y fallsoff. Even though uses of soy as a food product are mostly found inAsia, the United States is the world’s leading producer. Accordingto the UN Food and Agriculture Organization, major soy producers as of 2005 (in millions of metric tons) were:CountryUnited StatesBrazilAustraliaArgentinaChinaIndiaParaguayCanadaBoliviaOther nationsWorld Total
Production83.952.744.738.317.46.63.53.01.762.5314.3
The United States is also the leading exporter of soybeans. Onemarket factor affecting futures prices in the future will be environmental concerns. Greenpeace and the World Wildlife Federationclaim that soybean cultivation has destroyed large areas of Amazonrainforest. As green policies become more prevalent around theworld, the effect on soy prices could be substantial. Brazil has thesecond highest production of soybeans in the world, so even if cutbacks in growing areas were to be limited to Brazil alone, it wouldimpact world supplies significantly.In the United States, soybeans are among the so-called biotechfoods, and have been genetically modified for many uses. Forexample, in 1995 ‘‘Roundup Ready’’ soybeans were introduced,
184
Classifications of Futures
which cannot be killed by the popular active ingredient in Roundup.This allows farmers to spray the herbicide without losing valuablecrops, while reducing weeds in soy fields. Before 1997, only 8% ofU.S.-grown soy was genetically modified. By 2006, 89% were GMsoy.Vegetable-type uses of soybeans include production of tofu, soyflour, and soy milk (it is not actually milk, but is widely referred toas milk). As an oil, soy has a high protein content (38% to 45%).Soybeans are the leading agricultural export in the United States,which is encouraging for futures traders because international demand supports continued expansion of the U.S. crop.Soy meal is what remains after extraction of the soy flakes andis used for defatted soy flour. This product contains under 1% oil.Full-fat soy flour is produced from unextracted, dehulled soybeans, and has about 20% oil content. Low-fat soy flour is produced by adding back a portion of oil to defatted soy flour. Andhigh-fat soy involves adding higher levels of oil.One widespread use of soy as a human food source is infantformula. This use is especially useful for lactose-intolerant infantsor those allergic to milk protein. These products are sold in powdered or concentrated liquid form. Soybeans are also used to produce nut butter, a less fattening peanut butter substitute. Soy isalso used to produce margarine, soy yogurt and cheese, cookingfat (like Crisco), and many other substitutes for popular foods.Nonfood uses of soybeans include manufacture of soap, cosmetics, resin, plastic, ink, crayons, solvents, and clothing. It is alsoa potential biodiesel fuel base, and is used as fermenting stock toproduce vodka.Figures 10-6, 10-7, and 10-8 show the March 2008 contractsfor soybeans, soybean oil, and soybean meal as of December 2007.Note the soybeans trend. Prices rise steadily throughout thesecond half of the year, but the RSI level also rose and reached 80.This indicates the contract was close to overbought. The soybeanoil showed a very similar trend. Soybean meal contracts showedthe same tendency, but at the end of the chart period, price andRSI both dropped off.
185
AgricultureFIGURE 10.6. SOYBEANS—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
■
Western Barley and CanolaBarley is a leading cereal grain as well as livestock food crop andmalting base. Barley is second only to wheat in importance anduses. However, barley is more expensive to produce and more sensitive to varying soil conditions. The UN Food and Agriculture Organization reported the top barley producers as of 2005 (inmillions of metric tonnes):Country
Production
RussiaCanadaGermanyFranceUkraine
16.712.111.710.49.3
186
Classifications of Futures
FIGURE 10.7. SOYBEAN OIL—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
TurkeyAustraliaUnited KingdomUnited StatesSpainOther nationsWorld Total
9.06.65.54.64.447.7138.0
Uses of barley are different than most other grains. About halfof total production is applied to livestock feed and a large portionof the remaining production is used for malting of beer and whiskey, as well as nonalcoholic products like barley water and mugicha(a popular drink in Japan and Korea). In Europe, barley is a verypopular ingredient in soup and stew.Western barley is a futures trade, based on production in Alberta, Canada. This is the source for nearly half (44%) of Canada’s
Agriculture
187
FIGURE 10.8. SOYBEAN MEAL—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
total barley crop (Saskatchewan produces 35% and Manitoba produces 12%). Much of the Western barley from Alberta is exportedto overseas markets, but the majority remains in Canada and isused as livestock feed.Most of the Western barley produced trades on the cash market, but the Western barley contract (traded on the Winnipeg Commodity Exchange) has seen increased volume in recent years asprice variations make cash markets less certain.Barley has become one of Canada’s most important crops. Inthe 10 years ending 2005, Western barley averaged over 12 millionmetric tonnes, the second highest volume in the world. Because alarge portion of Western barley is used as livestock feed, barleyserves multiple purposes in the futures market. Barley prices affectprices of livestock, as well as malted beverages. To a lesser degree,changes in barley prices also affect food prices, especially in Europewhere barley is most popular.
188
Classifications of Futures
Figure 10-9 shows the December 2007 chart for March 2008Western barley.Note the large price run-up in August and September, accompanied by signals in both MACD and RSI; and then the price retreat confirmed by the same technical signals.The origin of the word canola is ‘‘Canadian Oil, Low Acid.’’ Itwas developed first in 1978 and is also known as lear oil (LowErucic Acid Rapeseed). GM canola oil is resistant to herbicides,and today 80% of Canadian-grown canola is of the GM variety.Canola is also Australia’s third largest crop and is used by wheatfarmers as a break crop to improve quality of soils. (A ‘‘break crop’’is a secondary crop used in crop rotation, to break the cycle ofweeds, infestations, and diseases.) In the United States, over 90%of canola is produced in one state, North Dakota. In addition to itsFIGURE 10.9. WESTERN BARLEY—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
Agriculture
189
primary use in cooking, canola has potential as a biodiesel fuel.Canola futures trade on the Winnipeg Commodity Exchange.Figure 10-10 shows the March 2008 canola contract as of December 2007.Note the price rise in November and December, and the movement of RSI approaching 80, a signal that the trend was approaching overbought conditions.
■
LumberWhile lumber is not usually considered part of the agricultural futures classification, it is included here. The product is planted, harvested, and renewed. These attributes give lumber enough incommon to be treated as an agricultural commodity.Lumber is well-known for its uses in construction. It is alsoessential for production of wool pulp and paper products. Pulp-
FIGURE 10.10. CANOLA—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
190
Classifications of Futures
wood (rough lumber) is used as a raw material for furniture manufacturing. Finished lumber is milled in standard sizing and is usedprimarily in the construction business. Popular softwoods includepine, cedar, fir, spruce, and hemlock.Engineered lumber is designed for very specific uses. These include laminated veneer lumber (LVL), which are doubled or tripledup and provided in longer lengths for use as structural beams. Thisproduct is necessary where dimensional lumber would not be structurally strong enough to provide adequate support and where spansare too long for other products. Wood I-joists (also called trus joists) are used in flooring, or as piers in flooring foundations. Manufactured trusses are used for the construction of roofs, providingfaster and easier construction and support than other methods.Oriented strand board (OSB) consists of strands of thin woodglued together to improve strength. OSB is a replacement for plywood and used for exterior walls, flooring, and decking. In flooring, it often includes the popular tongue-and-groove design.For futures trading, one important factor significantly affectinglumber prices is an ongoing dispute between the United States andCanada. Mostly affected has been Canada’s westernmost province,British Columbia, where a majority of softwood lumber exports areproduced. U.S. claims that the Canadian lumber industry is pricedunfairly due to federal and provincial subsidies is at the core of thedispute. In fact, the Canadian government owns most of Canada’stimber resources. Harvest prices (stumpage fees) are set by administrative decision rather than in the competitive market. This affectsnot only market prices but futures contract prices as well. This dispute has been going on since 1982.Figure 10-11 shows the March 2008 lumber contract as of December 2007.A four-month price decline in the last months of 2007 was accompanied by RSDI falling below 40, a signal that the contract maybe undersold at that point.For additional information on agricultural futures, trends, anduseful statistics, check:National Grain and Feed Association, www.ngfa.orgUSDA National Agriculture Library, www.nal.usda.gov
Agriculture
191
FIGURE 10.11. LUMBER—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
USDA, at www.usda.govUSDA National Agriculture Statistics Service, www.nass.usda.govThe next chapter moves into livestock futures, which often areaffected directly by crop cycles and prices.
■
Notes1. International Grain Council, ‘‘Grain Market Report,’’ and Centro Internacional de Mejoramiento de Maiz y Trigo (CIMMYT), World Wheat Overviewand Outlook, 2000-2001 (www.CIMMYT.org).2. Marc Faber, Tomorrow’s Gold (Hong Kong: CLSA Books, 2003).3. Samuel Johnson, Dictionary of the English Language (1755).
C H A P T E R
1 1
LIVESTOCK
T
he overall importance of livestock—including all meat productsused for food and dairy production—represents about one-fifth ofthe typical family’s monthly budget (according to the USDA).1 Thecosts going into livestock businesses include not only the cost ofacquisition of the product, but feed and marketing costs as well.Feed, a factor of the agricultural market, is going to vary in costwith corn, wheat, oats, barley, and other feed sources. If corncrops, a major feed source, are used increasingly for ethanol production, then the cost of corn is going to rise; and that means thecost of livestock will rise as well, and those costs will be reflected infutures prices even before they hit the family pocketbook.More than most other futures contracts, livestock futures tendto be extremely volatile. This is due to the feed costs, competition,and seasonal factors affecting what it costs to feed livestock anddeliver the final product to market. That means transportationcosts also affect livestock, not to mention the expected cycles,weather, and current trends in the marketplace. For example, inpast years fear about mad cow disease, which began to affect livestock in Great Britain, caused a considerable price change in theU.S. livestock futures market. Demand fell rapidly as consumers192
Livestock
193
stopped buying beef products, and restrictions in the livestock import/export market aggravated the situation.There is little doubt that future volatility in livestock prices willcontinue, for a variety of reasons. In this chapter, four major futures are examined: live cattle, feeder cattle, lean hogs, and porkbellies.
■
Live Cattle FuturesCows have served as a major food source for centuries, not onlyfor beef but also for a range of dairy products. Industries based oncattle marketing are vast. The Chicago Mercantile Exchange(CME) began offering live cattle futures contracts in 1964, representing the first such contract on a living animal.Because livestock cannot be stored indefinitely, the turnaroundin the market is relatively short. This may add to the volatility inlive cattle futures, but supplies of meat also affect prices, and thatis going to vary based on numerous factors. For example, in someyears the herd number will be higher or lower than average, basedon perceptions of market demand, feed costs, and other factors.But herd expansion—the process of creating more livestock—takes five to seven years to be realized, based on breeding cyclesand the need to select out females for breeding rather than forslaughter. So during periods of herd expansion, long-term productincreases but short-term supplies fall. In periods of herd contraction, the opposite effect is seen. Short-term availability increases asmore livestock are slaughtered, although long-term availability isintentionally reduced. Herd contraction may take as much as fouryears to complete the cycle.So in the livestock market, the futures prices vary considerablynot only as a result of current supply and demand, but also basedon future capacity. The decision to expand or contract herd size isbased on a producer’s estimates of profitability, and that is alwaysa factor of costs, primarily the costs of feed. During periods whenfeed prices rise, profitability declines. This reality demonstrates thatmost commodities are intertwined and move as a consequence ofone another. The costs associated with energy, agriculture, andlivestock are the primary cause-and-effect futures for this reality.
194
Classifications of Futures
Ranchers in the beef industry make important decisions in theircow/calf operations. Cows breed in late summer, and birthing is aspring event. This beef industry is focused in a few states with potentially great temperature swings, especially in winter. So thestates between Texas and Montana are the primary base for thecycle of cow/calf production. Weather also affects the grazing patterns of beef and accounts for some seasonal movement of cattlefrom one locale to another.Calves are weaned from 6 to 10 months after birth, when theyreach a ‘‘feeder weight’’ between 600 and 800 pounds. They arethen classified as feeder cattle (more about this in the next section).Thus, it takes as long as 18 months between breeding and slaughter. During that time, producers have to consider feed costs, disease prevention, and other costs associated with developing theirmarket.Most U.S.-produced live cattle is consumed domestically.Trade restrictions affect exports, and in recent years, Japan andSouth Korea have curtailed imports of U.S. beef, based on fears ofmad cow disease. Before this disease was first diagnosed in a U.S.cow in 2003, $1.7 billion of exports to Asian countries per year wasa major activity. In 2006, a third case of mad cow disease continued the ban on beef in Asian markets.These factors make live cattle an uncertain futures contract.However, the popularity of beef and dairy cannot be denied, andlive cattle represent a strong and high-volume market, although futures prices are anything but certain. Figure 11-1 shows the April2008 contract for live cattle as of December 2007.
■
Feeder CattleFeeder cattle futures have been available on the CME since 1971.By definition, feeder cattle are calves weighing between 600 and800 pounds. Once calves attain weight in this range, they aremoved to feedlots for fattening and slaughter. The futures contractis priced based on the CME Feeder Cattle Index, representing theaverages of seven-day cash prices from the largest producingstates. These 12 states are Colorado, Iowa, Kansas, Missouri,
Livestock
195
FIGURE 11.1. LIVE CATTLE—APRIL CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
Montana, Nebraska, New Mexico, North Dakota, Oklahoma,South Dakota, Texas, and Wyoming. For information about howthe average is calculated, check the CME link at www.cme.com/files/calculationCMEFeederCattle.pdf.Feeder cattle prices vary based on the herd levels in prior years,which of course affects the number of calves in the current year.To fatten stock, grain is needed; so grain prices directly impactfeeder cattle and, as a result, meat prices in coming months.Figure 11-2 shows the April, 2008 contract as of December2007.Note the price decline over the period shown, as well as theRSI. This dipped below the threshold of 40 a few times and endedthe period slightly above. This indicator shows that the price decline is close to oversold levels.
196
Classifications of Futures
FIGURE 11.2. FEEDER CATTLE—APRIL CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
■
Lean Hogs and Pork BelliesThe futures contract for lean hogs (a more civilized name for hogcarcasses) has traded on the CME since 1997. Both producers andimport/export businesses use the contract, which was initiated toreplace live hog futures traded previously. Since the market tradesin lean hogs, it makes sense to trade in this form rather than infutures based on value of the live animals.The lean hogs contract is quite volatile. Because this contractis used more by producers than by speculators, it is less liquid thanmany other futures contracts. In addition, according to a surveyconducted by the University of Missouri, as of 2006 (http://agebb.missouri.edu/mkt/porkind06.ppt20), the number of small hogproducers in the United States has decreased, while the number oflarge-scale operations has increased dramatically. The study revealed a change since 1988, when hog farms with fewer than 1,000
197
Livestock
head represented 32% of the entire market share, and larger(50,000Ⳮ) farms were only 7% of the market. In 2006, those operations with less than 1,000 head fell to 1%, while the larger farmsrose to 43%:Herd Size (thousands)
% of Total Market
under 11–1011–5051–500Over 500Total
1%14212143100%
In addition to market share, the number of hog farms in thelarger volume portion of the market grew as well. From 1994 to2006, the study showed:Number of Farms
% of Slaughtered Hogs
Year
50–500
Over 500
50–500
Over 500
19941997200020032006
57127136149164
918202427
7%13172021
10%24353943
As smaller hog farms represent a shrinking portion of the market,prices also fell. In 1997, futures prices of lean hogs were $83.55per pound; in 1999, they had fallen to $20.70. By the end of 2007,prices had returned to a range between $60 and $70.The market resides mostly in five states: Iowa, Minnesota, Illinois, Indiana, and Ohio. Production also affects the market price.Average gestation for hogs is 114 days, and litter size is about 10piglets. It takes more than six months for hogs to reach a marketweight of 250 pounds. So with the breeding season starting in thespring, the highest volume of slaughter takes place in the fall.The lean hogs futures contract includes end market productsincluding ham, pork chops, and lunch meats. In comparison, porkbellies consist mainly of bacon, and futures contracts were first of-
198
Classifications of Futures
fered by the CME in 1961. This was the first futures contract forslaughtered livestock; other futures trading involved live animalsuntil that time. Both markets are robust in today’s market, as consumption levels have risen. Today, hog products contain about halfthe fat content of 50 years prior. Another factor affecting demandis the growing fast food industry, where high volume of sales includes many products such as bacon (hamburgers and breakfastmenus). The United States is the world’s largest exporter as well,with more exports going to Japan than any other nation. Anotherfactor helping pork markets is increased concern about mad cowdisease, negatively affecting beef demand.Figure 11-3 shows the lean hogs April 2008 contract as of December 2007.Note the steady price decline from September through December. The RSI level had fallen below 40 on numerous occasions, andFIGURE 11.3. LEAN HOGS—APRIL CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
Livestock
199
ended the period under that level. This indicates that the contractmay be oversold at that point.Figure 11-4 shows the pork bellies contract with a March 2008delivery date as of December 2007.The pork bellies contract was quite volatile in this five-monthperiod. Note that at the end of both price declines, RSI fell belowthe 40 level. Thus, the contract was oversold at both of these lowpoints. The November price growth confirms this indicator.The next chapter continues an examination of futures contractswith precious metals, including six important contracts: gold, silver, copper, aluminum, platinum, and palladium.
■
Notes1. USDA Economic Research Service, ‘‘Food Consumption: Household FoodExpenditures,’’ February 5, 2008.
FIGURE 11.4. PORK BELLIES—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
C H A P T E R
1 2
PRECIOUS METALS
M
■
etals serve many uses in many markets. Futures contracts respondto metals as a form of currency, for manufacturing, jewelry, medicine and dentistry, and many other important and essential applications. This chapter summarizes six important precious metals interms of market use and futures contracts. Beyond these, numerous other metals can be traded, bought and sold directly, or invested in through ETFs.Among ETFs, gold and silver draw the most interest. GoldETFs include streetTRACKS Gold Shares (GLD), iSharesCOMEX Gold Trust (IAU), Market Vectors Gold Miners (GDX),and PowerShares DB Gold (DGL). Silver ETFs include iSharesSilver Trust (SLV) and PowerShares DB Silver (DBS). Many otherETFs include portfolios mixing precious metals and including metals and other futures contracts.
GoldBefore the 1970s, the U.S. currency conformed to the gold standard, meaning the currency in circulation was limited by gold reserves. Before 1934, a troy ounce of gold was valued by the United200
Precious Metals
201
States at $20.67. In 1934, this was raised to $35 per ounce. OnMarch 17, 1968, a two-tiered pricing system was set, keeping theinternational settlement price at $35 per ounce but allowing themarket price to fluctuate. Although the United States did borrowadditional funds beyond reserves, its ability to accumulate debt wasinhibited by the gold standard. Today, the largest gold reserve ismaintained at the New York Federal Reserve Bank, which has approximately 3% of all the gold ever mined. Another large deposit isheld at Fort Knox, Kentucky.Today, the gold standard is not used as the basic internationalexchange, and although the U.S. dollar is widely used as the international currency of choice, the vulnerability of currency values hasbecome a matter of concern in the futures market and elsewhere.Today, gold serves not as a standard for valuation, but often as analternative to currency. When speculators are worried about thesafety of currency, they often move investment dollars into gold,through direct ownership of bullion, shares of gold mining companies, ETFs, or gold futures.Many countries use gold for coinage, and minting creates potential investment value as the price-per-ounce of gold rises overtime. Most coins have been minted in 22k weight, also called crowngold, since pure gold of 24k is too soft for this application. Amongthe popular gold coins in circulation today are the Canadian GoldMaple Leaf, the Australian Gold Kangaroo, and the American Buffalo. However, gold coins hold more interest among coin collectorsand gold speculators than for use as currency. Coins such as theAmerican Gold Eagle and British Gold Sovereign have strong market interest among coin enthusiasts.In addition to its importance as an alternate form of currency,gold is used in a broad range of applications, notably dentistry andelectronics. Gold’s features include a high resistance to corrosion,so it is the preferred metal for such applications. Gold also formseasily with other metals to form alloys. This enables manufacturingand industrial applications to expand the use of gold in their products and processes.In electronic applications, gold is an excellent heat and electricity conductor and, because it is resistant to corrosive effects of heat,moisture, and oxygen, gold is by far the preferred metal in jewelry.
202
Classifications of Futures
Jewelry manufactured with gold is alloyed with many other metals,usually silver, copper, iron, aluminum, palladium, and nickel. Goldsolder is used in jewelry manufacturing.Interest in gold on many levels has persisted for centuries. Goldhas been considered a healthy alternative medicine in many cultures and has been believed to have healing powers. Today, goldhas been shown to have anti-inflammatory properties and gold saltsare often included in medicines to treat arthritis. Gold leaf and golddust are also used in some gourmet foods as decorative features.This is derived from the belief in gold’s healing power as well as thedesire among wealthy hosts to show off their ability to use gold inthis manner. An herbal liqueur found in Germany is called Goldwasser (Goldwater), and contains gold flakes. The flakes add nonutritional value to the water, but the drink is a popular statussymbol.Dentistry relies on gold for construction of crowns, bridges,and fillings. The gold alloy used for these applications is malleablebut produces better results than the porcelain crowns of the past.Gold production is concentrated in a few areas of the globe.About one-half of all gold in the decades between 1970 and 2007was mined in South Africa. In 2007, China became the world’sleading gold producer. Other major gold finds have occurred in theUnited States, Australia, Russia, and Peru. About two-thirds of allgold used within the United States comes from mines in SouthDakota and Nevada. Additional large reserves of gold exist in theworld’s oceans, but it is not economically possible to extract it. Onaverage, extraction costs $238 per troy ounce.Gold prices are set on the gold fixing standard, based in London since 1919. The London Bullion Market Association (www.lbma.org.uk) sets the gold fixing; it publishes fixing for gold andsilver as well as U.S. and U.K. forward valuation. According to theLBMA, ‘‘The fixings are an open process at which market participants can transact business on the basis of a single quoted price.Orders can be changed throughout the proceedings as the price ismoved higher and lower until such time as buyers’ and sellers’ orders are satisfied and the price is said to be ‘fixed.’’’1Prices vary based not only on supply and demand, but on perceptions of political unrest and threats to currency values. So gold
Precious Metals
203
and its value on the futures market reacts to a multitude of marketfactors and perceptions, not the least of which is the level of actualand known gold reserves. In 2005, the World Gold Council (www.gold.org) estimated total worldwide gold supply at 3,557 tonnesand total demand at 3,386 tonnes. Of the demand level, 81% isused to manufacture jewelry.The United States holds more than twice the reserves of anyother country (8,135 troy ounces as of 2006), followed by Germany (3,427 ounces), and the International Monetary Fund (3,217ounces). Besides popular use in jewelry, physical ownership of goldis a popular idea. Investors and speculators hold gold in the formof coinage, gold bars (from 1 gram up to 400 troy ounces), andgold certificates, held in place of the actual gold, which is held forinvestors by the company or country issuing the certificates. ThePerth Mint (www.perthmint.com.au) is the most authoritativesource for finding approved dealers and issuers of gold certificates.Price levels of gold are reflected in