cottonindustry raised the market share to over 60 percent by 1990, moving to 68 percent by 1997, according to National Cotton Council statistics.The demand side of the supply-demand equation is also impacted by the importation of textile and finished garments from theFar East. Competition from Korea and China, using cotton grown inthat part of the world, reduces the demand for U.S. grown cotton.
Price DeterminantsCotton is a crop that is produced once a year. Although it is grownin 75 countries, most countries use all their production internally.Therefore, the cotton price analysts need only track the productionof the five key producers mentioned earlier.Additionally, while demand changes are very significant, theyusually occur slowly and in somewhat predictable patterns. Supplychanges, on the other hand, occur abruptly and without warning.Not surprisingly, supply-demand factors start with weather. Aswith any crop, weather is critical, particularly during the growingseason. For example, rain and cold temperatures can delay plantingin the spring. Late-planted cotton can be caught by an early frost. Awet, cool fall can cause the cotton boll to rot. If rain washes the insecticide off the plants, insects, particularly boll weevils, boll worms,and thrips, will do plenty of damage. Too little moisture reducesyield; too much reduces fruiting and causes late maturity.Government programs during the last 60 years have had asmuch impact on production (supply) as the weather has. Government protection of cotton began in 1929 with the AgriculturalMarketing Act, which established loan rates. Later, price supportprograms priced the U.S. crop out of the world market, and cottoncarryover grew to 17 million bales in the mid-1960s.The USDA says that the continuation of planting flexibility established in the 1996 farm legislation should mean the upland cotton area will remain responsive to its own price, competing cropprices, and other market signals. Exports are forecast to increase an
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average of 2 percent annually through 2008/2009, after a small decline in 2001/2002. The 1996 Farm Act capped total expenditures forcotton user marketing certificates (Step 2 payments designed tokeep U.S. upland cotton competitive) at $701 million during fiscalyears 1996 –2002, but funding was exhausted by the end of calendaryear 1998. USDA projections assume that the program will not becapped for fiscal years 2003 and later. As a result, it says annual Step2 expenditures near $150 million are assumed in baseline projections for crop years 2002/2003 through 2008/2009.Fashion often dictates price. The demand for permanent pressclothing hurt the demand for cotton for many years. This fadreached its bottom, and there is a greater demand than ever beforefor more “natural” fabrics, particularly jeans made from cotton. Asnoted earlier, cotton’s percentage share of the total apparel markethas rebounded from a low of 35 percent in 1982 to 68 percent in 1997.Inventory and carryover is the amount of cotton available atany one time. It is a critical element that must also be taken into consideration. Cotton ginners, brokers, millers, and shippers all holdinventory, not to mention the Commodity Credit Corporation.Seasonality is predictable. Prices usually reach lows in late fallduring harvest. Highs normally come between May and July. Thecrop year officially begins August 1 of each year.
Trader’s NotesThere are many types of cotton. When evaluating demand, makesure the need is for the type of cotton you plan to “buy” on the futures exchange. For example, on the New York Cotton Exchange, thecontract calls for 100 bales (50,000 pounds) of “low-middling, 1-1/16 inch premium mike.” You would hate to go long only to find outthe market is demanding extra-long staple cotton.METALSOVERVIEW OF THE SILVER MARKET
Silver was first used by people sometime around 4000 b.c., which isslightly after people learned to use gold and copper. The earliestknown mines of “native” silver (pure silver found in nugget form)were in Asia Minor.
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The first use of silver was decorative, primarily jewelry and armor. Inscriptions found in the Royal Tombs of Chaldaea indicatethat by the fourth millennium b.c., silver had become a medium ofexchange. It was the ancient Greeks who popularized the use ofminted silver coinage. Europe remained silver poor until Spanishand Portuguese explorers discovered vast deposits in the Americasduring the sixteenth century.
Supply SideTotal world production ranges between 300 and 500 million troyounces per year. The main producing countries are Australia, Canada, Mexico, Peru, the United States, and the Commonwealth of Independent States.Most U.S. silver mines have played out, and the metal is nowprimarily produced as a by-product of the mining of base metalssuch as copper, zinc, and lead. Silver is also often found in association with gold ore. The fact that most silver is produced as a byproduct makes production somewhat insensitive to demand. Increased demand for the base metals, on the other hand, can createoversupply situations for silver.People have a habit of hoarding precious metals. This can distort the supply side of the supply-demand equation. When silverbecomes very precious, hoarders will dump their silver, thus driving prices sharply lower. India best reflects the magnitude of thisproblem. It is estimated that Indians hold 5,000 million ounces of silver—approximately a 12¹⁄₂-year supply.The French are also known as world-class silver hoarders. Thereare no accurate figures on how much silver is hidden away in France.In addition, new and efficient technologies have been developed to recover silver from photographic solutions, thereby addingrecycled silver to the supply side of the balance sheet.
Demand SideThe demand for silver as a medium of monetary exchange has allbut dried up. Only about 7 percent of silver supplies are still manufactured into coins each year. Its traditional use in jewelry, silverplace settings, and art objects still represents a major portion of annual consumption.
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The really big users are the electrical and photographic industries. Silver has several very desirable physical characteristics. It’s abetter conductor of heat and electricity than copper. And some of itssalts are light- and radiation-sensitive and form the active ingredient in almost all film emulsions. In photography, about half of thesilver consumed is for x-ray plates.
Marketing of SilverIn London, the silver marketing capital of the world, there are twovery distinct silver markets. The first is the bullion market. Threebanks—HSBC Bank plc, Deutsche Bank A.G., and the Bank of NoviaScotia-ScotiaMocatta—hold a daily “fixing” meeting each morningto set the price they are willing to pay for silver. This “fixes” the cashor spot price and gives brokers around the world a benchmark priceto trade on.The other market, of course, is the futures market. The two major futures exchanges trading silver are the New York CommoditiesExchange (COMEX) and the Chicago Board of Trade (CBOT). TheFar Eastern silver markets, particularly Hong Kong, Singapore, andTokyo, have been steadily gaining in importance. The London Metal Exchange also began trading a silver futures contract in 1999.
Fundamental AnalysisThere are five key areas the investor in silver must analyze from afundamental point of view.First is industrial usage. Is the use of photographic film andemulsions expected to increase or decrease? The rapidgrowth of digital cameras and their use with the Internetthreatens this market. Statistics show that in 1997 more than 2million digital cameras were sold—this was the second consecutive year the new devices outsold the traditional 35-mmsingle-lens reflex cameras. The popularity of digital camerasis spreading from commercial use to the general public and iscertain to have an adverse affect on the amount of silver usedfor photographic purposes. Other industrial uses of silver,such as an electrical conductor and as a catalyst, must begauged as well.
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The second area of concern is currency fluctuation. Althoughnot a perfect hedge against inflation, silver prices reflect thevalues of stronger currencies.Third, you need to evaluate the impact of the political situation. Unstable world conditions encourage the hoarding ofsilver and other precious metals. Some governments have often tried to “control” the price of silver through legislation ordecree. Other governments, such as India, have attempted torestrict the export of this precious metal. Can you predictwhat political action is going to occur? What impact will thepolitical changes have on silver prices?Fourth, you must estimate production and recovery. Normally, more silver is consumed each year than is mined, but thesupply remains plentiful.Lastly, you must consider the unpredictable, such as the factthat major producers have been known to disrupt the marketto gain a political advantage.
Technical AnalysisTwo technical formations work well for silver. Major lows in the silver market are usually made in rounded bottoms. Rounded bottomsmay take years to develop, as was the case from 1974 to 1978, or from1968 to 1973.After creating a rounded bottom, silver often makes a spectacular rally—frequently doubling or tripling from its previous high.Highs, on the other hand, occur in a matter of seconds. A reversalfrom a top is often a spectacular spike top with “island reversals”and other kinds of violent formations.Seasonally, you should expect silver to create its lows duringsummer, and its highs are often made in January.OVERVIEW OF THE GOLD MARKET
Like silver, gold came into common use around 4000 b.c. It was firstfound in nugget form and later mined. Although it has been in constant use since prehistoric time, 90 percent of the world’s gold hasbeen mined since 1848. More than one-third of the amount produced
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since the beginning of time has been mined in the last 30 years. Thereason is simply the advances made in mining technology.One of the unique characteristics of gold is its malleability. Anounce can be formed into wire over 1 mile in length. That’s one ofthe reasons it has been a favorite metal of jewelers over the centuries.However, from a supply-demand perspective, it is quite inelastic. This means that demand is somewhat insensitive to supplyprice. For example, if the supply drops, demand may not be greatly affected. Gold is not like food. With food, if supplies disappear,prices soar. If the gold supply decreases, consumers (particularly industrial users) simply go without or find a replacement, e.g., platinum, palladium, or silver.Gold has some other supply-demand considerations that an investor must be prepared to evaluate. First, gold is usually used inapplications that allow for reclamation. It’s so valuable that stepsare usually taken to plan the recovery of whatever gold is used. Thisis particularly true in industrial applications. Therefore, disappearance as we know it in other commodities, like soybeans, corn, cattle, copper, etc., is not a serious factor.
Supply SideNew gold comes from mining. South Africa is by far the leading producer, followed by the United States, China, the Commonwealth ofIndependent States (CIS), Australia, and Canada. The rest of theworld trails far behind.Hoarders distort the supply side of the supply-demand equation. Central banks maintain the largest stockpiles. For example,central banks in the top 15 industrial countries store over 85 timesthe world’s total annual production. If just 1 percent of this supplycomes to market in any one year, the annual supply of gold woulddouble.Gold is one of the most politically sensitive commodities, andunpredictable behavior by its major producers can affect prices.South Africa and the Commonwealth of Independent States are major producers, although the CIS output has slipped in the past fewyears. In 1996 it ranked behind both the United States and China. Inthe past, South Africa and the Commonwealth of IndependentStates have been somewhat unreliable suppliers that did not always
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bring their gold into the marketplace in an orderly manner. SouthAfrica, however, became more politically and economically stablein the mid-to-late 1990s, after the end of apartheid and the establishment of a black-dominated government led by Nelson Mandela.Russia and some of the other CIS countries still are politically andeconomically unpredictable, and their influence in production haswaned.The Organization of Petroleum Exporting Countries (OPEC)members are another group of unstable gold hoarders. They releasegold reserves based on the price of a barrel of oil. If petroleum pricesdrop, they must sell gold to pay debts. If petroleum prices rise,they’ll buy gold to add to their hoards.Individuals, particularly individuals in countries that have experienced serious monetary problems, have learned to hoard gold.Germany, for example, has experienced the total destruction of itscurrency four times in the last 100 years. France is not far behind.Citizens of the United States are supposed to have enormous stockstashed away. The problem for fundamental analysis is that no oneknows for sure how much is hidden away and what it would taketo bring it back into the marketplace.
Demand SideDecorative uses, primarily jewelry and objects d’art, account forabout 60 percent of demand. Other major uses include electronics,dentistry, coinage, medicine, and chemicals.Unfortunately, for commodity analysts, demand doesn’t project price since it is an inelastic commodity. Additionally, there areseveral substitutes (metals mentioned earlier) that can dampen a demand-driven market.
Marketing of GoldLike silver, the gold bullion price is fixed each day in London. Fivemajor brokers get together twice each trading day and set the price.The brokers are N.M. Rothschild & Sons Ltd., Deutsche Bank A.G.,HSBC Bank plc, Bank of Nova Scotia-ScotiaMocatta, and RepublicNational Bank of New York. Other very important marketing centers for bullion are Zurich, Hong Kong, and Singapore. Chicago andNew York City dominate the futures market in gold.
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Fundamental AnalysisThe problem involved in analyzing the price of gold is isolating thepressures that impact gold. Gold is a commodity that is used in avariety of ways, but its impact is wider because humans have a sentimental attraction to jewelry made from this metal. Governmentsuse it for coinage or to pay foreign debt. It has a monetary value. Individuals respond to this by hoarding it to stave off the effects of inflation or to protect themselves in times of financial crisis.Through their central banks, governments also control the vastmajority of aboveground gold. Therefore, it becomes a tool of theirforeign or domestic policies. President Roosevelt’s “New Deal,” in1933, made the possession of gold bullion illegal and confiscated bullion held by U.S. citizens. Iran and Iraq sold gold to support their war.South Africa, before the end of apartheid, used gold to bribe othercountries to lift sanctions imposed to protest the treatment of blacks.During the late 1990s, with gold already far down the slope ofa 10-year decline, European Union central banks pushed it evenlower by selling gold reserves, partly to help their countries meetcriteria for the European Monetary Union. Plans for the International Monetary Fund (IMF) to sell part of its gold reserves to funddebt relief for poor nations also pressured gold. Gold prices fell tobelow $260 an ounce in mid-1999. But in late 1999, the EuropeanCentral Bank (ECB) and the central banks of 15 other countries saidthey would limit gold sales to 400 tons per year through 2004. Also,the IMF bowed to U.S. congressional pressure to abandon its planto sell 10 million ounces of gold, opting instead to revalue up to 14million ounces of gold at current market prices to fund the debt relief programs. The actions briefly pushed gold back to over $325 anounce, although it later slipped again. The actions eliminate someof the political pressure on gold, if the ECB and the other countriesstick to their pledge during the period.
Technical AnalysisJust as gold is one of the most popular of possessions, it is also acommodity on which analysts love to do price projections, because“everyone” follows gold.Its seasonal pattern finds the high most often around Februaryand the low in place around August. The reason for this is the mi-
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gration of workers to and from their farms. Supplies from SouthAfrica are reduced when they are out planting their fields in February (our winter—their summer). Supplies increase when they return to the mines in August (our summer—their winter).The silver-to-gold ratio is a simple, technical trading system.You simply calculate the number of troy ounces of silver it takes tobuy 1 ounce of gold. At present, the “normal” ratio is around 60 to1. When it drops below 50 to 1, gold is too scarce compared with silver and should be bought. When above 70 to 1, buy silver. Gold markets often trend. The basic bar chart formation analysis can often beused successfully.OVERVIEW OF THE COPPER MARKET
Copper, known as the “red metal” since antiquity, was first used bypeople for the manufacture of weapons, armor, and tools. Becauseof its malleability, people quickly learned to blend it with other metals to produce more rigid materials, such as bronze and brass. Sinceprerecorded history, copper has been one of the most widely usedmetals. Even today, copper is one of the most actively traded metals on an international basis.
Supply SideCopper enters the supply stream from two directions: newly minedand reclaimed. Copper mining utilizes the open pit method. Largeamounts of earth are dug and run through a three-step process ofmilling, smelting, and refining. The milling procedure crushes andgrinds the earth dug from the open pits. It is then moved through aflotation device that separates the copper ore from the earth, resulting in a copper concentrate. Intense heat is applied to the copperconcentrate in the smelting step. This produces a copper that is 99percent pure. The last stage is refining. It is an electrolytic techniquethat removes just about all the remaining impurities, bringing thecopper to a purity level of 99.9 percent. This is the most commonlytraded grade on futures markets.Newly mined copper primarily comes from four areas: thewestern slopes of the Andes mountains in Chile and Peru, the SouthAfrican countries of Zaire and Zambia, the United States, and Canada. These countries account for approximately two-thirds of the
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world’s mining production. In the United States, Arizona producesthe most copper.One of the most popular characteristics of copper is its abilityto resist corrosion. This makes copper an ideal metal to recycle. Thescrap or secondary production of copper has been an ever-increasing source and must be taken into account when doing fundamental price analysis.
Demand SideCopper is an industrial metal. Therefore, the demand for coppercomes primarily from developed countries. Its industrial uses stemfrom its ability to conduct heat and electricity, resistance to corrosion, strength, ductility, and malleability. Copper is often alloyedwith tin and nickel.The two largest consuming countries are the United States andJapan. Japan, however, is not a major producer. The electrical industry is the largest single user. Copper, because it conducts electricity well, is used as wiring and in electrical components of allsorts. The growth of the space and telecommunications industriesin recent years has boosted usage even more. Extensive use of copper can also be found in the housing, automobile, and plumbing industries. In addition, a considerable amount of copper is used forjewelry and coinage.
Price DeterminantsSince much of copper is mined in undeveloped countries and consumed in developed countries, it must be exported from its sourceto where it is needed. This means that foreign exchange rates andtransportation play an important part in the price discovery process. Second, no single nation has a monopoly on either the miningor refining of copper. It is truly a worldwide commodity. This fosters competition, which impacts pricing strategies.As mentioned earlier, copper is a commercial metal used heavily in construction, automobiles, and electrical appliances. For thisreason, the supply-demand equation is sensitive to economic trendswithin the developed countries. If housing starts or new-car salesplunge, you can expect copper prices will follow as demand slack-
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ens. Actually, copper prices usually lead the way as users cut backon inventories.Thus, during economic hard times, look to short the coppermarket, but be sure to evaluate the situation on a global basis. If not,you could be caught in a situation where prices stay firm becausedemand is still strong in some parts of the world.When evaluating economic or business cycles, you need to payparticular attention to the strength or velocity of change. Demandfor copper feeds on itself and becomes stronger and stronger as demand builds momentum.Politics in both the source and consuming countries must bemonitored closely. For example, strikes by mine workers can restrictsupply and drive prices higher. Political unrest in undevelopedcountries is common and can spill over into the copper mines orslow down the movement of copper to the consumer nations.In the developed countries, political programs that promotehousing, construction, or manufacturing of electrical componentsfoster demand and usually translate into higher copper prices. Governments can also influence demand with their monetary policy. Forexample, programs that encourage development of industry andpromote jobs usually have a favorable impact on prices. Governments also directly control the amount of copper used for coins. Ifthey lower interest rates, it will often impact housing starts, whichwill eventually be felt in the price of copper. Finally, don’t forget thedefense industry, which is a major user.Copper inventories on all levels can be a damper or spark toprices. Heavy inventories hold prices down; shortages instigate bullmarkets.
SeasonalityCopper does have a seasonal pattern related to its uses in the housing and automobile industries. These industries build inventoriesthat cause copper prices to peak during February through April. Thetrough usually comes in late summer and early fall.
Trader’s NotesBecause copper futures contracts have a long history, are heavilytraded, and are known for making long trending moves, they are
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very popular among speculators. Copper futures trade somewhatsimilar to lumber, which is also a commercial commodity and is influenced by interest rates and housing starts.Copper futures are traded on the COMEX division of the NewYork Mercantile Exchange. Cash copper is also traded on the London Metal Exchange.ENERGYAN OVERVIEW OF PETROLEUMAND PETROLEUM PRODUCTS
The petroleum market historically was a reasonably stable marketwith steady prices and a reliable distribution system until the early1970s. Since then, a lot of changes have occurred. The primary disruptions began in 1973 and 1974 with the formation of OPEC andthe oil embargo. Prices shot up; lines formed at gas stations.The major significance of these developments was a shift ofpower away from the major oil companies (the Seven Sisters) andinto the hands of the producers. OPEC has had its ups and downsin its attempts to be a unified force in the energy world, with its influence ebbing and waning. Big players, notably Saudi Arabia, haveoften ignored the agreed quotas. Some producing countries refusedto join, hampering efforts by OPEC to keep supply down to the level it would like.The sharp drop in crude oil prices in the late 1990s to below $10a barrel galvanized OPEC to holding closer to its quotas to get supply back into line. Prices moved back up to more than $20 a barrelin 1999.Chaos often reigns in the energy market, providing both superopportunities and high risk for investors. The Iranian crisis of 1978and 1979 continued these trends, as did the Iraq-Iran War and theIraq-Allied (Desert Storm) War of 1990. Even in times of relativeprice and supply stability, the ominous threat of disruptions hangsover the market because of the friction between the United Statesand some Arab countries and between Israel and most Arab countries, particularly in view of the continued close United States–Israeli ties. Israeli-Palestine peace accords in the late 1990s could leadto lessened tensions in the Middle East, but it only takes a spark toignite the long-smoldering distrust in the region.
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Supply versus DemandTwo of the largest producers of crude oil, the Commonwealth of Independent States and the United States, are also net importers. Thatgives control of supplies to the major exporters: Saudi Arabia, Iran,Iraq, Kuwait, Libya, Nigeria, and Algeria. This group of producersmust carefully balance output and usage.For a time, the producers believed usage would never be aproblem. They could charge what they wanted and the worldwould pay, but high prices convinced even U.S. citizens that enoughwas enough. Eventually, in 1983, conservation efforts left consumption in the United States unchanged for the first time in its history.This led to an oversupply of crude oil and lower prices. The oil cartel weakened, and the point was made. Although U.S. oil importsdeclined from 1983 until they reached a low of 3.2 million barrelsper day in 1986, they began a steady climb after that. By the end of1998, the United States was importing 8.7 million barrels per day, aresult of a booming economy.
SeasonalityDemand has another twist when it comes to petroleum. Gas for automobiles is most in demand in the summer, while demand for heating oil peaks in the winter. These two factors complement each other as far as demands for raw crude, refining, and storage capacity isconcerned.The basic process of a refinery is distillation. Crude oil is heated until it vaporizes. The vapor or gas is then cooled to a liquid form.This process separates (“cuts” or “fractions”) raw crude into several petroleum products. Compounds in the raw crude vaporize atdifferent temperatures; the lighter the compound, the lower temperature at which it vaporizes. The “fractions” that compose crudeoil, in order from lighter to heavier, are butanes, gasolines, naphtha,kerosene, heating oil, and residual oil.Two other critical considerations are the types of crude available to a refinery and the distillation process a refinery uses. First,there are sweet and sour crudes. The lower the sulfur (less than 0.5percent by weight), the sweeter it is. Sour crude contains over 1 percent sulfur. This characteristic has become very important becauseof pollution standards. Density is another consideration. Low-den-
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sity, or light, crude is more desirable because it produces more of themore valuable products, namely gasoline and jet fuel. The origin ofthe crude is also a critical factor. It accounts for such characteristicsas viscosity; pour point; color, flash, and fine points; and metalscontent.Second, every refinery is designed to efficiently process a certain type of crude. If the right crude is not available for the way therefinery is set up or for the end products needed, the price for the“right” crude may shoot up on the spot market while other crudesgo begging for a home.
Price DeterminantsNot unexpectedly, price determinants start with weather. Unseasonably warm or cold weather during the winter (heating oil season) can play havoc with projections. Conservation will continue tobe another factor. How seriously are consumers reacting to pressureby the government and other bodies to conserve energy? Politicalthreats of war, blockades, etc., send prices higher. Peace and cooperation among nations drives the price down. The solidarity ofOPEC sends prices up, while squabbling leads to lower prices.Plentiful stockpiles and pipeline supplies reduce prices; shortages send prices skyrocketing. Discovery of new reserves damagesprice prospects. High prices can open closed or inefficient wells.Crude oil and its by-products can be stored for reasonably long periods of time. One would expect the deferred contracts to evenlyreflect the cost of storage and insurance, as is usually true in thegrains. However, because of the seasonality of both gasoline andheating oil (the two main by-products), this is not true. Also, petroleum is a very regional business, with each area of the country having different demands.
Trader’s NotesThe petroleum markets lend themselves to hedging. Oil companiesneed to hedge future production; refiners hedge their requirementsfor crude and production of gasoline and heating oil; jobbers buycontracts of gasoline futures to hedge their needs.Intercontract (crude oil versus gasoline, crude versus heating
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oil, gasoline versus heating oil) and intracontract (buying 1 monthand selling another) spreads are very popular. More sophisticatedspeculators arbitrage between the New York and London futuresmarkets. The important thing for the investor to note is that theseare usually very liquid markets.
STOCK INDEXESOVERVIEW OF THE STOCK INDEXFUTURES MARKETS
Stock indexes and their futures market counterparts proliferatedduring the bull market of the