• 1 day PDVSA Booted From Caribbean Terminal Over Unpaid Bills
  • 1 day Russia Warns Ukraine Against Recovering Oil Off The Coast Of Crimea
  • 1 day Syrian Rebels Relinquish Control Of Major Gas Field
  • 2 days Schlumberger Warns Of Moderating Investment In North America
  • 2 days Oil Prices Set For Weekly Loss As Profit Taking Trumps Mideast Tensions
  • 2 days Energy Regulators Look To Guard Grid From Cyberattacks
  • 2 days Mexico Says OPEC Has Not Approached It For Deal Extension
  • 2 days New Video Game Targets Oil Infrastructure
  • 2 days Shell Restarts Bonny Light Exports
  • 2 days Russia’s Rosneft To Take Majority In Kurdish Oil Pipeline
  • 2 days Iraq Struggles To Replace Damaged Kirkuk Equipment As Output Falls
  • 2 days British Utility Companies Brace For Major Reforms
  • 2 days Montenegro A ‘Sweet Spot’ Of Untapped Oil, Gas In The Adriatic
  • 3 days Rosneft CEO: Rising U.S. Shale A Downside Risk To Oil Prices
  • 3 days Brazil Could Invite More Bids For Unsold Pre-Salt Oil Blocks
  • 3 days OPEC/Non-OPEC Seek Consensus On Deal Before Nov Summit
  • 3 days London Stock Exchange Boss Defends Push To Win Aramco IPO
  • 3 days Rosneft Signs $400M Deal With Kurdistan
  • 3 days Kinder Morgan Warns About Trans Mountain Delays
  • 3 days India, China, U.S., Complain Of Venezuelan Crude Oil Quality Issues
  • 3 days Kurdish Kirkuk-Ceyhan Crude Oil Flows Plunge To 225,000 Bpd
  • 3 days Russia, Saudis Team Up To Boost Fracking Tech
  • 4 days Conflicting News Spurs Doubt On Aramco IPO
  • 4 days Exxon Starts Production At New Refinery In Texas
  • 4 days Iraq Asks BP To Redevelop Kirkuk Oil Fields
  • 5 days Oil Prices Rise After U.S. API Reports Strong Crude Inventory Draw
  • 5 days Oil Gains Spur Growth In Canada’s Oil Cities
  • 5 days China To Take 5% Of Rosneft’s Output In New Deal
  • 5 days UAE Oil Giant Seeks Partnership For Possible IPO
  • 5 days Planting Trees Could Cut Emissions As Much As Quitting Oil
  • 5 days VW Fails To Secure Critical Commodity For EVs
  • 5 days Enbridge Pipeline Expansion Finally Approved
  • 5 days Iraqi Forces Seize Control Of North Oil Co Fields In Kirkuk
  • 5 days OPEC Oil Deal Compliance Falls To 86%
  • 5 days U.S. Oil Production To Increase in November As Rig Count Falls
  • 6 days Gazprom Neft Unhappy With OPEC-Russia Production Cut Deal
  • 6 days Disputed Venezuelan Vote Could Lead To More Sanctions, Clashes
  • 6 days EU Urges U.S. Congress To Protect Iran Nuclear Deal
  • 6 days Oil Rig Explosion In Louisiana Leaves 7 Injured, 1 Still Missing
  • 6 days Aramco Says No Plans To Shelve IPO
The Financial Lexicon

The Financial Lexicon

I am an investor/trader with nearly a decade of experience in the financial world. I have experience investing in and trading equities, options, and a…

More Info

Here's How to Hide in Commodities

Here's How to Hide in Commodities

I am a big believer in the notion that there is no “one size fits all” portfolio allocation to which investors should turn when building their wealth.  At the same time, in an age of money printing, constant uncertainty in the Middle East, and a worldwide population that isn’t getting any smaller, I think there is a case to be made for most investors to have some type of allocation to commodities.  That allocation could be diversified across commodities or focused on just one.

If I were forced to choose just one, my focus would be in the precious metals space, and I would be hard pressed not to choose gold.  I have much to say about precious metals (and commodities) in my new book, “The 5 Fundamentals of Building a Retirement Portfolio,” and think that gold is simply too important a commodity to ignore in today’s day and age.

With that said, given the slowdown in economic growth in Europe and China, combined with the difficult decisions facing U.S. politicians in the coming months (fiscal cliff, debt ceiling), it is prudent to remain cautious in your investing, even after the recent declines in so-called “risk assets.”  In the world of commodities, this doesn’t necessarily mean abandoning a bias to the long side.  For some portfolio managers, that might not even be an option.  Instead, it means investing wisely to minimize the potential for losses should a worldwide recession occur next year, while also maintaining the potential for capital appreciation should commodity prices suddenly rebound. 

When you are concerned about the potential for a multi-month pullback in commodity prices, one strategy for maintaining a long position but minimizing your risk is to hide out in the parts of the futures curves that are less likely to suffer the worst of a sell-off.  I would like to illustrate what I mean by using the inverted futures curve in soybeans.  The following table shows the recent prices and expiration months for various soybeans futures contracts that were traded on November 8, 2012.

Soybeans Futures Prices

The decline in prices as you go further out in time is known as an inverted futures curve (also referred to as backwardation).  The difficult weather conditions this past summer helped to push soybeans into a strong backwardation where they remain to this day.  It should not be unexpected that when near-term supply constraints become a concern, commodities traders will push a futures curve into an inverted state until the near-term supply concerns abate.  Despite the recent pullback in soybeans, it remains in a solid backwardation.  Should the futures curve remain in this state, you will have the opportunity to roll your contracts forward and purchase the next contract at a cheaper price.  Selling high and buying low is certainly a strategy favored by investors.  But if you have concerns about worldwide economic growth and think the effects of this year’s drought will wane over time, you should consider hiding out in some of the future dated contracts.  Here are a few scenarios to consider that can help you better determine where on the futures curve to hide:

1.       If you think economic growth will slow, that the possibility of a 2013 recession with a global reach is too much to ignore, and you don’t want to make the bet that next year’s weather will be a repeat of 2012, then you should focus your attention on the late 2013 to late 2014 part of the soybeans curve.  Depending on the size of your positions, certain months may be more favorable than others from a liquidity standpoint.  If concerns about weather, drought, and near-term supplies abate, the backwardation is at risk of flattening.  This means that the near-month contracts are more at risk of underperformance relative to the further-dated contracts.  It doesn’t necessarily mean soybeans will decline in price.  Even slow worldwide growth could cause the entire futures curve to rise.  But less of a concern regarding drought would portend underperformance of the near-month contracts.

2.       If you think economic growth will slow, that there is a serious risk of recession in 2013, but that drought concerns will persist, then focusing on the July 2013 to September 2013 part of the curve makes sense.  This would provide some buffer against falling prices due to economic growth concerns, but it would also prevent you from giving up the full extent of the expected premium that would persist from ongoing drought concerns.

3.       If you think economic growth will pick up and that drought concerns will persist, just stay long the near-month contracts, allowing yourself the possibility to profit from any widening in the futures curve and from the positive roll.

4.       From my perspective, the most difficult scenario to figure out would be a pickup in economic growth and drought concerns simultaneously abating.  There would likely be a narrowing of the backwardation, but it might not happen right away as traders get long the more liquid near-term contracts and justify this action by expressing concern for future supplies due to economic growth.  I think that over time, the lack of concern about a drought would trump mild economic growth from a shape of the futures curve perspective, eventually causing the inversion to flatten.  But that could take some time.

Crude oil is another popular commodity to trade, and its futures curve has a different structure (slight contango through 2013, thereafter turning into backwardation).  This curve would need to be treated differently than the soybeans curve.  It doesn’t mean you can’t hide out in future dated contracts, but you’ll have to go through a different decision-making process about what has caused the current shape of the crude oil futures curve and how that might change in the different types of scenarios outlined above.  The same is true for any other commodities you might trade. 

One final point worth noting: For energy traders who find it too difficult to decide on which part of the futures curve to hide, you could consider investing in funds that track the futures prices of multiple contracts.  This would include the United States 12 Month Oil Fund, ticker symbol USL, and the United States 12 Month Natural Gas Fund, ticker symbol UNL.

Keep in mind that just because you are long commodities but are nervous about future declines in price doesn’t mean you must abandon the long bias in your portfolio.  You do have the option of hiding out in different parts of the futures curve.

By. The Financial Lexicon




Back to homepage


Leave a comment

Leave a comment




Oilprice - The No. 1 Source for Oil & Energy News