Thursday, February 20, 2014

Commodities Short Squeezes

The commodities space has been the hot sector, with gold rallying big from the beginning of the year, crude oil also very strong lately, and of course monster short squeezes in natural gas and coffee.

Instead of natural gas, I actually believe coffee is the best short out there in the commodity space.  Natural gas inventories by end of March are going to be lowest since 2003, so it will prevent any sharp drops after winter is over.

For coffee, world acreage has increased every year, inventories are not tight.  The super spike in coffee in 2011 encouraged farmers to plant coffee trees anywhere they had empty space over the last 3 years.  The drought in Brazil will reduce yields, but the sheer amount of acreage devoted to coffee is being forgotten.  These prices are an overshoot, as coffee is a fairly thin market, and speculators can drive moves in the short term above and beyond fundamentals.

It is one giant short squeeze, with commercials and counter trend traders getting margin calls from their short NG, CL, and KC positions. While hedge funds and CTAs pile on the long side.  This week feels like the apex of the move, with traders suddenly falling in love with commodities again, but the fundamentals just don't back the moves.


Anonymous said...

Hi MO, short natural gas trade seems to be an easy trade because in longer time frame, temperature will normalize sooner or later. But at the same time, daily weather is almost unpredictable; short squeeze is highly likely.

Any suggestion how to size the position for this trade?


Market Owl said...

I would wait to short natural gas. If we can get a good short squeeze on the March expiration of NG futures, that could be the optimal short entry point for April NG. But I prefer to short coffee to natural gas. Nat gas has tight inventories, and the market won't be able to drop much until after summer.

Market Owl said...

If you look at a historical price chart of coffee, a similar situation came up in late 1999. Coffee was in a strong downtrend, after peaking out in mid 1997, weather issues resulted in a big spike. Similar to that, Coffee peaked in the spring of 2011, and now we have spiked off a very strong downtrend, based on weather issues. The spike didn't last, and we continued down for several months.