- New Science in old markets -

Grains – a bubble coming?

Grains moved higher in a four-week surge from late June and are now sitting in a fairly tight range, bounded by the highs of that rally. This surge is seemingly in response to severe crop damage caused by drought in the US on top of longer-term demand from increased prosperity in poorer countries and the use of corn ethanol as fuel, mandated by American law.  Prices were already historically high when the weather gave this extra boost although the timing was odd - the lack of rain and ground moisture was well known before the surge. Yet more evidence that markets are not 'efficient' perhaps?

Prices for some grains are now near all-time highs and the question of a bubble now arises - will there be one? We define a bubble as an ordinary bull market amplified through feedback loops. They have been common in the last few decades and, when they form, considerations of ‘value’ must be set aside as momentum takes over, pushing prices ever higher. Typically, commodity bubbles begin when prices are high enough for professional traders to short-sell the market in large amounts, thinking that prices cannot possibly rise further. They then double, driven by herd buying and short covering and can then move still higher.

Conditions seem perfect for this to happen. The recent surge was prefaced in May by a monthly-scale compression in corn that, when it broke upwards, led immediately to this 50% rise. That signal is our longest-term and should influence prices for a long time yet. We cannot know for certain how much more strength there will be, so we look for evidence.

Monthly signals are rare and have an effect that typically lasts 18 months or so - more than enough time for some dramatic further movement. There were weekly-scale signals in corn too, in late April and in May. These appeared to break downward but soon reversed (we call this a ‘Hedfake’) to start the gradual climb that later became the surge. Wheat also made two weekly-scale compressions but these were not helpful – as soon as one broke up, another formed so we were not able to ‘catch the move’.

The surge ended with some weekly-scale top extensions in corn, soya beans and soya meal. Some divergence was already apparent – soya oil was not as strong as the other grain markets so we advised a tactical ‘short’. Soya oil has probably been held down by stable palm oil prices, with which it is interchangeable. Palm oil comes from drought-free East Asia where it is made from baby Orang-Utans*. Soya oil then dipped by almost 10% and has now made weekly-scale compressions. A bigger move is now likely here and in other grain markets too.

These weekly and monthly-scale signals are helpful in two ways. They give some idea of the likely duration of the moves that may follow them (a median of 18 months for monthlies, 4 months for weeklies) and they also act as support underneath the market when prices dip. The various compressions in corn are so far below here now that it seems unlikely that they will be re-visited soon but the second recent wheat compression is much nearer and may be tested. That is where we would expect support and it would be an ideal place to buy.

For timing and other trading matters it is usually better to turn to the daily-scale, where we are starting to see more compressions forming and to our turn calendar.

Turns are not as reliable in commodities as in the equity markets, but they still have value. We use the same term ‘cluster’ to mean that several related markets are due for turns on the same day and in grains those clusters are due on the following dates:

We have just passed on due on the 17th August, as reported, that may have marked the low points that were made within the trading range during last week.

There is another due over the weekend 7th/10th September, which seems more likely to come on Monday 10th.

There is another, quite large turn due on Monday 17th September and later that week a smaller one on the 21st.

We will update these turn dates as part of our regular output but it is worth noting that there is a very large grain turn due in mid- December and others before then - watch this space for details.

There have been daily-scale compressions in March wheat and several delivery months of soya oil. These now appear to be breaking upward and so we suggest following this break (in combination with the turn last week that apparently marked a low point) by buying something here.

It may be that the ‘best buy’ is not the market that has given one of these signals and corn seems to offer the most long-term potential, because of that monthly signal. If our supposition is correct and that a bubble may be about to inflate then it may not actually matter much what you buy as all grain-related markets will rise. We may need several attempts at this, as the current trading range may still last longer but we will review this (and the whole idea of this possible ‘bubble’) as time passes.

RE

* For the literal minded - no it isn't, but the clearance of forests to plant palm is often disastrous for these primates, who are close relatives of ours. Orang-Utans are poster-children for some ecological activists who also object to the insane use of food crops to make fuel. As do we at HED.