How to Make Money in Commodities

21

click to enlarge

A chart provides a way to see clearly the trends and patterns of commodity futures price changes.

22

click to enlarge

23

click to enlarge

24

Each horizontal line on the December Live Hog contract chart represents a one-half cent per pound change in price. Extra-dark lines showing major price levels are here separated by 2 cent increments. For the February Hog contract, however, each horizontal line represents a full one cent per pound change in price, and every extra-dark line shows an increment of 5 cents per pound. The difference in the look of the charts follows accordingly, as the December chart is constructed by smaller increments and thus shows more sensitivity to price changes. At a quick glance, you might think that the price of the December contract was far more volatile than the price of the February contract. In fact, the two charts show nearly identical price moves. For example, the big price decline from February to August hits 10 extra-dark price lines on the chart for December Hogs. The decline on the chart for February Hogs (deliverable the following February) goes through only 4 extra-dark lines. Yet both contracts actually registered a similar price decline, about 17?20 cents. With every 1 cent per pound move in the price of a 30,000 pound hogs contract meaning $300 lost or won, the stakes are just as high for the February contract as for the December contract, no matter how the charts may look at first.

      The best way to track the significance of price moves, and to plan exactly how to trade them, thus requires a ready knowledge of how much money is being won or lost with every "tick" or fluctuation of the commodity's price. Every time the price of wheat goes up 1 cent per bushel, for instance, simple mathematics tells us that the value of the standard 5,000 bushel contract goes up $50. Every time the price of live cattle goes down 1 cent per pound, the value of the standard 40,000 pound contract goes down $400. Similar computations can be done for each commodity traded, and the results put down in a table you should keep at hand whenever planning your trade.

25

FUTURES TRADING FACTS*
COMMODITY	CONTRACT SIZE	VALUE OF MOVE
British Pound	25,000 BP	$.05 = $1,250
Canadian Dollar	$100,000 CD	$.01 = $1,000
Cattle (Feeder)	42,000 Lbs	1¢ = $420
Cattle (Live)	40,000 Lbs	1¢ = $400
Cocoa	10 metric tons	$1 = $10
Coffee	37,500 Lbs	1¢ = $375
Copper	25,000 Lbs	1¢ = $250
Corn	5,000 bushels	1¢ = $50
Cotton	50,000 Lbs	1¢ = $500
Deutsche Mark	125,000 DM	1¢ = $1,250
Ginnie Mae Mtges.	$100,000 @ 8%	1% = $1,000
Gold	100 troy oz.	$1 = $100
Hogs (Live)	30,000 Lbs	1¢ = $300
Japanese Yen	12.5 Mil. JY	$.001 = $1,250
Lumber	130,000 bd. ft.	$1 = $130
Oats	5,000 bushels	1¢ = $50
Orange Juice	15,000 Lbs	1¢ = $150
Platinum	50 troy oz.	$1 = $50
Plywood	76,032 sq. ft.	$1 = $76.03
Pork Bellies	38,000 Lbs	1¢ = $380
Potatoes (NY)	50,000 Lbs	1¢ = $500
Potatoes (Chi)	80,000 Lbs	1¢ = $800
Silver	5,000 troy oz.	10? = $500
Soybeans	5,000 bushels	1¢ = $50
Soybean Meal	100 tons	$1 = $100
Soybean Oil	60,000 Lbs	1¢ = $600
Sugar	112,000 Lbs	1¢ = $1,120
T-Bills	$1 million	.1 = $250
T-Bonds	$100,000	1% = $1000
Wheat	5,000 bushels	1¢ = $50
* Note: Contract specifications do change. Check with your broker for current details.

26

Equipped with a knowledge of how to construct a graph, and familiar with the facts needed to interpret the chart's meaning, the speculator can read the price action of any commodity. The visual display of the chart reveals the fluctuations, sometimes mild and sometimes extreme, of commodity prices as they respond to changes in supply and demand. No one needs to be a university scholar to know that with abundance comes low prices, and with scarcity comes high prices. How does a period of abundant supply appear on a commodity futures price graph?

click to enlarge

27

      Sugar, as every grocery shopper knows, has been a volatile commodity during the last decade. It is a "world" crop, subject to the uncertainties of weather and production in numerous producing nations around the globe. The October Sugar chart presents a close up view of sugar futures prices during a period of relative calm. The price line appears to have many sharp ups and downs, but these are partly explained by the sensitivity of the chart, which shows major increments at every one?half cent level. The price of sugar futures fluctuated in a range of only 2 cents during these ten months. Certainly there were some profit opportunities, but none were very large or very sustained. Ample supplies dampened the volatility of sugar prices. Not for long, however.

      Examine now the chart for May Sugar:

28

click to enlarge

29

The left hand side represents the same action portrayed in the previous sugar chart. The price line has been considerably smoothed out by the use of 2 cent incremental units rather than one-half cent levels. This better represents the quiet nature of the sugar market during the first half of the year, and makes it possible to chart the dramatic price rise that occurred in the following months. Sugar prices took off, more than doubling in six months' time. The former estimates of sugar supplies and coming harvests had been tossed aside as new information suggested a world-wide shortage. The reports from Cuba were of an almost total failure of the year's sugar crops. So the futures markets in sugar took off with news of scarcity. Unless a corrective crash intervened, the message was for eventually higher prices at the grocery store.

      Cereals, ice cream, candy, processed foods of every kind, soda pop, lemonade, dozens of our supermarket staples contain sugar. The price of each and every one must rise with the rise in sugar prices, and more dollars be taken out of the pockets of unprotected consumers. The same laws of abundance, scarcity, and ripple-effect price rises holds for all the other commodities, even money itself. When the U.S. Federal Reserve Board decides to "tighten credit," it reduces the supply of dollars available to the nation's businesses and consumers. The scarcity of money means that the price of money -- interest rates -- goes up. The "interest rate" futures markets came into being as a way to reduce the risks of such fluctuations in the price of money, and they operate according to the same basic principles as the markets in wheat, soybeans, or cattle.

      Look back now at the chart for May Sugar. It also illustrates how investors who chose to use the futures markets could profit from rising prices, making very large sums on a modest amount of risk capital. One single futures

30

contract in sugar contains 112,000 pounds. If you buy one May Sugar futures contract, you are buying the right to 112,000 pounds of sugar, delivered in May at the price you now pay. A speculator in the May Sugar futures contract could have bought at a price of 12 cents per pound in October. (As we shall soon learn, the choice of this particular time and price was a result of method, not accident.) The margin requirement for one sugar contract was then $2,000. A mere $2,000 controlled the right to profit (or be ruined) by the change in value of 112,000 pounds of sugar.

      What happened? The chart tells the happy story. May Sugar hit a high of 24.5 cents, then dropped back to 22 cents. Let us say that our trader figures that, at this point, sugar has crested and it's time to take the money and run. The profit per pound is 10 cents. Our "Trading Facts" let us quickly calculate the total profit on a single contract at $11,200. This translates into a return of over 500 percent on invested capital in only four months. A detailed breakdown would look like this:

[ previous | next]

Order a printed, softcover, copy of this book.