We frequently discuss the effectiveness of using the commercial trader position as a proxy for fundamental data. We began looking at this years and years ago in the agricultural markets due to the inelastic nature of these annual markets. Adding that these markets are controlled by individuals whose livelihoods are based on the successful calculation of supply and demand and you begin to see the value in their collective forecasting ability. Thus using the commercial hedging activity as a proxy helps put us on the side of the sellers when there is forward production to be sold above their predetermined value area just as the end users put us on the side of the long hedgers supporting undervalued prices.
Of the agricultural markets, the live cattle market is one of the most inelastic. There are two options with a cow; breed it or eat it. We've written at length about the declining size of the U.S. cattle market, still bumbling along near generational lows. Furthermore, the global appetite for premium cuts continues to surge. This explains the dichotomy of rising cattle and stake prices even as ground chuck has remained fairly stable. The last factor that has contributed to the cattle prices we've seen over the last two years has to do with declining grain prices. It's finally cheap enough to graze herds and supplement their diets. This has allowed farmers to hold cattle back from the slaughterhouses as they finally begin to regrow the domestic cattle herd. This has also made it more advantageous to feedlots finishing cattle prior to slaughter.
The cattle market has tracked its seasonality well, topping out in June and declining into fall. Of interest to us, is the commercial trader activity on this decline. Commercial traders have been buyers in 13 out of the last 14 weeks. Their net position is long 15,000 contracts. This is the largest bullish net position the commercial traders have accumulated since April of 2013. Moving to the chart below, you can see the COT buy and sell signals over the last year. Clearly, cattle are in an accumulation stage on the farms.
|Commercial traders have clearly dominated the cattle trade over the last year - calling both tops and bottoms.|
We view this sell off as a buying opportunity. Granted, the weakness in today's stock market could spill over to the rest of the commodity markets as my current screen shows only bonds and the Dollar in positive territory. Whether the bottom comes today ortomorrow is not as important as knowing that we should be on the buy side rather than chasing the sell side. As it sits, we'll buy December live cattle futures and place a protective stop at the swing low of $135.025 made on September 18th. If we're right, we certainly expect more than a $10 ($4,000) move higher, more than enough to justify the close to low risk of $1 ($400). However, a more conservative play is to place an entry buy stop just above yesterday's high of $140.40 and if that order is filled, place a protective sell stop at whatever today's low turns out to be.
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