Take Cues From Money Flow
Prior to the 2007 and 2008 commodity bubble, producers blamed speculators for any downfall in prices. When prices climbed, silence reigned. Now, the influence of traditional speculators and the newer funds is better recognized.
As a producer, I need to understand their motives for taking risks because their actions can be a window to the future and help direct my risk-management strategies.
I watch the historical large speculators, rather than the funds, which trade in a different way. Some analysts use total contracts (long or short) versus price, but my daughter Ashley's studies at Informa Economics a few years ago narrowed the focus to the net position (long or short) as a percentage of total open interest.
Risk Worth the Reward. The large speculators look for a story that has the potential to unfold in a way that makes the risk of an investment (accepting risk) today worth the possible reward.
During harvest, large speculators accumulated long soybean positions to near 20% of open interest, gambling on what-ifs. The risk is high: If South America produces a mega soybean crop that will supply the needs of the world in 2010, U.S. prices will drop. In addition, U.S. and world carryover levels are near record quantities, despite strong Chinese demand. However, any hiccup in South America's soybean production will send prices skyrocketing and create a bidding war for even more soybeans in the U.S. in 2010. That's what the large speculators are placing their bets on.
I will use the large speculators' position as one of the guides to my risk-management actions. I figure the likely outcome this year will be more of the same sky-high-prices media hype around the time large speculators sell their long positions to those buying back positions due to short hedge pressure or to those who wish to bet the farm on even higher prices.
Market psychology suggests large speculators' interest will top before the price peaks again. I'll take my clues accordingly.
Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact Jerry at firstname.lastname@example.org or (312) 896-2080.
Top Producer, January 2010