Developing A Longer-Term View In Commodities Using Weather

by: James Roemer

We are writing a special report today because I have received a bunch of personal emails with regards to some longer-term views about certain ETFs and commodities, and most particularly, the grain, cotton and natural gas market. Some of you are asking if there is a way to take a "longer-term" view, using climate/weather in trading agricultural and energy commodities. First of all, I invited you to look at many of the reports I wrote in 2011 and 2012 on Seeking Alpha, with respect to being one of the first to forecast the severe back to back U.S. corn/soybean belt droughts, and also the top of the grain market last fall. In addition, the 2011 snow drought and record warm winter, resulted in a 30% price collapse in natural gas, and there have been a host of other trades of anywhere from 1 month to a year. Gold, which is not weather of course, was a good longer-term trade being short about a year or so ago. At this point, I am unsure about gold, but feel strongly that prices anywhere close to $1500/ounce again is unlikely. If you have gold coins, hold onto them. If you want to trade the ETF GLD or others from the long side, I don't see any more than a 10% rally at most the rest of the year.

Developing a Longer Term View in Commodities, Using Weather

Other major weather related moves over the last 2 years have been short the coffee ETF (NYSEARCA:JO) and cotton (NYSEARCA:BAL) after the incredible 2010 move up in prices. Both of these commodities reached all time highs a couple of years ago. Coffee soared to close to $3.00/lb due to weather woes in Central America, Colombia and Brazil in 2010-2011, but has crashed more than 50% due to a rebound in global production (all weather). Cotton rallied to $2.20/lb in 2010 due to an increase in global demand from China, as they experienced historical summer floods in addition to their growing appetite for fiber. That same year, Pakistan had historical flooding. However, I later forecasted a rebound in global cotton production in 2011 and 2012 and this was a key "longer-term" trade strategy that an investor could have taken advantage of selling.

So how about cotton now, we recently discussed a possible buy in cotton. However, our confidence is fairly low for a major rally, given updated forecasts for west Texas rains but also good global crops

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Longer-Term Weather Trade Views -- Are there any?

So how about some longer-term weather trading views for the foreseeable future. Well, many commodities have already seen big dives in prices on a rebound in projected global production this year (coffee, corn, wheat, soybeans, cocoa). In addition, other than some short-term heat in the Midwest and East next week, we are slowly building stocks back up in natural gas. Just before the eastern heat breaks in about 8-10 days, natural gas will likely sell off again. Hence UNG has little major upside as well, in coming weeks. Hence, it is more risky in predicting major 'new' price moves in many of these commodities. However, given good weather in 'most world' regions in the months ahead, selling call options is really the smart play, as opposed to looking for a big 10-20% break down in commodity ETFs.

There will be plenty of short-term buys in the market, such as corn and soybeans late last week or on Monday, ahead of heat and dryness developing in the western belt, but the weather will likely turn bearish for a while. This kind of volatile grain market are not for most of you to trade, unless you have a futures account and learn how to trade weather day to day.

With regard to the grain market and natural gas. While I am concerned about western corn belt dryness, teleconnections that I often use would suggest a major break in the heat and dryness in about 9-10 days and more than most models suggest. The change in the PNA, EPO index that you see below, suggest a big heat, dryness ridge breaking down. This could be longer-term bearish the grain market again, but most of the big money, again, will be trading short to medium-term weather changes, which I presently cannot advise many of you to do.

Hence, it is possible that both the ETF CORN and SOYB have another 10% down in summer, as dryness eventually eases and it cools down in the corn belt, but many of the 'weather trades' these days are much more short term in nature with lots of volatility ahead.

KEY POINT? -- Probably the best way to play a lot of the agricultural and perhaps energy markets, is to look to sell call option spreads out of the money, that way you capture the volatility if prices stay within a narrow range and eventually head lower in most ag commodities. There are lots of short-term trading opportunities (long and short on weather), but I think at least 70% of the ag and natural gas sector, will not see prices rise 10% over the next few months. Hence, selling calls in corn, soybeans, natural gas and perhaps even coffee and sugar are the way to go. For cotton, it is a low risk trade to buy it, but with big rains in Texas early next week and poor demand around the world, this is not a high confidence buy recommendation.

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Teleconnections above separate the "men from the boys," when it comes to weather forecasting and most of these suggest a much cooler late July outlook than most computer models are suggesting. This will be welcome news for beach lovers and you die hard tennis and golf fans in the eastern U.S. after July 22 and will also keep natural gas prices from soaring.

Because of client obligations to hedge funds, we are not allowed to express all of our trading views. It is rare for us to write a report twice in one week. At this point, we do not anticipate another report for at least 2 more weeks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.