HAVE WE REACHED A LEVEL OF VALUE?
As I contemplated this article I considered the question; is it time to buy value? When I speak of buying value I am looking to see if there are any commodities so totally undervalued in price (cheap) as to be attractive due to the price alone. Example: If corn would be trading at $1.60 a bushel, the entire risk of a corn futures contract would be $8,000 dollars if corn went to zero, and frankly it isn’t going to zero. So is it a good value, a good buy? I believe Buying Value to be a valid long term trading strategy that frankly can last for several years. Therefore to appreciate the concepts of buying value understand that it is not a quick in and out trade. When you are buying value you are building a position and it is imperative to know the underlying historic lows as a measure of potential risk.
Understand that when buying value, one is not predicting the bottom of the market being traded but is of the belief that in time the market will rally above that level due to increased demand created by the lower price, or a reduction in production. The reality is that when one buys value they will probably enter the market earlier then the actual bottom exposing one to the risk of that further price decline. In order to increase the chances of success when buying value it is my opinion that one needs to significantly over margin their account so they can withstand the likelihood of the further price decline. When buying value minimum margining is the devils tool (as I discussed in my first booklet “Lessons Learned”)! So let us examine some popular and volatile commodities and see if we might be approaching value.
Soybeans: During the week of July 1, 1999 beans made a low of $4.02 then rallied into the week of April 1, 2004 when soybeans made high of $10.64, and as of this writing the recent low for November Soybeans was on September 9, 2005 at $5.68. Are Soybeans a good value buy? Well, if I knew that with any great certainty I would not be writing this article. I would be on a naked beach in Bermuda, otherwise known as NBIB. In my opinion however, given the past price history of Soybeans and the underlying USDA supply and demand projections I am hard pressed to come up with a good reason to buy value at this time. That does not mean that it is not a good time to buy value, but in just examining recent history I would not suggest one expose themselves to a potential $1.66 decline in price ($5.68-$4.02=$1.66). I would hold off buying value in soybeans. Is there a level? I need to see something in the mid-$4.00 level before I can get too excited about buying value in Soybeans.
In my opinion when industry analysts start talking about Soybeans below $4.00 it is time to start looking at buying value of Soybeans.
Coffee: This is an interesting commodity to examine. It is one of the commodities that the renowned Jim Rogers is long-term bullish on and discusses in his best selling book, “Hot Commodities”. During the week of May 1, 1997 Coffee made high of $318.00 a hundred-weight, followed by a low during the week of December 1, 2001 of $42.20, and at the time of this writing December Coffee was trading in the area of 92.50. Is it time to buy Coffee value? Remember what I said about NBIB? In my opinion however, I believe when and if coffee reaches the $70.00 per hundred weight level it is worthy of watching. If coffee happens to tumble to the $70.00 level make sure you fully appreciate the dollar value difference between $70.00 and $42.00 a hundred-weight.
Cotton: During the week of April 1, 1995 Cotton made a high of $117.00 a hundred and then dipped the $28.00 level during the week of October 1, 2001 and as of this writing the December contract was trading in the $52.00 level with near term lows having been made in the $42.00 area. Is it time to buy Cotton value? Remember what I said about NBIB? But of all the commodities that we have covered so far Cotton does get my attention. When Cotton made the recent lows at $42.00 level I did suggest that traders begin an earnest study of the Cotton market. As always the key is to realize the risk value between the $42.00 dollar level and the $28.00 level, or $14.00 dollars a hundred. Why? As I noted earlier, when buying value your first purchase will probably be your worst purchase, know the underlying risk well in advance of entering the markets.
Sugar: This is another of the commodities that Jim Rogers discusses in his book “Hot Commodities”. It is interesting to note that ever since the Rogers book hit the shelves Sugar has steadily rallied from the $7.00 a hundred- weight level to where October Sugar is trading in the area of $10.60 a hundred-weight as of this writing. Is this cause and effect? Who knows? I can remember back in my earlier career as a commodity broker Sugar was trading below $3.00 a hundred weight. A fellow broker used to proclaim that it was time to buy Sugar because it was cheaper than dirt, and it was actually cheaper than dirt. While I like the long term Sugar outlook I certainly would not recommend anyone buy Sugar based on the concept of buying value. Sugar would have to dip back in the $7.00 per hundred weight level to get my attention and then I would begin my research into the fundamentals impacting Sugar.
Corn: During the week of July 1, 1996 corn traded at a high of $5.55 a bushel. Which was promptly followed by a break in price to which bottomed out during the same week in year 2000 at a $1.74 a bushel, and recent lows were made in the December corn at $1.95. Is it time to buy value in corn? Remember what I said about NBIB? I will say that anytime corn dips below $1.90 I intensify my research into the fundamentals impacting corn, and I would recommend the same to any trader looking to buy value.
Several times I mentioned the need to research the fundamentals impacting the markets in question. In doing so I will try and ascertain is if the underlying supply demand realities have changed to where we will see an increased demand for the commodity due to the price, or a reduction in production due to decreasing margins. One must understand that low or cheap prices alone are not adequate reasons to begin value buying, they are only the beginning. As my partner of many years Steve Erdman likes to say, “When the pile is getting bigger, the price is going lower. When the pile is getting smaller the price is going higher”. When researching the fundamentals of a market that is being considered as a value buy one must try and determine if fundamentals impacting that market are suggesting that the pile is or will be getting or smaller. How does one adequately research a commodity that may be a candidate for value buying? Read! Read as many articles and research papers as you can regarding the commodity in question. If you are too busy to research it yourself then become associated with a commodity professional that understands the concept of buying value and has the resources to research the commodity in question.
Things to remember:
1) Look for commodities that appear to be undervalued
2) Be willing and able significantly over margin
3) Do the research to determine the status of the “pile”.
YOU MUST ALWAYS BE AWARE THAT THERE IS SIGNIFICANT RISK INVOLVED IN TRADING FUTURES AND/OR OPTIONS ON FUTURES AND ARE NOT SUITABLE FOR ALL INVESTORS.
posted by Lee Gaus @ 7:01 AM
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