How to Make Money in Commodities

81

CLICK TO ENLARGE

CATTLE: POTENTIAL PROFIT, ON A MARGIN OF $400, WAS $1,600.

82

click to enlarge

PORK BELLIES: BELLIES AND CATTLE CAN MOVE IN OPPOSITE DIRECTIONS. PROFIT IN BELLIIES ON THE SHORT SIDE WAS $2,160 PER CONTRACT, OR 360 PERCENT.

83

click to enlarge

SUGAR: PRICES DOUBLE IN SIX MONTHS. PROFITS ON THE LONG SIDE WERE $4,256 PER CONTRACT.

84

click to enlarge

CALCULATE FOR YOURSELF THE PROFIT IN PLYWOOD. EVERY $1 MOVE EQUALS $76.03.
WOULD YOU HAVE CAUGHT THE MOVE?

85

COMMENTARY: 1968 through 1972

      Our travels through history begin with the April 1968 Live Beef Cattle futures contract. For nearly 18 weeks in 1967 the price of the April 1968 contract hovered between 27.5 and 28.5 cents a pound. In mid-July, however, prices declined out of this narrow range. This was one time in history when beef prices were not constantly going up. When prices declined below 27.5 cents a pound, one futures contract could have been sold. The stop-loss order could have been placed above the trading range, around 28.75 or 29 cents. Once prices gathered the force to break out below the old channel, the big drop began and prices never rose back anywhere near their former norm. If the specualtor sold at 27.5 cents and liquidated when prices hit 25 cents in mid-November, the profit for each $400 in margin would have been $1000 -- a return of 250% in four months.

      The soybean oil market for 1968 is another example of how, incredible as it may seem, you can make handsome profits when prices go down. From late October to the middle of March, the price for the August 1968 contract stuck to the range between 8.8 and 9.2 cents per pound. Then an abnormally sharp move pushed the price below the old price floor. The market clearly signalled the methodical trader to sell at 8.7, with a stop-loss set around 9.2. After hesitating at the 8.6 level for another month, prices failed to rally back anywhere close to the old range (or the speculator's stop) and the collapse began in earnest. If you had bought back when prices leveled off at 7.2, the profit per contract would have been $900, a 300 percent return on the initial margin of $300.

86

      Of course history also tells us what happens to price over the long run. How much is soybean oil going for today? By 1980 the cash price of soybean oil was ranging between 20 and 27 cents a pound. Why? Once again, demand and supply. Take a look at the list of ingredients in your salad oil, margarine, or any of a dozen products containing vegetable oil. Chances are the main ingredient is soybean oil. Soybean oil and its two cousins in the soy complex, soybeans and soybean meal, have enjoyed enormous growth in popularity since the 1960s. These three items now form an integral part of the agriculture and food production systems, both in the United States and abroad. Their importance is reflected in their price, and the three often move together in parallel directions on the price charts.

      Cattle and soybean oil were not the only commodities to qualify for trading by our method during 1968. Other possibilities included futures contracts in barley, corn, live hogs, oats, platinum, propane, rapeseed, soybean meal, and wheat. But let us turn now to 1969 when rising prices in a number of commodities offered great trading situations.

      The April 1969 Live Beef Cattle contract presents an especially interesting case study. Here we find two narrow trading ranges and two price breakouts, one down and one up. From May to mid-July prices hold tight to the range between 26 and 26.6. When prices head below 26 cents, our speculator naturally sells. Only this time the force is not enough to inspire a long downtrend. Prices are already near their historic lows, and a new channel begins to form. By the first week in September, the trader has held the "short" position for more than a month, and watched prices level out, and then begin to creep upward. Since there is no wisdom in hanging on to a position that won't move favorably, the trader gets out with a small profit, and awaits a new signal from the market.

87

      That signal comes on November 14, when prices tire of their old low channel and start their steady climb upward. Now was a very good time to buy. The supply of cheap beef had finally been exhausted, herds reduced and inventories depleted, until prices had no choice but to rise, and rise substantially. Even though shoppers were complaining about the price of beef in the supermarkets, their complaints could have no persuasive effect on the workings of the market. A better solution for the frustrated consumer would be a profitable long position in the futures market. A contract purchased at 26¢ a pound and sold at 30¢ a pound would have meant a $1,600 profit for each $400 invested. The rate of return was 400 percent in five months time. You can buy a lot of steaks with that.

      The September 1969 Cocoa futures contract was another spectacular winner. The price remained near 28¢ a pound for nearly four months. Then it advanced to 29¢, 30¢, 31¢, and so on all the way up to nearly 48¢ a pound. Getting on board the cocoa express entailed no more than charting the trading channel, and acting when prices went through the ceiling at 28¢. The trader who bought at that point could watch the profits roll up effortlessly until prices grew volatile near 36¢. But a stop-loss properly trailed 1.4 or 1.8 cents behind the previous day's close would never have caused the position to be liquidated, and the trader could safely continue the climb up. If the position were closed out at 46¢, after the big one day rise and fall toward 48¢, the profit would have been $5,400 on an initial margin of $500, a return of 1,080 percent in less than six months time.

      Futures contracts for rapeseed trade on the Winnipeg Commodity Exchange in Canada. Rapeseed itself is about half the size of a "bb pellet" and deep brown in color, sometimes nearly reddish. It grows like wheat and is harvested each year across the plains of Canada. Crushed,

88

the seed produces an oil used in the production of rayon and acetate, or for human consumption as a substitute for olive and soybean oil. While very little rapeseed is grown in the U.S., this commodity is an important crop for Canada, China, France, India, and Poland.

      Trading the Canadian rapeseed market of 1969 demonstrated the life-saving value of the method we have been exploring. Rapeseed traded between $2.02 and $2.10 for four straight months. In July the price broke upward out of the channel, and the speculator bought at $2.12. The stop-loss order would be placed just below $2.00. Here you will note that prices subsequently declined to a level dangerously close to the "stop." But this time the trader stayed in, and waited. Why? First of all, discipline. The method determined a stop-loss just below $2.00. The wise trader won't second guess the method. Second, the trader had an idea about why prices were declining. There is traditionally a weakness in grain prices at some point early in the summer months, after harvests and before winter shortages. This could easily be discovered by a quick look at previous price charts and records. Sure enough, the price advance resumed in September until this humble seed was a star performer. Margin on the (then) 5,000 bushel contract was $500. If the long position were sold off at $2.75, profit per contract would be $3,250 or 650 percent.

      1970 was once more a good year for speculating in the soybean complex, only this time the price direction was up. The charts for soybean meal and soybean oil both reveal similar price patterns and profit opportunities. When the soybeans have been crushed by the processor, the meal and oil produced represent the real value and most popular markets; soybeans themselves are comparatively useless. The modern demand for soybean production can only partially

89

be explained by the widespread use of soybean oil. Just as important is the growing demand for soybean meal. This meal is one of the most protein rich foods available in the world, running as high as 50 percent protein. Ranchers discovered its great value as an element in livestock feed, so that now the demand for soybean meal (and thus the price fluctuations of meal, beans, and oil) depends in significant part on the state of the livestock industry (and thus on the price fluctuations of cattle, hogs, and poultry). Meal has also become an increasingly utilized filler in human food products, especially as a meat supplement or substitute.

      The first opportunity actually came in soybean oil in late 1969, when the January contract burst out of its 7 month long channel. This represented a profit of $1,800 per contract, on a margin of $300, a return of 600 percent. The January contract had hit its high on. November 13th, 1969. At that time, the October 1970 contract lagged well behind, as distant contracts usually do (obviously immediate supply and demand pressures have more influence on the price of contracts soon to be deliverable than on contracts falling due many months later). October oil made only a small peak in November, and then continued to rest in a narrow range until February of 1970. The demand for oil evidently lost none of its strength, arid carried the October contract sharply and steadily to new highs. This time maximum profits per contract were $3,720, or 800 percent. Thus using the method we have discussed, you could have profited twice, in the space of a year, from what was essentially the same price move in soybean oil, just by charting both the nearby and the distant contracts.

      Knowing that the price moves of soybean meal often parallel those of soybean oil, our trader was also charting meal contracts in this period. Sure enough, a lengthy channel

90

formed throughout late 1969 and into 1970. As the August Soybean Meal contract drew within a few months of delivery, the same demand pressure pushing soybean oil prices up did its work on meal. Here the profit opportunity was $1,000 per contract, a 333 percent return on the $300 margin.

      1971 presented contrasting opportunities in the livestock contracts. Once more beef prices started a strong ascent, possibly as a result of the "cattle cycle" as producers take a number of years to reduce (or build) their herds in response to price trends. Where would you have bought? Sold? Would you have been stopped out in September? Potential profit was, at a margin of $400, 400 percent at $1,600 per contract.

      August 1972 Pork Bellies tell a different tale. While an apparent shortage of cheap beef was driving cattle prices up, pork prices crashed, probably reflecting abundant stocks built up during the period of low, stable beef prices. The consumer will quickly switch back and forth between pork and beef in response to changes in their price differential, so that traders in cattle follow actions in the pork markets, and vice versa. Pork bellies, the underside of the hog from which bacon is made, declined in price. The trader could have sold on the first descent through the 33.6¢ level, placed a stop-loss order at 35.6 or 36¢. Were the contract liquidated (bought) at 27.6¢, profit would have been $2,160 per contract, 360 percent of the initial $600 margin.

      1972 brought many substantial market moves in the pattern we have isolated. These included futures contracts in oats, palladium, live beef cattle, cotton, silver coins, platinum, barley, soybean meal, plywood, sugar, the British Pound and wheat. Most of these commodities advanced in price, some spectacularly so. Thus 1972 was a bad year for the consumer, but a good year for the commodity futures trader. To the futures speculator, it makes no difference whether prices

[ previous | next]

Order a printed, softcover, copy of this book.