Coronavirus Has Some Commodity Traders Excited
The coronavirus scare and gold are made for each other. The soft commodities have taken a hit, but several commodities advisors see this as a good opportunity.
It didn’t really take much know-how for us to recommend going long gold when the coronavirus that still grips the financial world broke out not so long ago. Gold was already plenty hot and this could only make it hotter as investors both flee to the yellow metal as a hedge and to speculate.
The opportunities with trading futures contracts with gold versus just investing in the physical metal or a gold ETF are simply on a different level at a time like this, when they move so much, due to the amount of leverage that you can use. However, you can’t just buy any futures contract at maximum leverage without very careful risk management, because if you try to ride out moves against you, you can lose all of the money you put up as a deposit and plenty more without any trouble.
We therefore need to make sure that we not only pick our spots carefully but have some very tight stops in place, and the trick is to seek out higher risk to return ratios, which means that you need enough momentum to make it more likely that you will be able to let your trade run and shoot for the real big returns.
The returns with futures trading can be simply enormous if you can get in on a big move relatively safely. When you have gold moving up the way it has lately, this is a good opportunity to see just how much you can make with this, although only if you are in the know.
This is not for the uninitiated, so even prior to getting into what opportunities there may be with other commodities, or even with gold if you haven’t taken gotten in on any of the fun that’s been going on lately, we’re going to have to cover a couple of basics. People that have a hankering to dabble in futures trading often lack any real understanding of what it takes to succeed, especially when it comes to managing their risks properly, and successful futures trading is all about risk management.
The things we will briefly cover in this article don’t tend to be things that you can just go out and just read some books or take a course to learn enough about, or have your broker clue you in very much about, or even learn that well from the school of hard knocks, even if you blow up your account multiple times, but are things you absolutely need to know if you are going to do anything but get lucky and wait until your luck turns and lays a spanking on you.
Our focus here will be on those who normally consider themselves as investors, part timers in the world of futures, as opposed to those who do this for a living. We want something that Everyday Joe or Jane can use if they are up for it, where they can augment their investments by either using futures as a hedge or to add additional returns.
With stocks, where you get in isn’t that important, even though proper entries can definitely add to your overall return. You either pick a good stock that moves your way over time, or a not so good one that you hopefully get out, although many don’t. That won’t cut it here, as with commodities, timing is everything, at least if you are using leverage. If you don’t, trading commodities is generally not that exiting, but certainly can be if you really know what you are doing.
If you think that you can get a good entry with a futures position without a careful examination of charts, just jumping in when you see something moving or even on a lark because you’ve heard or believe something, you are in for a hard lesson. While you can enter futures trades aimlessly, you can’t trade them that way, even without leverage, as your trading will just be way out of sync with the market.
Speaking about entering on a lark, they are lining up to tell people that this is a good time to trade some soft commodities like corn that have taken a little hit from the coronavirus, undeserved or not, and these recommendations serve as excellent examples of how not to do it.
For example, let’s look at the recent comments of Sal Gilbertie of Teucrium Trading. It’s not that his observations aren’t useful, but the risk is that people will read these things and think that this is itself a reason for a trade, or even close.
Gilberte remarks that “here will be no real demand destruction in agriculture from the coronavirus. People still need to eat, which means agriculture demand will not abate.” The futures market did at least seem to think that there is a risk here, for instance with seeing corn futures drop by about 2% during this time, but we can’t just rely on these things and Gilbertie is right in perceiving that the coronavirus won’t be a big enough deal in itself to worry about.
Does this mean that we should just log in to our futures account and go long corn right now? This is where a lot of budding futures traders mess up, by thinking that if a trade seems more likely to go one way rather than another, in this case corn going up rather than down, that is enough.
Gilbertie seems sold enough though, and he goes on to say that “the coronavirus “lethargy” in grain and meat prices could provide investors with a chance to gain access to agricultural commodities prior to any Chinese buying that will occur from the U.S.-China phase-one trade agreement.”
For starters, there are a lot of factors that go into commodity futures pricing, with this only being one piece of the puzzle. While this looks like a recommendation, we shudder to think that people would jump on a trade with just these insights going for them.
It hasn’t just been corn that has taken a little hit since the coronavirus broke, as this has applied pretty much across the board to agricultural products. Although we do want to make clear that this can provide us opportunities that can be taken advantage of under the right conditions, the lesson here is that while this might point us in the right direction, there is more work to do before we can come to a reasonable decision here.
There Are All Sorts of Recommendations Out There to Go Long Agricultural Products
Gilbertie is far from alone in recommending going long soft commodities during this time, and there are good reasons to believe that this will at least provide some weight toward going long, but only if the time and the conditions are right. Otherwise, we’re just trading on a lark, even though the bird may be plenty real.
Let’s look at corn as an example. On Monday, January 27, the next trading day after the stock market started getting really spooked by the virus, corn dropped by 2% in just a day. If you were a futures trader, you could have made quite a bit of money with full leverage trading it that day, although by noon the next day, the fun was over and it stabilized. It’s been jumping up and down in place ever since and any signs of a rebound just haven’t materialized yet.
In the meantime, good traders could have added to their profits, by following the trends, and even a 4-hour chart provided several good trades provided that you really know what you are doing, getting in and out at the right times, but this is well beyond what can be expected from amateurs trading this casually and on longer timeframes than this.
You can’t just park leveraged money like this without exposing yourself to way too much risk, as along the way there have been 2% moves in both directions. This may not be that meaningful if you are unleveraged, but if that’s the case, corn is just too flat right now to want to have your money in it on either side.
This coronavirus issue isn’t even significant enough to be meaningful to those other than short-term traders, as a couple of percent means nothing basically in the time frame that is being suggested by Gilbertie and others, talking about getting in ahead of the Chinese buy and such. We don’t mean to pick on him though as there are plenty of other similar views out there right now. It seems that firms are looking to excite everyday folks who don’t understand that none of these observations are helpful to them and will just put them in positions that they may end up regretting, whether they use leverage or not.
Corn does offer some good opportunities for amateur futures traders though, but only when the time is right, and this is not the time at all, coronavirus or not, at least not yet. A 2% retracement over how long this ends up taking to be corrected just isn’t something that they can use, and again, you have to trade this much more tightly than they would ever dream of, using much more leverage than they would dare, and have skills well beyond theirs to take advantage of these little wiggles.
Picking your entries far more carefully than the promotors suggest is just one factor, and the next lesson involves understanding how commodities trade. The big money and the majority of the movement with commodity futures are from the hedgers, the people who actually buy and sell real corn, and their goal is not to seek to profit from their positions but to hedge.
If we are actually looking to ride real waves and not just little wiggles, we have to look at how this hedging plays out on the battlefield, where one side or the other will have the upper hand. We’re looking for seasonal trends, for instance what happens from spring to summer and then from summer to fall. This is the prime time for corn and looking at previous years should be pretty enlightening.
What makes commodity trading so different is that with other securities, speculators would game these trends quite a bit, where if you knew that corn does well on the long side from mid-spring to mid-summer for instance, moving up quite a bit during this time, speculators simply wouldn’t want to be short corn during the move up and not want to be long during the move down, and this would serve to flatten out the curve like we see during other times of the year.
Hedgers drive this market though, and speculators are only along for the ride, like people ride horses. It’s not that speculators don’t influence commodity markets, and there are some pretty big players on that side as well, but if there is considerably more hedging on one side or the other, as we see during these times of year, that’s going to get this horse really moving ahead or backward.
We can’t use anything like full leverage to trade these moves and need to leave that up to the pros who will be in and out dozens or hundreds of times during them. We still need to use enough to make it worth our while, and how you set your leverage with futures contracts is to match the amount that you are holding in reserve with your desired leverage ratio.
The Chart Always Tells the Full Story, But Only the Right One
You can really see this play out on a weekly chart of a continuous contract with Heiken Ashi bars, which make the moves easy to follow and trade. Last year, corn rose in price by 25% from May to early July, and then gave back every last bit of it by early September. 2018 wasn’t quite this nice, and few years are, but we did see a very nice climb during the springtime leading to a collapse once June hit, and then gave it all back by mid-July, 14% each way from top to bottom.
The spring run-up in 2017 was nothing special, although there was money for the making, but once this peaked, we gave up 13% between early July and early September, which is a great return when you multiply this by a few times and consider it’s only 2 months.
2016 was a huge year, with a move up of 25% between early April and early June, and a 29% move down between then and late August. 2015 saw corn in a downtrend all year until mid- June, so the move got underway late this year, but was very easy to spot once it was underway. The next 4 weeks saw corn rise by 23%, and then things reversed big as usual, where by the end of August corn moved 16% in the other direction.
2014 shows us how we need to pay close attention to the charts, and what we’re looking for is the price moving unusually on the weekly chart to get us wanting to get in on this. It turned out that corn was on a long downtrend from the summer of 2013 until the end of the year, giving up 26% over this time. When you see a big trend one way, you can count on a nice trend in the other direction when it’s over, and this is what this is all about.
From mid-January to the end of May, corn rebounded by 17%, and then, you moved down by 36%. Both the uptrend and the downtrend were early that year, but that’s why you need to pay attention, and the unusual circumstances that led up this do need to be taken into account.
That big selloff from June 2013 to January 2014 was preceded by a failed move to the upside, and not all of these trades work, but things were at least flat and no real harm done, and the ride down was plenty nice.
We’ll do one more year to cap this off, 2012. The up move this year was from mid-June to early August, to the tune of a whopping 45%. We didn’t see a green bar on the weekly until mid-November, where it dropped by 16%.
These are some huge moves over very short periods even without leverage. However, if we are careful, we can help ourselves even more by adding a little. The potential to double or triple up should really put a smile on our faces, as long as we realize that we are not riding these moves with an expectation of much up and down, and any bucking should have us back on the ground waiting to re-mount.
It’s also fine and reasonable to require a few attempts to mount these horses, but they ride like the wind once they start running and this lets us do what we’re told to, cutting losses and riding the winners. These winners ride a long way indeed with a little leverage. We just need to realize that we need to make cutting losses our first priority here, and only remain in a trade while things are going our way.
We also don’t want to think that hitting these dead on is even possible, unless you came from the future with charts in hand, and there will need to be a period where we’re waiting for the thing to take off and another where we wait for it to start showing us it is tired and ready to fall.
For those interested in commodities, this is where the real action is, not just looking at the potential for a little reversal from what may or may not be the coronavirus and getting excited about the prospect, at a time when it’s not even happening and is at the level of a guess, and not even having the guess mean much even if they are right.
With some practice, a little experience, as well as enough courage, trading commodities can both be exciting and profitable. Once again though, the key to this is using charts with continuous contracts, as individual futures charts lack continuity on the timeframes we’re looking for with this play.
Using leverage on weekly bars is not something you ever want to do unless you really do have a pretty big edge, but looking at seasonal patterns as well as the weekly trends with commodities, and especially handling these trades with care, can leave us with not only our risk managed well enough, but our upside being considerably greater, where we can make lots of bread while still staying safe enough.
Corn looks pretty trampled down right now and is of no interest to us on our timeframe. We have had some smaller trends since the selloff last summer but these aren’t the ones we want to focus on because the reward isn’t high enough to justify the risk with leverage, or the moves would be too tame if unleveraged.
If you are looking to grow corn or sell your corn, you need to choose the right time of the year to do it, and the same applies to trading corn futures. We generally grow our position first during growing season, then take it to market and sell it, and with futures, we can be both people and make money on both sides, provided we both recognize the opportunities and have the resolve to see our plan through.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
Topics of interest: News & updates from the Federal Deposit Insurance Corporation, Retirement, Insurance, Mortgage & more.