July 19, 2010

Energy, Livestock and Agricultural ETNs

(Click to enlarge the graphic).

Commodities have taken a back seat to Gold for much of the past 2 years; is that trend to continue, or are there signs of life?

The daily line charts above plot a relative strength plot of three commodity sectors Exchange Traded Notes (ETNs) to a Gold based Exchange Traded Fund (ETF). Daily bar charts for each sector ETN are present above the Gold ETF. From left to right, they are the Dow Jones-UBS Energy (JJE), Livestock (COW) and Agricultural (JJA) Subindex Total Return ETNs; for Gold, we use the SPDR Gold Trust ETF (GLD). Black vertical dashed lines represent dates of interest; red vertical dashed lines denote price levels or ratios of interest. Finally, a trend line is plotted for each ratio.

Obviously the entire commodity complex experienced phenomenal total return into their respective highs in Summer 08. Following their ascent, practically all commodities fell precipitously. Among the outliers, Gold abandoned its correlated, inflationary rise, instead returning to a familiar theme flight to safety. Indeed, the precious metal climbed to highs as deflation dominated markets into the close of CY 09.

What's happened since has been a mixed bag as investors and trader alike positioned portfolios for what most perceived as an inevitable return to inflationary behavior. Unfortunately for most, the commodities complex largely remained a supply/demand story reflecting prices more inline with scarcity or excess. Energy in particular has languished for months, and we've spoken to its various components for some time. What's been different in CY 10 is the price activity between two lesser-followed sectors in Livestock and Agricultural commodities. While not completely captured above, CY 10 largely saw Energy trade sideways and then down, Livestock rise then fall off, and Agriculture fall further deep into Spring 10.

This fact is most notable in studying relative strength behavior across a pivot low in Gold on 24 Mar 10, followed by pivot highs on 12 May 10 and 28 Jun 10 respectively. Trend lines from swing low to swing high extremes have been broken increasingly in each sector, defining strength amongst the sectors themselves. Left to right, the breakout in Energy is suspect, Livestock more convincing, and Agricultural substantial. Based on polarity pricing targets alone, Energy is below its former pivot low of 23.40, Livestock is forming a double top breakout near 29.35, and Agricultural has blown out former resistance at 40.28.

So which commodities represent the most promising opportunities to the long side? On the surface, Agriculture looks very attractive: that it broke so convincingly is hard to deny. On a ratio basis, however, it appears resistance is looming ahead near 0.372 on the far right chart. Those late to the game are probably better to look for further breakout in Livestock above 29.50. While numerically less on a ratio basis compared to Agricultural, Livestock appears to have greater "room to run" to its next ratio target near 0.264. This sector is likely to be favored against Energy as supply in individual components of the Energy itself have yet to be consumed (see UNG) or are likely to wane in demand (see UGA). Currently trading near 22.25, and having traded down for several weeks into the summer, it appears Energy has resumed a supply-driven downtrend that is less likely to abate than others.

Jeffery E. Lay, CMT
President
Talon Eight, LLC

Disclaimer: This post is intended solely to disseminate information, and is not, and shall not be construed to constitute financial, investment or other similar advice. All posted material should be independently verified for accuracy and current applicability. Readers of this post are referred to the Risk Disclosure for further information.

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