Dr. Copper Predicting Commodity Comeback In 2018

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Includes: BNO, CAFE, CANE, CORN, CPER, CUPM, DBO, DNO, DTO, DWT, JJCTF, JO, OIL, OILK, OILX, OLEM, OLO, SCO, SGAR, SGG, SOYB, SZO, UCO, USL, USO, USOI, UWT, WEAT, WEET, WTID, WTIU
by: RMB Group

Summary

Copper turned out to be one of the few commodities - other than lumber and, to a lesser extent, crude oil - that bucked the overall sideways-to-bearish commodity trend.

Chart says tax bump for dollar may not occur. The dollar index is weakening instead, sinking close to critical support at .9100.

Weather could be a game-changer in 2018.

We didn't release many "Big Move Trade Alerts" in 2017 because there weren't many "Big Move" opportunities available in 2017 - at least not in the commodity sector. Grains moved sideways, so did sugar, gold and silver. Coffee weakened slightly along with soybeans and natural gas. Copper turned out to be one of the few commodities - other than lumber and, to a lesser extent, crude oil - that bucked the overall sideways-to-bearish commodity trend.

Copper appeared on our radar last August when we noticed a potentially bullish "reverse head and shoulders" developing on its weekly price chart and recommended a bullish option play. A series of higher lows and higher highs is the classic definition of a solid bull trend in the red metal.

Data Source: Reuters/Datastream

Copper is used in so many industrial applications that it is often viewed as a bellwether for the health of the global economy. The correlations between it and global economic growth are believed to bestow upon the red metal, a PhD in Economics, which is why it is affectionately nicknamed "Dr. Copper."

Nearly two thirds of newly mined copper is consumed by population-heavy Asia. Consequently, good news for copper often signals good news for a host of other commodities that benefit directly from increased Asian demand. Lifestyle changes generated by a booming China and India mean greater demand for agricultural commodities, energy and metals. Copper often moves first, setting the stage for other commodities to follow.

Add a stronger Asian economy to the increasing pace of recovery in Europe and a weakening dollar and you get the ingredients for more "big move" opportunities in the commodity markets for 2018. The stimulative nature of the recent US tax cut and the potential for even more spending should an infrastructure bill pass have the potential to push asset inflation into the commodity sector.

Chart Says Tax Bump for Dollar May Not Occur

There has been a lot of market talk about a dollar rally caused by a return of funds to the US following the passage of the Trump tax bill. One would have expected the currency markets to anticipate the return of this cash already and to price it in accordingly. But that has not happened. The dollar index is weakening instead, sinking close to critical support at .9100. The US Dollar Index could sink as low as .8550 in a hurry should this key support level fail.

This is important because most key commodities are priced in dollars. A weaker greenback means it will take more dollars to buy an equivalent amount of commodities. Europe is expected to begin raising its interest rates soon. If the big bad buck cannot seem to mount a rally even with some of the most dollar-friendly relative interest rates it has ever experienced, imagine what could happen when relative rates become a whole lot less dollar-friendly. A weaker dollar means higher commodity prices all else being equal.

Data Source: Reuters/Datastream

Crude Oil Also Signaling Stronger Global Economy

In our Big Move Trade Alert released earlier this month, we asked the question, "Can Crude Climb Higher?" So far the answer has been "yes." Like demand for copper, demand for energy is often a sign of a stronger global economy. Crude's ability to rally above and hold solid resistance at $55 per barrel is extremely friendly not only to its own prospects but also for commodities overall. Like copper, crude is an early-mover. An expansion of the baby bull in crude oil bodes well for Asian demand and for other commodities as well.

Data Source: Reuters/Datastream

While crude oil could head even higher just based on increasing Asian demand, it could explode to the upside in the event of a geopolitical crisis caused by the current proxy war being waged by Iran and Saudi Arabia or by a miscalculation by either side of the North Korea/United States conflict.

Call Options in Key Commodities are Relatively Cheap

However, what excites us most right now is how inexpensive call options are in many critical commodities. Years of sideways price action have stripped volatility premium from both calls and puts as option sellers accept fewer and fewer dollars for their obligations to buy and sell commodities like crude oil, coffee, sugar and silver.

If the signals copper and crude oil are giving us now prove out, we expect the low volatility that has defined these markets to expand and to expand rapidly, benefiting traders who were able to buy volatility on the cheap. Sugar, coffee, crude oil and corn are examples of markets with relatively cheap options. All four have histories marked by explosive volatility.

Weather Could Be a Game-Changer In 2018

Five straight years of bumper crops in corn, wheat and soybeans have met ever-increasing global and Asian demand without significantly increasing stockpiles. This means any major weather disruption in any critical growing region of the globe has the potential to upend the tenuous supply/demand balance provided by years of near-perfect growing weather.

Will the good weather end in 2018? Earlier forecasts for a 2018 "La Niña" seem to be panning out. A low-level La Niña is expected to remain in force throughout the winter. Winter-time La Niñas have been associated with disruptive spring and summer growing weather across the American Breadbasket in the past. Will it happen in 2018? Only Mother Nature knows for sure.

Our Favorite Trade Heading Into 2018

If you were to ask us to choose just one trade heading into the New Year, it would be the purchase of the December 2018 $4.00 corn call options we originally recommended purchasing for $1,250 or less in Alert #12 which we published in late October. Currently going for $950, these call options are even cheaper than when we first recommended them.

As we pointed out in our original "Alert," the price of these calls assumes a continuation of current sideways price action. In October, the December 2018 corn options were pricing in a maximum volatility of 13.9% for nearly all of 2018. Now they are pricing in a maximum volatility of just 12.5% for the both the Southern and Northern Hemisphere growing seasons.

When we put it all together: 1) Dr. Copper's bullish signal, 2) crude oil's positive signal, 3) a weak dollar, 4) the potential for a La Niña weather disruption and 5) the chance to establish a relatively inexpensive, fixed-risk, longer-term position in a potentially explosive market, we can't help but come to the conclusion that corn is currently giving us the biggest potential bang for our speculative buck.

Data Source: Reuters/Datastream

Notice how similar this chart is to the crude oil chart displayed earlier in this post. It is not a coincidence. Vast quantities of US corn are used to produce ethanol which is mixed with gasoline. Demand for ethanol tends to rise with the price of gasoline. The strengthening US economy means more people are driving and using more gasoline. Our upside targets for corn remain $4.50 per bushel and $5.20 per bushel with the potential for a move as high as $6.40 should any major weather disruption occur.

Each of our $4.00 calls will be worth as least $2,500 should corn rally to $4.50 per bushel, at least $6,000 should corn hit $5.20 per bushel and at least $12,000 should corn hit $6.40 per bushel prior to option expiration on November 23, 2018. Our calls will expire with no value if we are still holding them past expiration and the underlying corn futures contract is below $4.00. Our maximum risk is the price we pay for the option plus transaction cost.

What to Do Now

Consider buying December 2018 corn calls if you haven't done so already.

The risk of loss in trading futures and/or options is substantial and each investor and/or trader must consider whether this is a suitable investment. Past performance, whether actual or indicated by simulated historical tests of strategies, is not indicative of future results. Trading advice is based on information taken from trades and statistical services and other sources that R.J. O'Brien believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades.

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.