, creating the possibility for an anonymous, purely financial transaction. Many of the people who buy futures contracts do not want to receive physical oil in Cushing, but instead intend from the beginning to later sell the contract to somebody else in order to reap a financial gain if the price goes up, as a way to hedge against certain risks. For example, a refiner, even if not located in Cushing, might buy (and later sell) a NYMEX futures contract as a form of insurance against an increase in the price of oil during the time the contract is held. Alternatively, a pension fund might want to buy (and later sell) a futures contract in order to have some insurance against inflation or commodity price moves that could adversely affect other holdings in its portfolio. Other people might be interested in a futures contract because they have a particular belief about the direction that oil prices will head. If someone buys a futures contract and at some later date sells the same contract, the futures exchange nets out those transactions, so much of the time when two parties enter into a futures contract, no oil ends up being physically delivered to anybody.

But if you buy a futures contract and never sell it, a NYMEX contract entitles you to receive delivery of 1000 barrels of physical oil at Cushing, Oklahoma some time in the month specified by the contract. Trading in the June NYMEX futures contract ended on May 20, three business days before the last day of pipeline scheduling on the 25th, to allow parties who held on to their futures contract all the way to expiry 3 days in which to schedule a date in June for physical delivery to Cushing.

The CFTC complaint alleges that between January 8 and January 18 of 2008, oil traders Nicholas Wildgoose and James Dyer entered into forward contracts to buy 4.6 million barrels of oil for physical delivery in February, an amount that represented 66% of their beginning-of-month estimate of the total physical Cushing market. Between January 3 and January 16, the pair is alleged to have also bought about 13,600 February futures contracts (equivalent to 13.6 million barrels of oil) and sold the same number of March futures contracts. The claim is that by creating the appearance of temporarily tighter conditions in the physical market, the February futures price would rise relative to the March and the traders would profit as they closed out their futures positions between January 16 and January 22.

The graph below plots the prices of the February and March NYMEX futures contracts during the month of January 2008. Note that the CFTC is not alleging that these actions were a cause of rising oil prices– in fact, the price of oil was falling during this period. Rather, the allegation is that these actions resulted in an increase in the spread between the February and March futures price, that is, in the absence of these actions, the February price would have fallen more and the March price would have fallen less.

Price of February and March NYMEX light sweet crude oil futures during the month of January 2008.
cftc complaint1 economy

The CFTC complaint alleges that Wildgoose and Dyer subsequently acquired by January 25 a net short position in March futures and long position in April futures equivalent to 12.2 million barrels. The allegation is that this was done in anticipation of suddenly selling off on the last possible day (Jan 25) all 4.6 million barrels of the physical oil previously accumulated; I gather that the allegation is that this was achieved by finding somebody currently holding rights to delivery of an equivalent volume in March who was willing to swap and take delivery instead in February, provided that the offered February price was sufficiently low. The effect of such a huge last-day sale would have been to depress the February physical price as the market discovered that the apparent big demand for oil just wasn’t there. Although Wildgoose and Dyer would of course have taken a big loss on their physical contracts (by virtue of having bought at the artificially higher prices that their bids created and then selling at the artificially lower prices that their sales induced), the CFTC alleges that they more than made up for these losses with bigger profits on the corresponding futures transactions. The CFTC complaint alleges that the pair lost $15 million on the physical transactions but gained $50 million on futures transactions, profiting first by the increase in the February-March spread induced by creating the impression of an unusually tight February physical market, and then later profiting by the decrease in the March-April spread by surprising the market with much more physical oil available for delivery than people had been assuming.

Price of March and April NYMEX light sweet crude oil futures during the month of January 2008.
cftc complaint2 economy

The CFTC complaint goes on to allege that the pair repeated the same sequence of transactions in March of 2008– initially profiting from a long position on the April-May spread by surprising the market by buying a large quantity of physical oil for April delivery in the first part of the month, and then profiting from a short position on the May-June spread by surprising the market by selling off their physical positions on the last possible day.

Price of April and May NYMEX light sweet crude oil futures during the month of March 2008.
cftc complaint3 economy

Again, March 2008 was not a month in which the oil price overall is alleged to have been driven up as a result of the traders’ actions. Instead, the claim is that their actions led to an initial increase in the April-May spread and a subsequent decrease in the May-June spread.

Price of May and June NYMEX light sweet crude oil futures during the month of March 2008.
cftc complaint4 economy

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