TradingCommoditiesAn introductiontounderstandingcommodities

BrainteaserProblem:

Acasinooffersacardgameusingadeckof52cards.Theruleisthatyouturnovertwocardseachtime.Foreachpair,ifbothareblack,theygotothedealer’spile;ifbotharered,theygotoyourpile;ifoneblackandonered,theyarediscarded.Theprocessisrepeateduntilyougothroughall52cards.Ifyouhavemorecardsinyourpile,youwin$100;otherwise(includingties)yougetnothing.Howmuchwouldyoubewillingtopaytoplaythisgame?

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• Youalwayslose…pay0dollars• Why?• Tryadeckwith2blackand2reds.• Tip:Simplifyproblemsifyoucan,thenrecognizeapattern.

BrainteaserSolution:

• Trump:RepublicancontrolandTrumpisPresident.Thishasvaryingeffectsondifferentcountries,industries,andfinancialassets.• EmergingMarketshavesufferedfromtheoutcome• Manycommoditieshaveperformedwell(metals)whileothersareunaffected(ags)• InterestRatessellingoff

• UpcomingEvents:DraghiSpeech(Monday),UKCPI(Tuesday),EUGDP(Tuesday)

MarketUpdateMarketWeekinReview

• Areasonablyinterchangeablephysicalgoodormaterial• Somecommoditiesaretradedonexchanges:CBOT,CME,NYMEX,ICE• Exchangessetdeliverablegrades• Ex:Sugar– Rawcentrifugalcanesugarbasedon96degreesaveragepolarization

CommoditiesWhatarecommodities?

CommoditiesTypesofCommodities

Agricultural•Grains:Corn,Soybean,Wheat,•Softs:Cocoa,Coffee,Sugar,FrozenConcentratedOrangeJuice•Livestock:Cattle,Hogs

Metals•Industrial:Copper,Aluminum,Iron,Nickel,Zinc•Precious:Gold,Silver

Energy•Oil:WTI,Brent•Distillates(RefinedProducts):HeatingOil,Gasoline•Ethanol,NaturalGas

CommoditiesCommodityMarkets

SpotMarket• Physicallydeliverortakedelivery• Takesadvantageofgeographicpricedifferences• Ex:Ifafarmerharvestedcornandwantstosellimmediately

FuturesMarket• Promisetobuyorsellinthefuture• Speculateonfuturepricesorhedgecommodityprices• Ex:Ifafarmerunsureofweather,canlockinsellingprice

CommoditiesCommodityMarkets

Producers•Reduceriskbylockinginselling

price

Consumers•Reduceriskbylockinginbuying

price

ManagedMoney•Takesonriskbybettingoncommoditypricemovements

Carlos

CommodityMarketParticipants

CommoditiesCommodityTrends

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1/1/1970 1/1/1974 1/1/1978 1/1/1982 1/1/1986 1/1/1990 1/1/1994 1/1/1998 1/1/2002 1/1/2006 1/1/2010 1/1/2014

CommodityPriceIndex(S&PGSCIIndex)

CommoditiesCommodityTrends

0.00%

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8/1/1970 8/1/1974 8/1/1978 8/1/1982 8/1/1986 8/1/1990 8/1/1994 8/1/1998 8/1/2002 8/1/2006 8/1/2010 8/1/2014

CommodityVolatility

CommoditiesCommodityTrends

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-0.8

-0.6

-0.4

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0

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1.2

1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014

CommodityCorrelationtoEquityMarkets

CommoditiesCommodityContractSpecs

CornFutures

ContractUnit 5,000bushels (~127metrictons)

PriceQuotation Centsperbushel

TradingHours Monday – Friday,8:30AM– 1:20PMCT

MinimumPrice Fluctuation ¼ofonecentperbushel($12.50percontract)

Listed Contracts March(H),May (K),July(N),September(U),&December(Z)

SettlementMethod Deliverable

GradeandQuality #2YellowCornatcontractprice,#1YellowCornat1.5cent/bushelpremium,#3Yellowat1.5cent/busheldiscount

CommoditiesFuturesCurve– Contango

CommoditiesFuturesCurve– Backwardation

CommoditiesWhatdrivescommodityprices?

CostofCarry•Oversupplyleadstostoragecapacitypressures,resultsinhighercostofcarry,wideningcontango•ExploitiveStrategy:Shortfrontmonth,Longfurthermonth.

Seasonality•Idiosyncraticfactorsrelatedtoseasonalityofcommodity(i.e.weather)•ExploitiveStrategy:Long/Shortbasedondirectionalview

Inter-CommodityRelationships•Certaincommoditiesarecorrelatedtoothercommodities•ExploitiveStrategy:Longonecommodity,Shorttheothercommodity

“Shocks”•Supplydisruptions(droughtforgrains,geopoliticaltensionsforenergy)•ExploitiveStrategy:Long/Shortbasedondirectionalview

CommodityDrivers

CommoditiesTradingStrategies:CommodityRelationships

LongPlatinum/ShortPalladium(Fundamentalview)MacroPortfolio• Thesis:NewsofVolkswagen’semissionsscandal(“Dieselgate”)resultedinaoverly-bearishpricedropinplatinum,theprimarycomponentfordiesel-basedcatalyticconverters.ThepricedropisnotjustifiedandisaresultofnegativeVolkswagencoverage,andthespreadbetweenPalladiumandPlatinumwillcorrectbacktonormallevels.

LongCorn/ShortSoybean(Fundamentalview)MultiPortfolio• Thesis:Duetoabnormalbumpercropofcorn(unprecedentedcapacityforsecondcorncrop)fromoptimalplantingconditionsandstrongsafrinha (secondcorncrop)inBrazil,cornbecameextremelycheaprelativetosoybean.Infollowingseason,farmerswillreduceplantedcornacresforsoybeanacresgiventherelativepriceattractiveness,yieldingadecreaseinsoybeanpricesandincreaseincornpricesthefollowingharvest.

CommoditiesTradingStrategies:CommodityRelationships

LongLiveCattle/ShortFeederCattle&ShortCorn(Quantitativeview)QuantPortfolio

• Thesis:Thoughassumingassetsfollowarandom-walkprocess,assetscanstillbeco-integratedandthereforeco-movewitheachother.BecausetheCattleCrush(theinitiatedposition)isaproxyforraisingbabycattle(thefeedercattle)byfeeding(throughcorn)andthensellingasafattenedslaughter-readycattle(livecattle),itmakessensefortheseassetstoco-move.Whenthepricesoftheseassetsdiverge,signals(rollingstandarddeviations)pickupthedivergenceandstrategyinitiatespositionbettingonreversionbacktonormalco-movementrelationship.

LongSugar(Quantitativeview)MultiPortfolio• Thesis:BecauseBrazil,thelargestproducerofsugar,exports46%oftheworld’ssugarcrop,Braziliancostofproductionhasadirectrelationshiptosugarprices.Byregressing,Braziliancostofproductionofsugartoprices,itisrevealedthatover80%ofthevariabilityofthesugarpricesisexplainedbyBraziliancostofproduction(𝑅").Therefore,currencydepreciationoftheBrazilianrealhasadirectrelationshipwithdecreasedsugarprices,andsignals(residuals)candeterminewhethersugarisoverpricedorunderpricedgivenBraziliancurrencydepreciation.

CommoditiesTradingStrategies:Seasonality,Shocks,andCostofCarry

LongPalmOil(Seasonality)MacroPortfolio•Thesis:Withlastyear’sEl-Ninoprojectedtobeoneofhistory’sstrongestEl-Nino,thiswillaffectPalmOilproductioninthe largestproducingareas(Asia).Lastyear’sEl-Ninoisnotproperlypricedin,asrisk-premiumforpotentialshortageduetoweatherisnothighenoughrelativetosimilarpastsituations.

LongOats(“SupplyShock”)MultiPortfolio•Thesis:Duetosnowstormsinthewinterdisruptingrailtransportation,bottleneckingduetoinefficienciesinrailtransportation,increasedusageofrailtransportforcrudeoil,lackofprioritytotransportoats(othergrainslikewheattakepriority), andlowoatinventoriesinMinneapolis,oatpricesisexpectedtosurgeuponcontractfutureexpiryasshippersstruggletodeliveroatstofuturesdeliverypointinMinneapolis.

ShortFrontMonthCocoa/LongBackMonthCocoa(CostofCarry)Multi/MacroPortfolio•Thesis:EbolahysteriainAfricatwoyearsdirectlydisruptedproductionofCocoa(producedinIvoryCoast,Ghana).Amidsttheharvestingseasonofcocoa,Ebolahysteriashiftedthewholefuturescurvefromcontango tobackwardationduetopanicfromexpectedshortageofcocoa.Ebolawillonlytemporarydisruptharvestofcocoa,andgivenanexpectedbetterthanaverageharvest,cocoa’sfuturecurveshouldrevertbacktocontango state.