Still Bullish on Softs

By Mike Norman

Today my guest for the second part of his interview here is Jurgens Bauer, who is the chief soft commodity analyst at PitGuru.com. (Read part one here.)

Norman: All right. So you’re still on the floor – that’s an anachronism – but I’m curious to find out what’s it like. Anyone who has spent time as I have, as you have back, in the heyday, and we’ve experienced what the floor was all about, and even today when you walk through the New York Stock Exchange, it’s a shadow of what it was. But it must be just dead down there. What do you do; is it mostly options going on?

Bauer: The futures pits are closed. Futures are now on ICE. The markets I trade are all traded electronically. I trade options, and the options pits are alive and well. Currently there’s really … I don’t want to use the word appropriate, but there’s no electronic trading platform exclusive for options that is attractive to market makers, and so the best place to get a market is to have all those market makers in one location and bring the market to them so they can make markets.

Norman: Options trading is really a specialized, tailor-made kind of activity, right? It’s not a plain-vanilla future; you buy it, you sell it. Options really takes a lot more savvy and understanding, and a personalized sort of approach.

Bauer: I tend to agree with you. I also think the option brokers are brilliant guys. I think that soliciting their opinion of market direction from the options locals frequently will yield some pretty good results. You know, they’re sharp guys. Most of them just trade volatility – they’re not trading direction, they’re just trading volatility. They’re seeking to profit on moves in how rapidly the price moves up or down, and increase in that, and of course, volatility has gone up a lot for many reasons, because markets are more easily pushed around.

Norman: And there’s a lot of money coming in now. We talked about that in the other interview, and for me it’s an ongoing point: that you take ... a small mutual fund, could overwhelm some of these commodity markets in terms of the buying power there. I mean, it’s not like a securities market where, look, if you need more bonds, if you need more stocks, you issue them. Commodities are finite materials, and so some of these smaller agricultural ones, they could very easily ... what about that manipulation?

Bauer: I don’t want to use the word manipulation; what I would like to say is they could be temporarily influenced. But remember, because of the delivery mechanism, because of convergence, that sooner or later you’re going to pay the piper, because it’s going to get near delivery. The speculators did not want to take delivery of these markets, at least not the markets that I trade, as a general rule. Now that may change; we’ve seen some attempts at that over the years – remember the Hunt brothers and the bean oil and all that stuff, and the silver market? But principally the folks that get involved in the delivery process are going to be the professionals who actually are the users of the underlying.

Norman: But this has been an argument ... the folks who say that speculation is not a factor – they’ve used this argument – and I think there’s an error inherent in this argument. They say, well look, because these speculators are not taking delivery, how can they really push the price up? If you’re a producer, and you started to get into this on the last interview … if you’re a producer and mountains of money are coming into your market, causing the price of the futures contracts to rise, you raise your prices; you don’t stand there in front of a freight train and sell. So the physical price goes up, and you do have a sort of a tail-wagging-the-dog situation, don’t you?

Bauer: You can have that from the tail wagging the dog, not that the options are the tail wagging the dog.

Norman: Not the options; I’m talking about the speculators pushing up the price of the futures contracts.

Bauer: I understand what you’re saying and yes, it’s temporary, and yes, dramatic price fluctuation can generate huge margin calls. We saw that last year in Kansas City; we saw that in cotton, the market that I’ve traded for years and years, and the industry suffered dramatically as a result. There’s been hearings now in the CFTC to determine whether this justifies additional regulation.

Norman: Right; well, they’re close. Do you think something is going to happen?

Bauer: Government has a tendency to want to get bigger and get their fingers involved in it. I would say yes, unfortunately. I’m a laissez faire capitalist, OK? But I think that the government is going to find reasons to get more aggressively involved in regulating the commodity markets.

Norman: So do you disagree with the people in the trade whom you just spoke of, who are saying that this is hurting them?

Bauer: In the cotton market, we’ve seen some businesses that have been in business for 100, 120 years that seriously are going out of business.

Norman: That can’t be good.

Bauer: No, it’s not good. These markets were created for the ultimate user ... the grower, the producer … the user of these commodities, so that they could offset price risk associated with it. They need to attract speculators so that they’ll have someone willing to take the opposite side of that position, who is willing to speculate on the price and take a risk, OK?

But when you have such a huge influx, yeah, it can bully the markets, it can push them around in either direction. And when we see the index funds roll, when we see them leave the front month and move into the second month, you see those spreads widening because they’re selling the front month and buying the back month, and you see those spreads widen as we approach that rolling period, or as we go into that rolling period.

Now once delivery occurs, though, reality sets back in. But I think you’re also seeing the index fund traders adjust to that, so they’re not just putting all their positions on in the front month, they’re putting positions on in some of the later months.

Norman: Yeah, because that front month, and a lot of individual investors didn’t understand this because there was a roll cost in there that if the market was trading in a contango, with futures prices above the spot every month, there’s a cost to rolling that over. And so while the underlying commodity maybe went up in price, those ETFs didn’t do very much because it factored in the cost of that roll. That’s something that people should be careful about.

Bauer: Well, whenever you invest in something of that nature, you should really be looking at the red herring, the prospectus, to determine what exactly is going on.

Norman: And maybe you should have a professional manager handle it.

Bauer: Absolutely, absolutely. So as far as predictions for the markets, so I can make an idiot of myself again, I’ve done that. I still want to be bullish on coffee. We’re going through, as we alluded to earlier … the entire economy is not doing all that well, so yes, it’s carrying an influence on prices, and temporarily right now, I think we’re seeing a weight put on and we’re seeing a lot of the markets play defense, with sugar being an obvious exception. Today we saw cocoa blast off on electronic trading, but that’s another story. Somebody made that a fat finger and hit a 1,000 instead of 100, and who knows?

Norman: We’ll save that for the next interview.

Bauer: I like sugar; I think sugar has got a shot, once it makes a new line. I think it’s going to run to 25 cents and then I think there’s the possibility of 30 cents.

Norman: And a professional manager, you heard it from a guy on the floor. Van Eck, who is the sponsor and actually the owner of this Web site right here, HardAssetsInvestor. Jurgens, great to see you. That’s it for now, folks.