Case study of the
COT Reports and 
CORN - part 2

Last week I began a case study on the COT Reports and corn. (see pdf file of my 4/18/2010 commentary) In that case study I began by explaining the FIVE different weekly COT Reports issued by the CFTC. Then I compared the report information and concluded that the new Disaggregated COT Report FOR CORN was the most complete information on the large traders in corn.

My conclusions include

1. The " Commercial (producer/ merchant/processor/ user)" category is the best representation of the true "commercial" trader that is considered by the trading public to be the "smart money." They are the ones that deal daily in the markets and have the best fundamental information and supply, demand and value. These "large trader commercials" are exempt from position limits when hedging their commercial activity. Traders will want to track the readings of this category to gain a representation of the commercial's view of the value of the market. When the net commercial position is the largest hedge in the last one, three or five years (we only have three plus years history of the new categories) we can conclude that the dealers view corn as overpriced. When the net commercial position is the smallest hedge in the last one, three or five years we can conclude that the dealers view corn as cheap.  

2. In Corn, the "Swap Dealer" category positions are most similar to the Commodity Index Trader positions on the Supplemental Report. For now we can view these positions as part of the hedges by firms against "structured contracts" to commodity funds to provide the returns of the various commodity indexes. (Commodity Index funds generally do not take direct positions in commodity futures, they provide commodity index returns to their investors by entering into structured contracts with trading firms to provide the fund with the returns of the index.) These "large traders" are exempt from position limits when hedging index related obligations. Traders will want to track the readings of this category to understand the impact on open interest of the allocation (growing or contracting) of the general investment public to commodities that are not specifically tied to the conditions of the individual commodity. For example, crude oil is over weighted in the commodity indexes and a rise in crude can attract more index investment which will result in additional accumulation in corn futures in proportion to corn in the indexes whether or not corn is performing consistent with the trend of the index.

3. The "Money Manager," for the purpose of this report, is a registered commodity trading advisor (CTA); a registered commodity pool operator (CPO); or an unregistered fund identified by CFTC. These traders are engaged in managing and conducting organized futures trading on behalf of clients. Generally, these accounts are subject to position limits and therefore were not included in the commercial category in the legacy reports. Actively managed futures trading, as a group, tend to be trend following and the progress of a trend can be confirmed based on monitoring the positions of this category of the Disaggregated COT Report.

4. "Other Reportables." Every other reportable trader that is not placed into one of the other three categories is placed into the “other reportables” category. Like the managed money category, as a group, these large traders tend to be trend followers.

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Comparison of the "Disaggregated Report" to the "Legacy reports (with option deltas)":

The non reportable (small spec) positions are the same in all reports.

The Money Manager and the Other Reportables in the Disagg Report are generally the large non commercial positions in the Legacy Report.

The Swaps FOR CORN in the Disagg Report are generally the Index Trader positions in the Supplemental Report. This general conclusion may not be correct for all markets. For example, the swaps in crude oil may be related to "over the counter" contracts offset in foreign commodity exchanges.

FOR CORN, the " Swaps" and the " Commercial (producer/ merchant/ processor/ user)" in the Disagg Report generally total the positions on the commercial category in the Legacy Report.

My conclusion is the Disagg Report data FOR CORN is the best complete source of data on the open interest in the corn futures and options. Further, the chart of corn with the Disagg Data plotted is the easiest way to draw conclusions about the "players" opinion in corn.

In the following chart of weekly corn:
Red line - net commercial (producer, merchant, processor, user)
Green Line - net other large spec
Yellow Line - net small spec
Blue Line - net swap dealer
Magenta Line - net money managers

Five year chart 

CHART 7

Three year chart

CHART 8

In the top five year chart and above three year chart of the CORN, the Disagg Data for April 13 is plotted over the weekly chart of corn:

A. The magenta colored Managed Money are following the trend lower and increasing positions with the acceleration of the down trend. The Other Large Trader green line has also been reducing positions since the beginning of the year's down trend.

B. The accumulation of Swap Dealer positions ( blue line) have held steady to higher since the beginning of the year consistent with the steady performance of the Commodity Indexes, which have had only a minor impact from the downtrend in corn.

C. The ( red line) net commercial positons (producer, merchant, processor, user) are showing accumulation consistent with the view that corn is extending it's downtrend to the point corn is getting cheap.

AS THE RED LINE NET COMMERCIAL POSITION RISES TO INDICATE NEAR THE SMALLEST HEDGE IN THE LAST YEAR, WE WANT TO MONITOR CORN FOR SIGNS OF A CHANGE IN TREND.

If the down trend in corn is starting to show signs of changing and the net commercials view the market as cheap and are not increasing their hedges, where will the money managers find willing sellers to offset their heavy short position? The index fund traders probably don't even know the price level of corn. They hold corn positions because corn is part of the index on which they owe returns. If the trend changes, they will not release their positions. The commercials generally won't increase shorts until price is no longer too cheap. SO WHERE WILL THE MONEY MANGERS FIND SUPPLY TO EXIT THEIR SHORTS AND TURN LONG? 

The answer is AT HIGHER PRICES! This is the dysfunctional market condition we look for in using the data from the COT Reports.

Corn is NOT at that extreme yet, but we may see that condition soon.

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And it may come sooner than most may expect!

In my market timing service, I have "sells" on the stock market, commodity market and gold; but in my Commodity Index Timing .com web site, I recommended bullish vertical call spreads in CORN. 

My start up bullish recommendation in corn in Commodity Index Timing .com is from considering the possibility that increased Iceland volcanic activity could impacted climate which could reduce yield and drive grain prices higher. I will consider making a recommendation in this free report when the net commercial position in corn gives a stronger indication that the fundamentals are suggesting that the corn market  is getting cheap.

Following is a chart of CORN in 1980 after the eruption of Mt Saint Helens in the spring of 1980. (Mt Saint Helens eruption in 1980 http://en.wikipedia.org/wiki/Mt._St._Helens_eruption ) 1980 was a year of recession and the peak in GOLD. Was the Mt Saint Helen eruption a factor in the price run up? 

CHART 9

Following is a chart of CORN in 1973 after the Heimaey Eruption in Iceland in January through May 1973. 1973 was a year of recession and the peak in OIL. Was the Heimaey Eruption in Iceland a factor in the price run up?

CHART 10

THERE WERE MANY OTHER CONDITIONS IN THESE YEARS THAT MAY HAVE BEEN RESPONSIBLE FOR THE RUN UP IN GRAIN PRICES IN 1973 AND 1980. But, we ALSO have many other reasons in 2010.

Last week in my Commodity Index Timing .com Web site, I showed 1980 charts of corn, beans, wheat, heating oil, cattle, hogs, gold, CRB, and sugar, which generally concluded that Mt Saint Helens resulted in a cooler growing season and yields were lower and prices rose. Next Sunday I will post chats for these markets from 1973 which will also show rising prices throughout the growing season.

As explained in the linked Christian Science Monitor article above, http://www.csmonitor.com/Science/2010/0418/Iceland-s-Eyjafjallajoekull-volcano-is-nothing-to-Angry-Sister-Katla the three times in recorded history when Eyjafjallajökull has erupted, its neighbor, the much larger Katla, has followed suit. 

CHART 11

So right now the Eyjafjallajökull eruption might impact the growing season, and IF Katla erupts and effects the growing season we could find the trend following money managers in a race to reverse positions.

Last week I explained: GENERAL COMMENT ON THIS CASE STUDY. 

Over the coming weeks in this free weekly commentary, I will focus on corn and the Commitments of Traders data. I hope to walk us through, in real time, the possible drop in the price of corn to under value and monitor the accumulation of net commercial positions during the liquidation of the other large trader positions. Eventually Corn could get cheap, but we will have to monitor the Commodity Index market - Oil and Gold - to keep an eye on the condition of the index trader positions that hedge the huge investment in the commodity funds. Then, I hope we can eventually watch the change in trend to the upside once corn gets to an extremely undervalued price.

I chose to do a COT case study to follow the development of corn through the summer because of conflicting ideas on the impact of the 2009 2010 El Nino, (see http://www.cpc.ncep.noaa.gov/products/predictions/90day/fxus05.html ) and some other forecasts of an over due drought cycle. Now, if we add in the possible impact of a KATLA ERUPTION, we might have a lot of activity in this real time case study this summer!