The Rude Awakening
Wall Street, New York
Friday, February 3, 2006 ------------------------- - Relishing the opportunity to tango with volatility in
the markets,
- How you can play the herd and secure strong holdings
in the commodity sector and,
- Champagne glasses flying through the air: violent to
some, foreplay to others…
------------------------- Eric Fry reporting from the hinterlands of Westchester
County… Your editor abhors volatility…both in the realm of
investment and in the realm of love. He relishes steady
returns from the former and mellow evenings from the
latter. He would gladly forgo the ecstasy of "higher highs"
to be spared the agony of "lower lows." Volatility presents
a dicey risk-reward proposition: The anxiety it imposes is
certain; the reward it promises is not… Thus, your editor would not want to trade shares of Google
any more than he would want to engage in a champagne-glass-
smashing argument at the Pearl restaurant in South Beach.
Although he could rise to either occasion, he would not
enjoy it. But some folks thrive on volatility…or at least know how
to manage it successfully. They not only tolerate it, they
seek it out…along with the unique opportunities that
volatility presents. For these rare individuals, a
screaming fit of wine-glass throwing is not a display of
hostility; it is foreplay. Likewise, a 20% one-day drop in
a stock is not a tragedy; it is an opportunity…maybe to
buy, or maybe to sell short. The fundamentals would dictate
the response. Lately, many of the commodity markets have become
extraordinarily volatile, which causes some seasoned
commodity traders, like Richard Morrow of Bullfrog Capital
Management, to stand aside…or to look for opportunities
to sell short. But other seasoned traders, like Kevin Kerr, the mind
behind the Resource Trader Alert, embrace the volatility by
selectively buying options on commodity futures. Despite
the fact that Richard and Kevin employ extremely different
tactics, both have amassed impressive track records. So we
chatted with both of these seasoned professionals yesterday
to get their take on the commodity markets…and what we
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http://www.agora-inc.com/reports/RTA/ERTAG203 ------------------------- When Gold is Google
By Eric J. Fry Commodities are rallying…and because they are rallying,
investors are buying them…and because investors are
buying them, commodities are rallying. You get the idea. Commodities are red-hot…and everyone knows it. Even so,
almost no one knows exactly what to do about it. Should we
be buying $65 crude oil or selling it? Should we be buying
$570 gold, or selling it? Should we by buying 19-cent sugar
or selling it? Or if we are stock investors, should we be
buying ExxonMobil and Archer Daniels Midland and Phelps
Dodge, or selling them? The answers are not self-evident,
especially because many large institutional investors have
decided to throw money at the commodity markets. "Billions of dollars of long-only index-fund money is
pouring into these markets," explains Richard Morrow,
founder of Bullfrog Capital Management. "And that's
throwing the traditional fundamental influences all out of
whack. These markets are just too small to handle an influx
of money this large." "How small is small?" I ask. "If you added up the entire value of the 2005/06 corn,
wheat, soybean, cotton and rice crops they would total
roughly 60 billion dollars. In other words, the entire
U.S. Agricultural row crop sector is 1/200 the size of the
S&P500. So this new liquidity that's pouring into 'our
markets' cannot be efficiently absorbed." "Sounds like you've got two sets of 'fundamentals'
influencing the commodity markets,' I suggest. "You've got
real-world demand for the commodities themselves; and
you've got index-fund demand." "Right," Richard agrees, "and the interaction between these
two different sets of fundamentals have created extreme
price inefficiencies." "Give me some examples," I ask. "We're going to have the biggest US and world soybean crop
ever, with the largest carryout ever. And beans are $6.00.
They just shouldn't be up here. With record U.S. and world
soy carryout [Editor's note: "carryout" refers to the end-
of-season stockpile] and big U.S. soy acreage coming, I'm
looking for an opportunity on the short side of the soy
market. Cotton is another interesting one. The funds are
record-long into one of the largest US carryouts ever! The
U.S. crop is materially larger than a month ago and the
U.S. domestic consumption is falling like a stone from
already low levels. Furthermore, cotton exports are running
below pace to meet the USDA estimate. So it is very
possible that the U.S. will end up with a cotton carryout
over 8.0 mil bales. This would be the largest carryout in
history and is more indicative of sub 45-cent July cotton
rather than 58-cent cotton." "He who has the money makes the rules, I guess." "Yep," Richard agrees, "We're no longer in a world market
for commodities, or even a U.S. market; we're in an index-
fund market. The markets that I trade are being swamped by
long only index money. Cotton, corn, wheat and cattle all
have record open interest due to the tidal wave of index
fund flows. These markets are simply too small to handle
these huge inflows on a weekly basis. 
"If it is any comfort to you," I reply, "index-fund money
seems to be sloshing around in all the commodity markets."
"Oh yeah, I know," says Richard. "I think you've got about
$20 of index-fund premium in the crude oil market right
now. Crude should be trading about 5.8x natural gas on a
BTU basis. But the current ratio is 7.3 to 1, or 26% over
valued. And I think natural gas is way overvalued. Natural
gas inventories are going to all-time highs. How anyone can
be bullish $9 natural gas is beyond me." "What about gold?" "Same story," Richard relates. "The inflows into gold and
silver are simply huge. We have no idea how high these
markets are going. Our feeling is that gold is the 'new
Google.' Investors want to own it at any price…I can tell
you this; if the money-flow into these markets stops,
there's going to be some great opportunities on the short
side." "Yeah, that's true," I agree, "but you might need to wait a
while for that to happen. The fundamental short-sellers are
almost always too early." "Maybe so," says Richard, "but I don't want to get carried
away with all that. I'm still finding opportunities to
trade…It's just that the game has changed." "Thanks Richard…and good luck." After hanging up the phone with Richard Morrow, I dialed
Kevin Kerr… "Hey Kevin, it looks like you're having some fun in these
markets," I begin the conversation. "Yeah, we're doing pretty well," Kevin replies, "but
there's a heck of a lot of volatility." "Are the index-funds changing the game?" "No question about it," Kevin says. "There is clearly a new
force in these markets. A new herd of buyers and
speculators…and they're more powerful than the
fundamentals. So I'm gonna play with them…I certainly
don't want to fight the herd." "Is that why you bought sugar calls a while back?" "Nice of you to mention that trade," Kevin chuckles. "We're
up more than 300% on that one. No, I entered sugar because
I thought it was too cheap in a world where ethanol
production was increasing demand for sugar. Then it made a
nice technical breakout to confirm the likelihood of a new
move higher. Once the move started, of course, ethanol
stories started landing on the front page of the Wall
Street Journal and the funds started piling in. That's what
I mean by playing with the herd."
"It probably didn't hurt that Bush mentioned ethanol in the
State of the Union Address."
"Yeah, that helped trigger yesterday's 100-point jump in
sugar," Kevin agreed. "I've never seen a move like that in
my entire career." "Are you getting a little nervous up here at 19-cent sugar? "Yeah, I've already advised my subscribers to close half
their position…and we'll probably exit the second half
very soon. "So what trades have you opened recently? "Well we've got a couple new positions in corn…The
rationale being quite similar to the one that prompted my
sugar trade. Ethanol production is the topic-du-jour, which
directly benefits the corn crop. Obviously, ethanol
production will not create any big pop in demand between
now and the expiration of our July options, but the STORIES
about ethanol will probably pull fund money into the corn
market. "So you're riding with the herd again? "Trying to, but I wouldn't buy corn just for that reason. I
thought corn was too cheap, even without the ethanol story.
But this story just provides the catalyst for a move…and
yesterday's breakout above 239 on the July contract seems
to confirm the idea that something is up in the corn
market." "But what about the underlying size of the corn crop
doesn't that concern you?" I asked. "Sure, it's hard to get wildly bullish about a crop that
could have record U.S. stocks at the end of the season.
That's why many traders out there feel corn is overpriced,
and that there's too much of it. They may be right. But
the point is that I don't think so. There's still a lot of
uncertainties with the grains for potential drought etc..
I could write a whole book on it, (actually I am) but
suffice it to say there are a lot of unknowns for the corn
right now…But don't get me wrong; I am not the type of
trader who gets married to a position. If corn starts to
head too far south, we'll take it off and try to buy it
cheaper…or just wait it out." "Thanks Kevin. I hope you keep having fun." "I'll try!" [Joel's Note: If the idea of cashing in on the high-paced
commodity market has tempted you in the past but volatility
had you worried, fear not. There is a way you can
capitalize on these amazing profit opportunities with
someone else worrying about how to work the trades. Kevin
Kerr is a bloke who relishes the opportunity to deliver
solid returns in a tumultuous market…and that's just what
he's been doing. Find out how you can join his highly
successful readership and take some cash to the bank
yourself by clicking here: Kevin Kerr's Resource Trader Alert
http://www.agora-inc.com/reports/RTA/ERTAFB23
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