Markets and fundamentals

Discussion in 'Trading' started by Joe Ross, Oct 15, 2010.

  1. After a breakout, look for a return (retracement). Successful returns can beget generous returns.

    When a market does finally overcome resistance, penetrate a psychological barrier, or break out of a formation or consolidation, it tends to do so boldly at first. But after its initial thrust, it often needs reassurance. To reconfirm its freedom, it may even return to the very area from which it just broke its constraints.

    When traders on the wrong side exit and new participants eagerly enter in the direction of the breakout, the return to retest succeeds in reenergizing, reinforcing, and resuming the new trend.

    Futures traders must always expect the unexpected when least expected. Would you, for example, expect prices to be pressured by a surge in supply before a decline in consumption?

    Let's look at some relationships in the soybean market.

    Brazil harvests soybeans from February through May, during which crushing facilities run at capacity. Flush with new supplies for sale (most soybean oil is consumed domestically), the world's second largest exporter of soybean meal competes aggressively in the world market.

    But soybean meal is a high-protein feed supplement for livestock. World consumption is greatest by far during the Northern Hemisphere's cold winter weather, when high caloric intake is required for animals to maintain and gain weight. Conversely, world consumption is lowest during July and August, when grass is available and the weather is hot.

    So you might expect soybean meal prices to be especially weak during June, just after Brazil's harvest and just before the heat of the northern summer. But that is not so! Soybean meal has instead been the leader in the grains and soy complex.

    Why is that the case? A seasonal transition appears to occur during June. As the surge in South American supplies begins to recede, the market turns back towards old-crop US supplies -- perhaps stimulating some change in commercial ownership. U.S. soybean processors, who may have hedged soybean meal during Brazil's harvest in order to protect product prices and profit margins, may now begin covering short positions. Conversely, with low July/August consumption already discounted, the market begins to anticipate a rise in Northern Hemisphere demand -- perhaps generating commercial buying.

    Although product value within the soy complex has generally begun to favor soybean meal over soybean oil from as early as March, this sudden surge in soybean meal has been especially reflected in spreads between the two right around the middle of June. You might want to mark that on your trading calendar; it has been a high percentage spread trade for many years.

    This strength in old-crop soybean meal is also reflected in spreads against new-crop soybean meal. As world demand returns to U.S. supplies, a new crop of soybeans is emerging to offer potentially plentiful new supplies late in the year. So, usually, the old-crop outperforms new-crop, often throughout the rest of the marketing year.