Options Arena: Can Commodities Make a Comeback?
Commodities evidently didn’t get the memo this year.While nearly every other sector tanked, commodity indexes showed strong returns in the first half of 2022. The Bloomberg Commodity Index (BCOM) gained 33% from January to June. But in the last month, commodities finally showed up to the bear market party. They’ve fallen hard, with BCOM down 18% from its high in June. It doesn’t take a genius to connect the dots. The Federal Reserve raises interest rates by 0.75%, investors start to price in a recession, and there goes commodities’ time in the sun. But let’s not get ahead of ourselves… Can we write off commodities as another bear market casualty just yet? After all, the war in Ukraine is still raging on. Oil prices remain sky-high. And continued concerns over supply could spur a longer-term bull market for the sector. This might be a temporary setback… In which case, get ready to go bargain hunting! Now, who better to sort this out than our very own True Options Masters? Let’s get their takes on what’s next for the sector — and which tickers are a buy right now…
Mike: Watch for the Coming Food Shortage Wars
I think rice is one of the most interesting markets in the world right now. Like other commodities, it soared. But it didn’t crash. Rice has held on to its gains.
The latest USDA crop report shows the gains are based on fundamentals. Production is expected to set a new record at 515.35 million tons. But global consumption is also expected to set a record at 519.2 million tons.
The laws of supply and demand say when demand exceeds supply, prices rise. That’s what’s happening here.
This is a market you may not watch, but it’s important to global stability. If rice prices are high, that could increase migration from rural communities to cities in developing countries. Families will often send a child to the city to earn higher wages, which can be sent back home to feed those left in the village. Governments know this, so they also know they need to create jobs in the cities.In Decision Points, George W. Bush wrote about this: “I told [Hu Jintao] I stayed awake worrying about another terrorist attack on America. He quickly replied that his biggest concern was creating 25 million new jobs a year. I found his answer fascinating… It showed he worried about the impact of disaffected, unemployed masses.” High rice prices could trigger the crisis in other countries that China has worked so hard to avoid. The trade, if it comes, will follow the advice of banker Nathan Rothschild from the Napoleonic wars: “buy on the sound of cannons, sell on the sound of trumpets.” It’s grim advice, but watch for the coming food shortage wars and be ready to invest where opportunities arise.
Amber: This Industry Had to Get Creative. Now, It’s Paying Off
Lumber is near support and attractive right now.
I grew up in an area with old-growth forests, loggers, and saw mills. Today, I have a few contacts in the industry who I’ve reached out to.I learned that mills adapted to the crash in 2019 and early 2020 by creating additional business opportunities. One sawmill owner opened up a pallet manufacturing plant, then merged the business with another that could provide transportation and recycling services. Others build specialized pallets or repair them. Bark, sawdust, and scrap wood goes to mulch or gets ground up in a horizontal grinder to produce boiler fuel. This has all led to stable stumpage prices. See, landowners are the first link in the supply chain. They sell their trees for harvest in local markets. Trees are then contracted by a timber buyer, harvested, and taken to a mill or manufacturer for wood product production. The finished products are shipped to markets. Since landowners have been able to withstand weakness in the market, they don’t immediately need to start cutting prices. This has established support.
Volatility comes into play after the mills, where long-haul transportation costs affect prices. If you aren’t in the land market, look at iShares Global Timber & Forestry ETF (WOOD). This ETF has an 84% correlation to raw lumber prices and is a great way to trade the market. Feb 2023 $74 calls are attractive at the current price.
Chris: Buy the Dip in Dairy
Inflation clocked in over 9% this week.selling puts alone can be dangerous. If I want less risk, I can simultaneously purchase a put that is out of the money at a lower strike price. This is known as a “put credit spread.” In exchange for the lower risk, I will have slightly lower income as well. But I’ll take that tradeoff any day, for the safety spreads offer.Buy the dip in commodities. Commodities are very likely entering a new supercycle, fueled by historically low prices relative to stocks, as well as inflation which increases the price of … well, commodities. So commodities are experiencing a heavy tailwind right now. But that doesn’t mean you should start buying them left and right… Inflation rises when goods are scarce, so it’s best to buy the dips in commodities with the most utility. Gold and silver don’t really fit the bill. Copper is also seeing its sharpest downturn in a decade due to slowing economic growth, and hence demand. Instead, you want to buy commodities that are still in an uptrend. Wheat is one candidate. While prices have dipped, its uptrend is still intact… But talks of a grain deal between Ukraine and Russia (two major global providers) could send prices lower in the short term. We’re on the right track, though. No matter what happens to the economy, people still need to eat. So, after a bit of digging, I’ve settled on a trade idea… Dairy. The UN’s Food and Agriculture Organization’s (FAO) World Food Situation report shows dairy prices are still going up, while vegetable oils and cereals have reversed. Now, I don’t care to trade in dairy futures, and there’s no dairy-based ETF available, either. But there are individual companies. Perhaps the purest play lies in Mondelez (MDLZ), which owns brands such as Cadbury, Nabisco, and Oreo. Since I expect Mondelez to either rise or not drop much, I can sell a put with a lower strike price than the stock’s current price to collect income. However, as Amber taught us this week,
As always, a wide “spread” of ideas from our options masters!You have rice, lumber, and dairy to choose from — but if you’re on a shopping spree, couldn’t hurt to arm your portfolio with all three…
And if you’re sitting on a commodity trade of your own, don’t be shy! Shoot us an email at TrueOptions@BanyanHill.com. We love hearing your ideas.
Until tomorrow,Mike Merson Managing Editor, True Options Masters