Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Eiro-group Review –The power of trading education - 4th Dec 20
Early Investors set to win big as FDA fast-tracks this ancient medicine - 3rd Dec 20
New PC System Switch On, Where's Windows 10 Licence Key? Overclockers UK OEM Review (5) - 3rd Dec 20
Poundland Budget Christmas Decorations Shopping 2020 to Beat the Corona Economic Depression - 3rd Dec 20
What is the right type of insurance for you, and how do you find it? - 3rd Dec 20
What Are the 3 Stocks That Will Benefit from Covid-19? - 3rd Dec 20
Gold & the USDX: Correlations - 2nd Dec 20
How An Ancient Medicine Is Taking On The $16 Trillion Pharmaceutical Industry - 2nd Dec 20
Amazon Black Friday vs Prime Day vs Cyber Monday, Which are Real or Fake Sales - 1st Dec 20
The No.1 Biotech Stock for 2021 - 1st Dec 20
Stocks Bears Last Chance Before Market Rally To SPX 4200 In 2021 - 1st Dec 20
Globalists Poised for a “Great Reset” – Any Role for Gold? - 1st Dec 20
How to Get FREE REAL Christmas Tree 2020! Easy DIY Money Saving - 1st Dec 20
The Truth About “6G” - 30th Nov 20
Ancient Aztec Secret Could Lead To A $6.9 Billion Biotech Breakthrough - 30th Nov 20
AMD Ryzen Zen 3 NO UK MSRP Stock - 5600x, 5800x, 5900x 5950x Selling at DOUBLE FAKE MSRP Prices - 29th Nov 20
Stock Market Short-term Decision Time - 29th Nov 20
Look at These 2 Big Warning Signs for the U.S. Economy - 29th Nov 20
Dow Stock Market Short-term and Long-term Trend Analysis - 28th Nov 20
How To Spot The End Of An Excess Market Trend Phase – Part II - 28th Nov 20
BLOCKCHAIN INVESTMENT PRIMER - 28th Nov 20
The Gold Stocks Correction is Maturing - 28th Nov 20
Biden and Yellen Pushed Gold Price Down to $1,800 - 28th Nov 20
Sheffield Christmas Lights 2020 - Peace Gardens vs 2019 and 2018 - 28th Nov 20
MUST WATCH Before You Waste Money on Buying A New PC Computer System - 27th Nov 20
Gold: Insurance for Prudent Investors, Precious Metals Reduce Risk & Preserve Wealth - 27th Nov 20
How To Spot The End Of An Excess Market Trend Phase - 27th Nov 20
Snow Falling Effect Christmas Lights Outdoor Projector Amazon Review - 27th Nov 20
4 Reasons Why You Shouldn't Put off Your Roof Repairs - 27th Nov 20
Further Clues Reveal Gold’s Weakness - 26th Nov 20
Fun Things to Do this Christmas - 26th Nov 20
Industries that Require Secure Messaging Apps - 26th Nov 20
Dow Stock Market Trend Analysis - 25th Nov 20
Amazon Black Friday Dell 32 Inch S3220DGF VA Curved Screen Gaming Monitor Bargain Deal! - 25th Nov 20
Biden the Silver Bull - 25th Nov 20
Inflation Warning to the Fed: Be Careful What You Wish For - 25th Nov 20
Financial Stocks Sector ETF Shows Unique Island Setup – What Next? - 25th Nov 20
Herd Immunity or Herd Insolvency: Which Will Affect Gold More? - 25th Nov 20
Stock Market SEASONAL TREND and ELECTION CYCLE - 24th Nov 20
Amazon Black Friday - Karcher K7 FC Pressure Washer Assembly and 1st Use - Is it Any Good? - 24th Nov 20
I Dislike Shallow People And Shallow Market Pullbacks - 24th Nov 20
Small Traders vs. Large Traders vs. Commercials: Who Is Right Most Often? - 24th Nov 20
10 Reasons You Should Trade With a Regulated Broker In UK - 24th Nov 20
Stock Market Elliott Wave Analysis - 23rd Nov 20
Evolution of the Fed - 23rd Nov 20
Gold and Silver Now and Then - A Comparison - 23rd Nov 20
Nasdaq NQ Has Stalled Above a 1.382 Fibonacci Expansion Range Three Times - 23rd Nov 20
Learn How To Trade Forex Successfully - 23rd Nov 20
Market 2020 vs 2016 and 2012 - 22nd Nov 20
Gold & Silver - Adapting Dynamic Learning Shows Possible Upside Price Rally - 22nd Nov 20
Stock Market Short-term Correction - 22nd Nov 20
Stock Market SPY/SPX Island Setups Warn Of A Potential Reversal In This Uptrend - 21st Nov 20
Why Budgies Make Great Pets for Kids - 21st Nov 20
How To Find The Best Dry Dog Food For Your Furry Best Friend?  - 21st Nov 20
The Key to a Successful LGBT Relationship is Matching by Preferences - 21st Nov 20
Stock Market Dow Long-term Trend Analysis - 20th Nov 20
Margin: How Stock Market Investors Are "Reaching for the Stars" - 20th Nov 20
World’s Largest Free-Trade Pact Inspiration for Global Economic Recovery - 20th Nov 20
Dating Sites Break all the Stereotypes About Distance - 20th Nov 20

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

Not All Commodities Stocks are Treated Equal (Part 2)

Commodities / Investing 2009 Feb 24, 2009 - 11:21 PM GMT

By: Oxbury_Research

Commodities Best Financial Markets Analysis ArticleThe first part of this two-part series essentially looked into the different effects monetary occurrences and supply and demand fundamentals can have on commodity prices. Monetary authorities around the world are implementing rampart growth in the money supply and quantitative easing in the form of negative real interest rates; meanwhile, the global economy is in free fall. The factors have opposite effects on commodity prices. We came to the logical conclusion that we wanted to give our portfolio exposure to the commodities that have significant monetary uses, aren't cyclical, or both. Two good examples are gold and the grains. I want to be careful with my next statement.


I'm a commodity bull across the board because of my belief that triple digit annual monetary inflation of the monetary base will trump any slack in global demand. Keeping that in mind, in order to maximize returns on capital, we want to avoid commodities that are cyclical, have limited exposure to monetary markets, or both. These include the industrial metals (copper, aluminum), silver and energy markets.

The last item I would like to note from the first part of this series is the softs (sugar, coffee, orange juice). The softs fall somewhere between the industrial complexes and the grains as far as cyclicality goes. They are a great tool to use for inter-market such as a long corn/short coffee or long soybeans/short orange juice. I'm a big fan of using inter-market spreads to give my portfolio sector exposure while reducing the risk exposure. These are all very important notions in trading commodities markets and should be kept in mind when reading the second part of this series.

Moving on, the single greatest factor that companies have control over other than their business model is price risks associated with the production of their underlying commodity. There's nothing you can do if a mine floods, or crop yields are crushed because of an early freeze. Maybe a certain producer was counting on a credit facility that simply doesn't exist anymore and they are simply SOL. These things are out of the producers' control. Hedges on the other hand, are completely controlled by management. They are used in some sort by commodity producers in almost every sector to reduce those risks. This is not to say putting a hedge on is a walk in the park; in fact it's just the opposite as you'll soon find out. Miners, farmers, and energy producers all use hedges to alleviate the risks associated with input costs and output values. Given the massive volatility and percent changes of commodity prices from peak to trough, using futures and cash markets to mitigate risks has never been more important than it is today and has been over the past year.

Grain Hedges Going Nuclear

What a 12 month period to be a farmer. Seed, fertilizer, and energy products soared along with commodity prices. Energy prices such as diesel used by tractors and heating oil used for storage, obviously followed oil prices higher. Seed and fertilizer are a slightly different story. When crop prices increase, farmers are more willing to spend money on inputs that will increase yields. Essentially, the value of increasing yield is increased, or the projects on the margin now become economical. The increased value of yield growth resulted in a strong demand for things like fertilizer and seed. The increased demand lead to higher prices.

Fertilizer costs in 2008 reached approximately $850 /ton of potash, $9000 /ton of anhydrous ammonia, and $1000 /ton of diammonium phosphate (dependant on the region). Seed prices also went to the moon reaching $90 /acre for corn and $60 /acre for soybeans (dependant on seed type). Just as higher crop prices lead to higher input prices, the ensuing collapse had an equal and opposite reaction. Input prices fell anywhere from 60-75%. As a result, hedges absolutely blew up. There were a number of grain elevators for example that secured corn at $8 /bushel because they had contractual obligations. Instead of using the cash market to get by, they secured large amounts of grains at extremely high prices.

There are several things to take from this when applying these notions to the commercial farm productions and input suppliers on the stock market. The basic principal is to identify the companies that made good hedges and the companies that made bad hedges. Here are a few examples:

- Make sure the company is currently securing energy, seed, and fertilizer needs using futures contracts when available. These inputs will definitely be more expensive 3, 6, or 9 months from now.

- Avoid, or look for a short opportunity for those who hedged costs 10 months ago and now lack sufficient capital to put to use.

- Buy companies that hedged future production with futures and options on futures when prices were peaking last spring.

- Look for seed/fertilizer producers who have significant long term contracts set during price peaks

Cargill is one of those agricultural companies that always seems to avoid the destruction left by market volatility. For example, when they need to secure supply, they're usually buyers of futures during low price periods and buyers of the cash market during high price periods. You don't see Cargill buying beans futures in the teens before a market pull back.

Then you have a company like ADM. For the most part, ADM has done a reasonably good job with their business model, save one grave error. ADM has a massive exposure to the ethanol industry…really massive. A potential trade with reduced risk that still has exposure to agricultural markets could be a long Cargill/short ADM position.

Click HERE to Comment on This Article – Make Your Voice Heard!

Learning from the A-Bombs in Metals Hedges

The mining/metals production industry is no different than the agricultural business in the sense of hedging risks. The applications apply just as well here. The ultimate goal is to give yourself exposure to producers who made good hedges and avoid the ones who blew up. Let's start our look into the metals industry with a shining example of utter failure.

Alcoa made every possible hedging and lack of hedging mistakes that a good company shouldn't. Alcoa is the third largest producer of aluminum in the world. The production of aluminum is very energy intensive throughout most of the process. It also happens to be a very cyclical industry. Alcoa managed to really make a mess of things on both the way up and the way down.

The price of aluminum peaked in July at $3380.15 /metric ton. In the second quarter of 2008 ending on June 30 th , Alcoa received an unprecedented average of $3058 /MT of aluminum. Initially, it looked really good on paper. Unfortunately, that couldn't have been less the case. Year over year income fell 24% from $715 million in Q2 2007 to $546 million in Q2 2008. In the six months starting on June 30 th 2007 , Alcoa's cash from operations all but disappeared as it fell from $2.32 billion to $719 million; a decline of nearly 70%.

So what hell did Alcoa do? I mean, I think I would have to try in order to screw up so bad. Like I said, Alcoa made every wrong play possible. This was probably a combination of both human greed and utter stupidity. They didn't hedge energy costs on the way up. Energy rose at a faster pace than aluminum prices and with aluminum production being energy intensive, their income took it on the chin. I should rephrase my prior statement. They almost didn't hedge energy costs. The brilliant minds running the show over there figured it would be a good idea to put on an energy hedge with oil trading over $120 /barrel. While they were locking in those fantastic prices oil prices, they never figured to hedge their production risks.

Is it becoming clear what their intentions were? Alcoa decided they were going to try and maximize potential returns while doing nothing to mitigate downside risks. Think about it. With energy hedged at $120 /barrel, a rise in prices (aluminum and oil) would have allowed them to maximize profits. Instead, they were left with the exact opposite situation and nothing to do but sit with their hands in their own dumb pockets. Investing in companies like Alcoa and the situations they get themselves into need to be avoided if you intend to preserve and grow you capital base. A couple more notions to be taken here:

-All lessons from agricultural markets regarding input and production hedges apply here.

-If you want exposure to price movements on the underlying commodity, you don't want the producer to have their production hedged. A production hedge essentially removes the affects of price action on revenues and profits.

So how about some exotic metals equities trades to close this piece out…

Say for example that you expect oil to outperform gold going forward. This is a very reasonable assumption given the radical action between the WTIC/Gold price ratios over the past 6 months. Energy is a major input cost of mining, especially with some of the more extravagant underground operations. If you think crude and gold are both increasing (crude outperforming gold), get long a company that has its energy costs hedged, with its gold production either completely un-hedged, or hedged at percentage less than the producer's energy hedges. If you believe gold is going to continue to outperform oil look to buy a company with hedged energy costs and an empty hedge book for production.

I saved one of my favorite out of the box trades for last. Let's say that you love everything about a company, its production prospects, location in the geo-political realm, business operations, etc.; unfortunately, you're missing a piece of the puzzle: management. Staying in hypothetical land, everything about the management is rock solid except for their ability to put a hedge on. Maybe they have a bad track record, or maybe you just disagree with the operations at the moment. It doesn't matter. You can put your own hedge on. As a share holder in a company, you are part owner; therefore, you have a defined amount of exposure to input and production risks. By identifying the percentage of the risk exposure that you own, you can quantify the affects price movements will have on your specific percentage of ownership. This can be done with options, futures, or ETFs depending on your comfort level.

I've covered a number of things in this two part series. It's not enough to throw your money in the commodities sector and hope for the best. The different notions in these two articles will help you maximize returns on capital.

By Nicholas Jones
Analyst, Oxbury Research

Nick has spent several years researching and preparing for the ripsaws in today's commodities markets.  Through independent research on commodities markets and free-market macroeconomics, he brings a worldy understanding to all who participate in this particular financial climate.

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

© 2009 Copyright Nicholas Jones / Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Oxbury Research Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules