Trading Opportunities in Non-Financial Futures Markets (Part 1)

There is an old adage which states "Both bad news and good news is always good news for futures traders." The reason is that as futures traders we can take Short positions as easily as we can Long positions. Today, too many new traders have chosen to focus exclusively on day-trading the E-mini stock index futures and may have overlooked the non-financial contracts which created the original futures industry in 1865. In fact, until Currencies began trading in 1972, all futures trading was confined to agricultural and mineral commodities.

[NOTE: this article will use the term "financial futures" to include Currencies, Interest Rates and Stock Indices]

Today, the non-financial futures may comprise only 20% of all U.S. futures trading volume. Nonetheless there are many exciting and vibrant markets to trade -- both with outright long or short positions and with intra-market and inter-market spread positions. Is there a trader (or consumer) today who is not aware that the price of Gold has tripled since the beginning of 2002 (from $270 an ounce to well above $900) or of Crude Oil's rise from $50 a barrel one year ago to almost $100 today!

But what of the agricultural futures contracts like Wheat and Sugar? A six-month bull market in wheat was followed by a 6-week bear market, only to recover and make new all-time highs exceeding $10.00 a bushel. And Sugar futures? The current bull market, which started in December 2007, has seen a 100% increase in the price per pound!

Daily bar chart for March 2008 Wheat Futures

Weekly continuation chart for Wheat, going back to April 2006

Short term traders may have interest in viewing the intra-day volatility in March Wheat, as seen in this January 30th, 60-minute bar chart.

Daily bar chart for March Sugar

Clearly there have been spectacular trading opportunities over the past six months. So how does a trader make that transition from financial futures to agricultural, energy and metal futures? Well, don't abandon the ironclad rules of "buy low and sell high," and "buy high and sell higher" but there are differences in the way these market sectors trade.

Fundamental vs. Technical Analysis

Speed of News and Special Release Dates

Anticipatory Markets and Realization Markets

Physical Delivery Concerns and the issue of First Notice Day

Storable Commodities vs. Nonstorable

Carrying Cost and Spread Relationships

Volume and Liquidity across the 24-hour trading day

Day-Trading vs. Position Trading

Daily Price Limits and Limit Up/Limit Down days

Specialized Managed Futures programs

Fundamental vs. Technical Analysis

For all futures markets, the fundamentalist has to focus on macro-economic issues and then drill down to the nitty-gritty supply/demand analysis for a particular commodity. To wit:

1. Has the demand for ethanol increased the acreage devoted to corn and how has that increased the supply?

2. But will this new source of demand cause ranchers to compete with ethanol plants for the supply?

3. And if corn gets too expensive will ranchers sell breeding stock today -- thereby increasing the short-term supply while inadvertently decreasing future supply -- and will this affect calendar spreads for Cattle futures?

This overly simplified example illustrates the intertwined economics of supply and demand among non-financial contracts.

There is a story we like to tell about a university's attempt to build an econometric model to forecast the price of Hogs. They gave up the quest because the short, medium and long term variables and multitude of cause and effect was too vast. Now granted this was back in the early days of computerization, nonetheless it illustrates the degree of specialization needed to focus exclusively on fundamental analysis.

But thankfully, the "rules" of technical analysis and trend following techniques work just as well for Crude and Corn as they do for the Pound and the S&P. So take heart and apply your Bollinger Bands exit and exit rules to this traditional futures market segment.

Speed of News and Special Release Dates

Generally, the Secretary of Agriculture does not make pronouncements that rock the trading world like those made by the Chairman of the Federal Reserve System. Furthermore, orange juice trees planted in April do not yield fruit in May. Our point being: Significant shifts in the supply and demand curves cannot occur in the short-run. But as our freshman economics professor used to point out, a shift in the curve is different from a shift up and down an existing supply or demand line. Hence, we still get to trade exciting (and some unprecedented) price movements which can take weeks or months until they really get noticed and begin to take off.

Unlike the financials which face a daily spate of economic releases, the "Ags" rely on monthly and quarterly reports. These often have a dramatic next-day effect on the markets and intra-day gyrations get driven by a case of expectations vs. the actual. The market anticipates a bullish report, a bullish report is released and the market drops. Why? Because the report wasn't as bullish as the commercials had hoped for and traders were disappointed. Days later, when calm and cooler heads prevail, the market resumes its upward course as traders realize the true bullish significance of the report.

Anticipation Markets vs. Expectation Markets

Too many traders quickly forget another lesson from Economics 101: "Price is the intersection of supply AND demand." The reason is that it is relatively easier to forecast (ie "anticipate) future supply than it is to gauge future demand. Doomed traders "realize" (often after the market has made its move) that the demand was greater or less than forecast. Let me illustrate with a basic and once again, overly simplified illustration.

Every year the USDA polls farmers as to the number of acres they intend to plant for corn. We have excellent data on the average number of bushels per acre for every county in the U.S. and taking into account long term growing conditions, we multiply the acres being planted by the average number of bushels per acre and we arrive at the "anticipated" new supply. Add to this the amount of corn held in storage facilities reduced by the amount of corn we expect to use prior to the next harvest and we arrive at the anticipated future supply. Compare this to a year ago and you have a pretty good idea whether the future supply will be greater or less than in prior years. Too much corn? Then we "anticipate" the greater supply will create a bear market. And prices start their downward trend. But price is where the supply curve crosses the demand curve and demand is just too often ignored. Why did corn prices rally when the anticipated supply was so large? Often it is because unforeseen demand was so much greater. "Ah ha," traders say. "We now realize that the market rallied on strong demand."

This article was written by Larry Schneider, director of marketing and business development for Zaner Group. Larry has spent over thirty years in the futures industry and likes to say he turned off the lights on the old Egg Futures contract when the CME closed trading.