How to Make Money in Commodities
131
COMMENTARY: 1977 through 1980
When we last looked at corn, back in 1975, distant futures
prices had fallen back to a range between $2.50 and $2.80. In 1976, futures
prices
edged sideways, then abruptly hit a high near $3.20 before
descending even further than the lows of 1975. In 1977, corn once more
traded in a close
range as the year began. This time, however, things were different.
1973 and 1974 had been years of successive record?high prices, and correspondingly
sharp collapses. In 1975, the high was again a sharp peak,
but it failed
to reach anywhere near the high set in 1974. In 1976, once
again the year's high, though distinguished, fell short of the high for
the previous year.
And the years' lows were getting successively lower. In 1977,
the bottom dropped out of the corn futures markets. It was the final downtrend
correction
to the great highs of '73 and '74. The reasons for the obvious
chart cycles could be found in supply and demand. World corn production
had actually
declined in 1972 and 1974, while demand, spurred by growth
in population and in livestock requiring feed, increased. After dipping
in 1974, U.S.
corn production rose steadily, encouraged by the high prices
and strong markets. World production also rose. Inevitably, these successive
record
harvests chipped away at corn prices, year after year, until
the abundance brought prices in August of 1977 to a four-year low. Profits
per contract
on a short sale were $5,400.
The speculator who was exhausted by all this action in the grain markets
might have turned to the cocoa futures contract for an easy ride. Like
sugar and coffee, cocoa is a world commodity subject to extreme price fluctuations
in
132
response to a very erratic supply and demand
equation. In 1976-77 world cocoa bean production hit a nine-year
low. Harvests in 1975?76 had trailed the record crop of the
year before. The result: cocoa futures in 1977 hit a price
7 times higher than the average price in 1970. At a profit
of $300 for every 1 cent move in the price of cocoa, figure
for yourself when you could have gotten into the market, and
what your profits would have been. You could conceivably have
retired on this trade alone.
(How? Let's say you bought two contracts when
prices broke the old ceiling at 60¢, with a margin deposit
of $1000 per contract. You continue to scale?in your purchases,
buying two
contracts each time that prices rise another 4¢, financing
the trades with profits on the earlier contracts. Stop-loss
is trailed 200 behind. After buying 72 contracts, you would
have been stopped out at the reversal to $1.80. All 60 contracts
bought at prices below $1.80 bring profits, while the ten purchased
above $1.80 cause no gain or loss. Total profits on your $2000
investment: $1,083,600 or 54,180 percent.)
1978 was a banner year for method traders
following the markets in livestock futures. Live cattle prices
had hit their last
big highs in 1975. Afterward each subsequent year's high was
successively lower, dragging down monthly average prices. The
lows for the year, however, stabilized in 1977, and prices
levelled out into the channel we see forming in mid-1977. This
was the time to keep charts up-dated daily and watch for signs
of recovery in cattle prices. The breakout up began in November
of 1977, and carried the price of the August Live Cattle futures
contract to a level of 61 cents a pound by May of 1978. Profit
per contract: $8,000.
133
click to enlarge
134
Even more impressive in 1978
was the action in pork bellies. A virtually parallel recovery
to that in cattle futures almost doubled the price of the July
1978 Pork Belly contract. Here, too, prices had hit their record
highs in 1975 by going over the $1.00 a pound mark. Once again,
highs and lows for 1976 and 1977 showed pork belly prices retracing
the big gain of 1975. But the low in 1977 resisted falling
below the 45 cent a pound level, and pork belly traders kept
their charts handy and looked for a strengthening, or collapse,
in prices. The sideways channel in July 1978 Bellies formed
in mid-1977 and lasted almost six months. The method trader
waited patiently. Once prices made their break, the ascent
was steep. In just three months, prices went from 50 cents
a pound to 85 cents. On one (old size) contract of 36,000 pounds,
profit was a very smart $12,600.
click to enlarge
135
As the trader builds a file of charts over
the years, many possible patterns in price movements become
apparent. You have seen in the last few illustrations the phenomenon
of three or four year price cycles, when prices rise successively
for a number of years and then fall just as successively in
reaction. This is by no means a rigid law or an always dependable
pattern. It can be consulted, however, while you graph the
formation of sideways channels and think about the direction
of their next breakout. But don't jump ahead of the market
based on an interpretation of long?range cycle patterns. As
always, wait until a real move in prices confirms (or refutes)
your analysis.
In previous examples you have seen how, sometimes, a group
of related commodities can rise or fall together. When such
a group move does occur, the method trader stands to make enormous
profits. The same chart analysis for one commodity will work
for the others, multiplying your profits without any appreciable
increase in risk or effort. If each and every one of the contracts
considered qualifies, through an inspection of price history
and price charts, for the method of trading we have proposed,
then you can go ahead and play them all. When the group price
move is over, one or two of the contracts may be seen to have
moved farther and faster. No one could have predicted this
ahead of time. By playing them all, the trader may be reasonably
assured of catching the best possible actions One golden opportunity
of this kind came in the lucrative grain and soybean futures
markets of 1979.
There are real world factors that tie together the prices
of corn, wheat, oats, soybeans, soybean meal and soybean oil.
If one commodity can be fairly easily substituted for another
by users, then the prices of those commodities will be linked.
The supply and demand for one will affect the supply and demand
for the others. This is especially true in the so-called
136
"feed-grain complex," for farmers
will switch the grain they buy for livestock feed if the price
of one alternative
falls or rises sharply. (Thus a simple view, for there are
differences among them, as in their protein content, but the
general principle holds true.) Corn is the dominant feed grain,
but if wheat is very cheap, it too becomes a feasible and attractive
substitute. Soybean meal, which with soybean oil is obtained
as a by-product of crushing whole soybeans, is a very high-protein
component now used extensively to enrich the quality of the
feed. If demand for feed is up, chances are that demand for
meal will be up, and so will prices across the board in the
soybean and feed grain groups. Heavy stockpiles of supply in
one or more of these commodities may depress prices for all.
Likewise heavy world demand for, say, wheat will put pressure
on other competitive grains, and on soybeans as well.
With this
sketch of interconnections in mind, take a look at the charts
for the grain and soybean futures markets of
1979. Astonishing!! In contract after contract, from wheat
to oats to soybean oil, an almost identical pattern (our favorite
one!) shows up. What happened? A combination of forces in grain
and bean supply and demand, plus a supportive set of long-term
price cycles, came together momentarily to offer wide-awake
traders a bonanza. Wheat had retraced its 1973 record high
each year, until prices hit bottom in 1977. The big run?up
had been partly fueled by massive Soviet purchases. World production
and Russian crops increased thereafter, lowering prices. In
1978, the turnaround began. Harvest projections for the USSR
began to hint at weaknesses, while a rising world standard
of living continued to expand demand for the feedgrains. The
Soviet decision to increase meat production ran headlong into
an inefficient farm system plagued by bad weather. The record
crops of 1977-1978 which
137
click to enlarge
138
had pushed prices so low helped keep them
relatively stable through 1978 and early into 1979.
1978-1979, however, showed a falling back
from the record harvests of the season before. Rumors began
to circulate about
a possibly disastrous decline in the upcoming Soviet wheat
crop. Thoughts went back to the spectacular bull markets of
1972-1973. On June 8, 1979, the U.S. Agriculture Department
released a report officially estimating a sharp reduction in
the potential 1979 Soviet grain harvest. If it held up, that
estimate would mean another round of large purchases of American
wheat and grains by the Soviets, and higher prices across the
board for these related commodities.
The race
was on. Prices on the news shot up fantastically in just a
few weeks' time, shattering one long-established
sideways channel after another. Farmers held crops back from
the market as they hoped for even higher prices, thus turning
the bull market into a self-fulfilling prophecy. Volume and
open interest on the futures exchanges increased dramatically
as traders flocked to join the profitable bulls, or make their
fortunes as bears when the prices settled back again. But the
upward move in wheat prices was dampened by another USDA report,
this one showing U.S. wheat supplies in 1979 at 2.1 billion
bushels, 17 percent above the 1.8 billion bushels of 1978.
In the following months prices bounced up and down in a wide
range as both export forecasts and crop predictions fluctuated
considerably. Then came the embargo on all grain sales to the
Soviet Union in early 1980, and this particular episode in
the grain markets came to an end.
How could you have made a killing on these ups and downs in
the grains and soybean complex? Following our method, charts
for corn and wheat would have shown a narrow trading range
developing around August, 1978 and continuing 1979. This would
have signalled you to watch the
139
charts
for the other related commodities, checking both nearby and
distant contracts in each of the commodities for the one exhibiting
the most profitable price
pattern. Between August of 1978 and March of 1979, easily recognizable
sideways channels were formed in some contract month for corn,
oats, soybeans, soybean meal and soybean oil. In the case of
wheat, you could also trade
contracts with narrow trading channels at the Minneapolis and
Kansas City exchanges, as well as at Chicago. This would make
a total of 8 different
futures contract markets, all traded simultaneously through
a single principle and uniform mode of analysis. Smith could
simply have drawn in the narrow
trading channels, set stop-orders to buy above the trading
ranges, planned the stop-loss orders to trail, and then sat
patiently back to wait for
the move.
In corn, oats, and
the soybean complex, a first move started in February. This
small upward jump resulted in the
formation of another general sideways trading channel. Wheat
set off the second, big move in
April, taking the others with it at a time lag of about a
month. You were now in the game for real. Let us be conservative,
and say that you traded
only one contract in each commodity, and only one contract
month of that commodity, for a total of 8 contracts. You
would have bought corn and oil
in January, wheat in April, oats in May, and soybeans and
soybean meal in June. As long as the charts were accurate and
the stop-orders and stop-loss
orders set, you didn't have to worry about which commodity
was really behind the big move, or which would go the farthest.
You had them all covered.
How would the results have looked?
140
MAXIMUM PROFITS: GRAINS AND SOYBEAN COMPLEX,
1979
|
 |
Commodity |
Bought |
Sold |
Profit
Per
Contract
|
Margin |
Wheat
(Chicago)
Dec. '79
|
|
|
|
|
Wheat (K.C.)
Sept. '79
|
|
|
|
|
Wheat (MPLS)
Sept. '79
|
|
|
|
|
Soybeans
Jan. '80
|
|
|
|
|
Soy. Meal
Dec. '79
|
|
|
|
|
Soy. Oil
Dec. '79 |
|
|
|
|
Corn Dec. '79 |
|
|
|
|
Oats Sept. '79 |
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
RETURN
ON INVESTMENT: 510%
|
|
|
Even if one were to subtract a full twenty percent from this
maximum profit as an allowance for commissions, poor executions,
and exits from the market after the reversal was underway,
total profits would still be $31,470 or 408 percent of the
initial margin requirement. What other investment medium that
is both rational and legal offers you a 400 percent return
on your investment in less than five months time?
1980 began as the most spectacular year in commodity futures
trading since the grain markets of 1972-1973 first brought
international fame to the speculative trade. The history books
had to be re-written once more as the prices of the "precious
metals" -- gold, silver, platinum, even copper
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