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Hot coffee, part 2

Coffee

In February of 2013, I had dedicated an article to coffee, Hot Coffee. In it I discussed its price, production and possible future development. Back then I wrote :

“…a pound of coffee cost 50 cents in the 1970s’ and currently goes for 141 cents. If you can find one staple commodity that costs less than triple the price from 40 years ago, please email me and let me know.Let’s take the analysis a step further. In commodities, high prices are the cure for high prices and vice versa, low prices the cure for low prices. Why? Quite simply, as a commodity becomes pricey, it is more profitable to grow/mine the commodity and thus, supply expands as demand drops. In the case of low prices, the opposite happens. When a commodity nears the price of production, supply falls off sharply as the production of the commodity yields little to nothing. That supply shock plus higher demand at lower prices lead to a general reversal in price… Therefore, as long as a commodity does not disappear altogether, the bottom price is naturally around the cost of production. Coffee costs about $1 to $1.2 per pound to produce at the moment depending on coffee bean and Location……. Evidently, coffee grows around the equator and as such, you need to add approximately 10 cents a pound in transportation cost to the colder climates north. Given total cost of $1.1-$1.3 per pound of coffee and a current price of $1.41, this may be a perfect time to buy coffee. This does not mean that coffee cannot fall to the cost of production but your down side is probably limited to 10-15% while the upside is a multiple of that. Besides, if your purchase of coffee turns out a loser your Sunday morning cup of coffee should be that much cheaper as well. Another way to look at this would be to say you can buy your coffee consumption for the next 1,5,10,20 years today at close to 2013 production cost. Makes sense to me…”

 

Now, what has happened to the price of coffee since I wrote that article 18 months ago? As so often, the down trend to below production cost continued as speculative and leveraged  positions were forced to liquidate. However, once the “hot money” was out of the market, the Price of coffee had nowhere to go but up as coffee producers would not be able to grow at Prices below production.

coffe chart

So far this year, coffee is the only commodity breaking out on the upside despite subdued inflationary pressures in the global economy. For all the short-term reasons, please read the following Reuters article “Why Coffee Prices are piping hot“.

Fundamentally, it is back to basics, supply and demand. As demand for coffee is constant and growing, the price for coffee is largely determined by supply which in turn is price sensitive. If you choose to get involved in the commodities markets, use common sense and avoid leverage. And as always, caveat emptor!

coffee2

 

 

 

 

 

 

 

The near term Euro vs. $ Debate

euro

Yesterday, I was interviewed by an Austrian newspaper regarding the direction of the EUR/USD Exchange rate. As always in this blog,  the content is not investment advice but must be regarded as personal opinion. Caveat emptor!

http://www.nachrichten.at/nachrichten/wirtschaft/Schlechte-Konjunktur-niedrige-Zinsen-Euro-verliert-deutlich-an-Wert;art15,1489673

 

Fundamental vs. Technical model showdown ahead

wave crest

In November of 2013 I wrote an article titled “Surfing the Elliot Wave” . In it I opined “One of the most respected long-term technical methodology to identify and chart financial market movement is called the Elliot Wave(on top). So far, the pattern displayed in US equity prices since 2009 follows the Elliot Wave model very accurately(for further analysis and explanation please click here). We are currently in the beginning of the final wave (4-5, look at top image) of the up move and the model suggests a peak of around 2000 in the S&P500 and 20,000 in the Dow, most likely within 12-18 months. I think this prediction is well in line with the typical psychological pattern of market cycles depicted below”.

So, here we are 10 months later and the perfect top of the final technical wave has been reached in the SPX(albeit  not in the Dow). The coming year will be very interesting for those market observers who lean towards technical or fundamental models as one approach will be proven wrong. Fundamentally, capital flows and credit creation are solid, monetary policy is loose and inflationary pressures subdued, all fuel for continued rising equity markets. Technically, we should see this point in time as close to the top of the market cycle according to the Elliot Wave theory. Good luck!

crushed by big wave

About Market Owl

Owl5

Source

Today I would like to share an article that was written in an Austrian newspaper about the author of this blog. Unfortunately for non-German speakers, the article is in German and may require a good sense of humor when utilizing an online translator.

http://www.nachrichten.at/nachrichten/wirtschaft/wirtschaftsraumooe/Linzer-Boersenhaendler-machte-in-Chicago-Karriere;art467,1448940

Dog days of summer

dogdays It appears that markets have followed most of Europe on summer vacation displaying very little movement. The calm can be perfectly put into historical context in the long term volatility chart below: Vix Source

Given the wide spread challenges in the global economy one can’t help but wonder whether the calm is justified or if this phase is merely the “dog days of summer” in the financial cycle that we observe as regularly as we experience summer in the calendar year.

Beneath the surface, many severe problems are brewing. For example, a year ago, I explicitly warned about Japan”s economic policy, named “Abenomics”, referring to the current Japanese prime minister. It now appears that the Japanese policy of flooding the market with printed yen has caused inflation to increase to 3.7% while the 10 year Japanese government bond yields 0.53%. Why would anyone in their right mind hang on to yen or Japanese government bonds? Abenomics is clearly unsustainable and all I can do is shake my head and wonder when this problem rises to the global financial surface.

Japan CPI

Source

 

Finally, I would like to show the chart below which shows a falling global GDP while global equity prices are rising. Considering that companies’ earnings are derived from GDP and equities’ reflect future profits, it is quite illogical to assume this dichotomy to continue indefinitely. Either GDP needs to move up or equities need to come down.

Death cross

Source

In conclusion I would like to once again remind readers that while complacency has entered the financial markets, do not expect this era of slow motion to last. Considering the action behind the curtain it is truly stunning to see the VIX at record lows. Caveat emptor!

 

 

 

Great Presentation by Mish Shedlock

Very often it pays to listen rather than speak. The presentation below is one where I would urge anyone with an interest in the financial markets and economics to spend some time soaking in the best analysis I have seen so far this year.

Enjoy!

 

 

Smoke & Mirrors ?

abstract smoke

When global central banks reduced short term interest rates to rounding errors in 2008, the mission was clear: prevent financial disaster and arrest a world wide liquidity crunch. Mission accomplished. Yet today, six years later, we still find zero interest rates and money printing on an epic scale. In the article “Central Banks shift into shares as low rates hit revenues”, The Financial Times reported this week that global central banks have accumulated $29.1 trillion of assets including equities pushing up prices in anything that can be exchanged for the promise of purchasing power of cash. For those of you that are having trouble with such large numbers, total annual global GDP is about $77 trillion. In essence, central banks have created nearly 40% of global real GDP through “unreal” activities.

GlobalGDP2014

Source Google

Rather than discuss the sense or nonsense of this global quasi-nationalization policy, I would like to point out to the reader that if history is our guide:

a) artificial price setting is always temporary in nature as price levels find their true levels in the long run

b) the longer price levels are kept away from their natural equilibrium, the bigger the resulting potential diversions and thus, the larger and more rapid the eventual price adjustment.

While the financial market skies are relatively blue at the moment, math and history both point to extreme conditions in the coming years. Enjoy the warm summer days for as long as they last. Winter is not too far away(first snow falling in September 2015 in my opinion).

 

High Frequency Trading visualized

HFT

In recent years, the computerization of the financial markets has been stunning. 10 years ago, orders were placed side by side humans in order to exchange financial products. Today, over 90% of all trade decisions are made and executed by computers without human input. Adding computers to human intelligence has allowed the financial markets to become more efficient, faster and liquid, all positive attributes. However, there is a segment of trading that relies on HFT(High Frequency Trading) where it is legitimate to question the purpose of market participation.

Take a look at the explanation below given by the New York Times.

High frequency trading

As you can see, the example above leads to worse execution for the customer who enters the market while the HFT computers “front run” the order in order to capture a tiny gain on large quantities. Is it legal, is it ethical, is it efficient? I leave all these questions for the reader to be answered. Personally, at my firm, we also exclusively trade through our computers but I find much more satisfaction in trying to get the market right rather than front run customer orders.

 

Finally, take a look at a video a precious friend of mine has shown me in this regard. It’s a human hand playing  “rock-paper-scissors” against a robot who wins every time due to faster signal recognition. Similar to HFT, decide for yourself, is the robot cheating or outright winning and does it matter or not?

 

Cycling on

golden globe and arrow

Whether it’s the seasons changing, the earth revolving around the sun or business cycles chasing boom and bust, life as we know it occurs in similar repeating patterns. The financial markets are no exception to the forces of nature that we all submit to. Recently, I wrote a piece about low volatility and today I would like to analyze the effects of low volaitility on the financial markets in a more comprehensive way. First of all, let me return to my primary professional expertise, the FX market where we are approaching historical record low volatility(see below).

 

FX vol

Source:BCA Research

Low volatility in the largest market of the world(FX) points to a benevolent global economy where growth is consistent and risk is low. Of course, this very notion of low risk breeds complacency and typically leads to large counter swings as the business cycle turns and perceptions about the future change. So, where are we in the business cycle right now and what does it mean for asset classes?

Economic cycle

Clearly, we are in between the early and late upswing Phase in the global business cycle that is accompanied by rising asset prices and contained inflation as shown above. If you take this chart and relate it to FX volatility you will also notice that there is still some room/time for letting this cycle play out, probably a year or so before this business cycle will reach its top and revert to the downside. The reason I think we have another positive year in the business cycle left is due to the fact that the general cycle described takes an average of about 8 years and 2007 was the peak of the previous one. As for assets, take a look at the length of major bull markets in asset classes over the past 60 years and you will notice a similar pattern once again.

Bubbles

 

Conclusion

As I have stated numerous times before, keep riding this business cycle but do realize that the sun eventually sets, and winter does eventually follow summer and fall, especially in places like Chicago. I will do my best to alert you to when I start to see the leaves fall off the tree and  fall has arrived. Then, it will be time to harvest and take cover. For now, enjoy the sunny weather despite the occasional global political thunderstorm….

Late summer

 

 

 

 

EU elections

EU parliament

Having lived in the US for the past 20 years and only followed European politics from afar, I have always been a proponent of both the EU and the EURO. However, both projects appear terribly flawed from the outside looking in. The EU parliament  longs for more unified power over matters that are strictly up to member states sovereign authority. The Euro currency remains a noble project with terminal flaws that will reveal themselves by the end of this decade. Having 18 finance ministries and economic programs yet only one currency and central bank is a recipe for failure and I applaud the ECB for having done a tremendous job in keeping the Euro stable and strong.

Strangely, the European citizens are poorly informed of their EU representatives whom they elect and send to Brussels. While 50% income tax rates are the norm across the EU, it appears that nobody outside the European parliament is aware of the fact that civil servants there pay no more than 12% income tax themselves. Hmmm, I suppose I have been gone for too long to fully understand this situation… Perhaps, that is why I focus on markets rather than politics when possible.

 

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