Lessons from the Pros


“Moooooo-ve” Over Stocks, Commodities Are Ready to Bounce

Yes, I was having a little fun with the title of this article.  Actually it reminds me of a story when I first started trading.  When I became interested in trading about 27 years ago I was fortunate enough to have found my first broker close to my home.  My initial adventures into the financial markets were a few cheap stocks including an airline initial public offering (IPO).  Mind you, I had no clue what I was doing, but I lived near an airport and I thought that qualified me to be an airline analyst.

When the IPO came out for Presidential Airlines I literally bought on the opening bell at the market.  You know how those orders work, you want in so bad at any price.  As most stupid mistakes go this one was no different.  I bought the high price of the IPO and after a very short time rode the price right into bankruptcy when the airline went out of business.  It was shortly after my purchase that I realized stock trading was not for me.  So I turned to my broker and said, “What else do you have other than stocks?”

This is when I got my first taste of commodity futures.  I mentioned I was lucky that his office was close to my home, but I was much more fortunate that he was a stock and commodity broker.  I’m not too sure he felt so fortunate with me living so close because I spent a lot of time in his office watching screens with nothing but prices flashing.  I would watch him trade the markets and he made it look so easy.  I remember one time he was long the Pork Belly market and it went Limit Down for the day (that means he was losing money).  The next day he bought more when it opened lower and it went Limit Down again that day (this means he was losing a lot of money).  The third day Pork Bellies gapped down again and I watched him buy more.  What little I knew about trading had me wondering what he was doing, so I asked him why he keeps buying.  His reply was, “It will be back.”  If my math was right he was down probably near $13 to 15 thousand dollars on these Pork Bellies.  A few days later the Pork Bellies started closing Limit Up in his favor (this means he was making his money back rather quickly each day).  And sure enough I watched him pull out about a $20 thousand profit.  What a bad thing for a novice trader like me to experience.  I now knew how to trade after watching him.  My philosophy just had to be, “The markets are wrong and I am right.”

As you can probably guess, that philosophy did not work well in the futures markets. Perhaps these are the lessons a self-taught trader faces and has to experience before they can learn to trade well. About 5 years later things started to come together for me and trading became more like a systematic process.

The funny thing about the time I spent in my brokers office was that I learned brokers never use client names when talking to somebody else, mostly for financial confidential reasons.  During this time I had been trading Live Cattle Futures on a regular basis and my nickname became “Moo Cow.”  Each time I would come in the office I was referred to as Moo Cow.

And that leads us into a seasonal pattern coming in the Goldman Sachs Commodity Index (GSCI).  In a recent article I wrote about this world production weighted Commodity Index and how it is heavily weighted in the Energy complex, but contains 24 different commodities.  A trader can use the GSCI to identify the overall trend of a basket of significant commodities around the world.  Just like a trader would use the S&P 500 Index trend to enhance their buy or sell decisions of individual stock.

I would like to thank Moore Research (www.mrci.com) for permission to use their seasonal charts for the GSCI and the Dollar Index.  Seasonality of individual and spreads of commodity futures, including the financial futures is an advantage to any trader.  But when you can see the overall commodity market seasonal pattern then you get a much broader view of the commodity futures markets.

In the following charts we will review some seasonal patterns for the GSCI and the Dollar Index.  During the next month to month in a half there is a strong seasonal pattern for both of these Indexes.

Note:  The following discussion is not meant to be a trade recommendation, but purely an educational reference of a cyclical reoccurring pattern in price action for the GSCI and the U.S. Dollar Index.

Chart 1

seasonal chart of the U.S. Dollar Index

Chart 1 is a seasonal chart of the U.S. Dollar Index.  Each of the lines represents a different historical study reference.  The black line is a 15 year average of the Dollar Index.  The red line is a 5 year average of the Dollar Index.  The left axis has numbers from the bottom up starting at 0 and going to 100.  This tells us what percent of the annual range we could possibly expect to find the Dollar Index in.  For example, if you look at the top of the chart you will see that during the last 15 and 5 year studies that the price of the U.S. Dollar Index has tended to be in the upper 95 to 100% of its range for the year between June and mid-July.

Another reason it is nice to have two time periods of seasonality is a trader can see if the market is changing its seasonal patterns by making the two lines diverge from each other by any significant amount.  As you can see in this chart the Dollar Index has been fairly consistent over time except towards the end of the year.

 Chart 2

seasonal chart of the GSCI

Chart 2 is a seasonal chart of the GSCI with the same time periods as Chart 1.  What I am looking at on these two charts is how the U.S. Dollar has tended to put in seasonal highs in June to mid-July while almost at the same time the GSCI has tended to put in seasonal lows in the last 5 years and a good basing pattern before resuming higher over the last 15 years.

This is referred to as an inverse market correlation.  Just like any market correlation from the past it does not mean it has to happen again.  Market correlations need to be tracked in real time and not just assumed that because a market was either inversely correlated or correlated many years ago that it will be constantly like that.  If you need any proof just look at a weekly chart of the 30 Year Bond and the S&P 500 since January of 2014, both are going up for 6 months now.  Really, I keep hearing traders say they are supposed to go in different directions?

While we are discussing how market correlations can be skewed and not to assume they have to work, seasonal patterns are very similar in any market.  A trader should never bet on a seasonal pattern without supporting Fundamental, Technical or both, information about the current year.  Events happening this year could be much stronger than at any time during the last 15 years of research.  Some examples can be weather, geo-politics, wars, major supply/demand interruptions, etc.  These events can distort even a perfect track record of a seasonal pattern during any given year.

Back to our seasonal analysis of the Dollar Index and the GSCI, as a trader you could be looking to find strong long term demand levels on the GSCI charts and strong supply levels on the Dollar Index charts.  Only take these trades if you feel the trend of these indexes is confirming your directional bias.

Participation in these markets could be in the spot forex or futures contracts for the US Dollar.  To participate in a broad commodity market move a trader might look at using Exchange Traded Funds (ETF’s) where they can limit their risk to only what they purchase.  If you decide to use ETF’s think about using a basket ETF (ETF with multiple commodities in it).  Or for ETF’s that track individual commodities think about the Energy sector since the GSCI is so heavily weighted in Energy.  Then there are also options on futures or you can trade a futures contract on a specific commodity.

“Don’t let a bad day make you feel like you have a bad life.” 

–      Don Dawson

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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