Monday 14 January 2013

A Technical Interlude

What’s better than starting the week sipping a nice cup of espresso, carefully sweetened by the addition of some sugar [Ed. Note: we actually like our coffee as it is and think that sugaring it should be made an offence punishable by death.]? Starting the week buying some coffee and sugar futures, that’s what!
With this post, we will provide a brief technical summary of these two markets, which in our opinion may be ripe for a buy. We won’t address their fundamental backdrop: suffice it to say that from a mid-to-long-term perspective we’re very bullish on sugar whilst we have mixed feelings on coffee. As a matter of fact, we’re convinced that sugar has not yet made its bull market high (i.e. we expect it to go higher than the 35c$/lb level reached at the beginning of 2011). Coffee on the other hand may have already had its blow-off top in May of 2011. Moreover the technical position of the former appears to us stronger than that of the latter. Finally, secular bear markets in equities tend to coincide with secular bull markets in the whole commodities complex (as opposed to specific, strictly supply/demand-driven cyclical bulls in single markets or sectors, which can happen at any time). You can peruse our post on stocks to better understand our perspective on this last topic.

Sugar

SugarChart A daily chart of the sugar price, constructed using Stockcharts.

As we can see in the chart above, sugar has been constrained in a “falling wedge” pattern since its early 2011 top. This pattern tends to be resolved to the upside (i.e. it’s a bullish pattern). It’s important to consider that this current pattern represents a meaningful long-term development, given that sugar has been stuck in a rather brutal (-50% peak-to-current-trough) and persistent (two years and running) bear market. This fact also increases the likelihood that a significant bottom is either behind us (we are inclined to think that the 13/12/2012 wash-out low around 18.30c$ indeed marked such turning point) or just in front of us: as already stated, this is for us of utmost concern, as we always strive to enter positions at a time when we think that the actual risk is significantly smaller (and way less likely to manifest itself) than the potential return.
Zooming in on recent action, we can notice that significant momentum divergences started to emerge approximately six months ago and continued to increase during recent declines, reinforcing our view that there simply isn’t any meaningful selling pressure left in the market. Both the CFTC Commitments of Traders data and Sentimentrader’s sentiment survey seem to confirm this assumption. Except for a couple of short-lived spikes, the latter has been oscillating in the 25% to 50% zone for more than a year: this means that for a protracted period of time very few participants have been bullish on this market and the few that have have also been quick to become bearish at the first signs of trouble. Anecdotal evidence (i.e. news headlines) confirms an entrenched bearish mindset. The former (chart below) have registered a consistently low level of speculative longs (and a consequently low level of commercials’ shorts) since the end of this summer, recently reaching rather extreme readings (with small speculators’ shorts at record levels and large speculators’ and commercials’ positioning at opposite multi-year extremes). It’s worth noting that previous instances where market participants were similarly positioned gave rise at least to powerful rallies (see May 2012 as a case in point, although that period’s readings pale in comparison to the current ones). It is precisely this kind of prolonged despondency that generates new, powerful bull markets.

SugarCoT 2012 Commitments of Traders data via http://www.cotpricecharts.com.

Finally, we can notice how price has been recently capped in its advances by the 50-day simple moving average, which also provided important support or resistance in the past. Although we’re already long sugar and are holding it as a long-term investment in our portfolio, the more technically inclined amongst our readers might want to wait for a convincing breakthrough above that level before committing to the long side. The previously mentioned low might act as a reasonable stop-loss level. A break-out above the important 20c$ level might also prove to be a good entry or adding point. However this is not really our cup of tea: we employ a different approach to risk management and to investing in general, but to each his own.

Coffee

As we already mentioned, we have a few reservations about coffee, but they’re mainly confined to the realm of the long-term. From a short-to-medium-term technical perspective this market seems to us to offer an excellent trading opportunity.

CoffeeChart A daily chart of coffee constructed using Stockcharts.

As can be clearly noticed, many of the considerations made for sugar apply to coffee as well: a long-term falling wedge pattern (not as nice as the previous one though) accompanied by meaningful divergences in momentum. Sentiment and positioning also paint a bullish picture: the survey on coffee has recently registered a depressed reading of 15% bulls (currently 26%), after having been stuck in the below-50% zone since late 2011 (with this summer’s rally constituting the only exception). Positioning is also at extremes, with commercials holding a record amount of longs and large speculators providing the mirror image with a record amount of shorts. Small speculators are in a no-man’s land, meaning they aren’t overly exposed to either side of the market. More details can be found in the chart below:

CoffeeCoT2012 CoT data for coffee via  http://www.cotpricecharts.com.

Again, it’s worth noting that a prolonged period of extreme readings usually produces a much more powerful and lasting trend than an episodic spike.
There is however something very important that differentiates coffee from sugar: the former has already broken above and rallied from its 50-day simple moving average and did so on a Friday (last one, to be precise) and with very convincing volume. Both of these are meaningful details: a powerful Friday break-out with a convincing close at the highs positively shapes the weekly chart and signals a strong commitment on the part of position traders (those willing to take their bets home with them for the weekend). It also signifies that all contracts that were sold during the week were actually sold at a lower price: this is bound to put significant pressure on many short-sellers and usually ensures at least a temporary follow through. And now enter volume: Friday’s volume on the March13 contract (the one currently traded) was the highest since rollover day (i.e. since the beginning of active trading). More importantly, it was higher than any previous down-day volume registered during the life of the contract (including both active and non-active periods). This not only shows the sheer buying pressure, but coupled with the surge from the 50-day SMA, over-qualifies Friday as a “pocket pivot buy point”. This is a concept developed by Chris Kacher and Gil Morales in their let’s-not-brag-about-our-successes book entitled “Trade like an O’Neil disciple (How we made 18,000% in the stock market)”: in the context of basing/bottoming patterns sudden, unexpected surges from or above important resistance levels or moving averages, accompanied by volume that is greater than the highest volume registered during the 10 previous down-days, often signal important changes in a market’s character and anticipate successful break-outs from the aforementioned patterns [Ed. Note: although we have more than a few reservations about the Authors and their work, editorial and not, and our investing style is as far removed from theirs as possible, we found this specific concept to offer value and we do have included it in our arsenal to our satisfaction.].
All of the above combines in making us think that coffee is a good buy at current levels, at least for the short-to-medium term. Technical traders might effectively manage their risk by placing their stop-losses either below Friday’s low/the 50-day SMA or somewhere around the recent 149/143c$ congestion area (the recent low at about 141.20c$ appears to distant to us).

Conclusion

We’re bullish on both sugar and coffee, although we do favor the former, at least from a long-term perspective. We’re walking the talk by actually being long both markets, but we want to stress that for us these represent rather small positions opened with the main purpose of diversifying our portfolio and keeping it well balanced. They offer good potential, but they also offer risks and more importantly plenty of volatility, hence they are not good candidates for a large exposure. Again, we recommend readers to embark on their own research and to always fully “own” their trading decisions: the best way to escape from losses is not to escape from responsibility.

No comments:

Post a Comment