All does not look well for equity markets today. With the Dow Jones Industrial now down over 120 points, a breakout in the volatility term structure is displaying a real worry in financial markets at the moment. The volatility term structure is simply two different expiration periods of CBOE Volatility Index Futures. You can see this spread has been trading in a tight congestion trending slowly downwards. Several times the spread has moved out of this congestion pattern only to fall back within. Will this breakout be the real one?
For several years the Federal Reserve has embarked upon an operation dubbed ‘Quantitative Easing.’ Essentially, quantitative easing is the purchasing of debt including U.S. treasury bonds and mortgage backed securities. U.S. treasury bonds and mortgage backed securities are important in financial markets because of there usage as collateral. Access to quality collateral is paramount in modern financial markets as access to quality collateral provides liquidity. Years of quantitative easing by the Federal Reserve has removed quality collateral from financial markets. The financial markets, in the event of lower access to quality collateral accentuated by the Federal Reserve have moved to gold to raise liquidity.
The slogan is, “When all else fails, repo gold.” Gold can be loaned out or leased to earn an income. Gold can effectively be used as collateral to obtain funding in global financial markets. This universal quality allows gold to mitigate extreme liquidity issues due to a lack of access to quality collateral.
Here is a chart of ‘Gold Repo.’ The ability to monitor gold repo is created from the buying and selling of gold futures contracts. Today was a very significant day in the gold repo market. A collapse today in the price of gold repo may signify the conclusion of gold being used extensively as a tool to stem liquidity risk.
The ending of the Federal Reserve’s quantitative easing program as well as the collapse in gold repo both display a financial market recovering from liquidity stress due to lack of access to quality collateral. This may bode well for the eventual recovery in financial markets to a sustainable path of growth. However, U.S. equity markets are not a good barometer of the health of financial markets. Equity markets may rise in times of extreme stress in financial markets due to lack of access to quality collateral. This is an inverted way to look at equity prices. A fall in equity prices may be a good sign that global financial markets are on the path to recovery.
Continuing to monitor the Arabica Coffee futures estimating that prices will not be able to trade significantly above the 194 level. This may be a great time to increase short exposure to Coffee futures via lower risk positions in the spread market. Coffee prices may need to fall much further in order to initiate absorption of excess stocks and stimulate reduced output. Coffee continues to trade in a moderate contango. True worries about physical supply should cause coffee to move into a backwardation market which is unlikely. Now may be a good time to begin positioning short on Arabica Coffee futures.
India’s cabinet committee on economic affairs approved a subsidy today for exporting tonnes of sugar. With the global market suffering from large inventories of sugar, India has created a situation where even more supplies of sugar may hit the global markets from the worlds second largest producer. Brazil, the largest producer of sugar in the world, criticized India’s sugar export subsidies sighting enhanced distortion of the global sugar trade. Sugar prices have been on a tear beginning the year 2014 up 6%. Forecasts of dry weather in Brazil have added to concerns over potential reductions in sugar supplies coming from the 2014 sugar harvest.
The Thai baht over the past three months had significantly weakened against the U.S. Dollar in the face of political unrest and massive protests. However, something has changed in Thailand. The currency markets are beginning to price in a recovery in the Thai Baht. The Bank of Thailand’s chief in the face of US Federal Reserve tapering has said their is no need for tighter monetary policy to stem dollar outflows. These comments from the Bank of Thailand chief assert Thailand’s optimism in its economy. The USD/THB currency pair has broke a major uptrend signaling a change in sentiment towards Thailand for the time being. This change in sentiment may be due to a belief in political unrest and massive protests subsiding or a solidified stance on monetary policy. Whatever the case, the currency markets are beginning to re-price risk in the Thai Baht which could mean the Thai Baht could increase against the Dollar.
A spectacular run up in Natural Gas prices possibly due to bad weather and inventory draws downs could be coming to an end. Above is a correlation chart between Light Sweet Crude Oil and Natural Gas prices. Natural Gas is now testing the $100 highs reached by Crude Oil weeks earlier. Hedgers may decide to swap cash flows between Natural Gas and Crude Oil to benefit from differences in margins between these two commodities. If the correlation between Crude Oil and Natural Gas is your guide, Natural Gas prices could be peaking at these levels.
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Investors seem to be a bit more than worried about equity exposure and volatility. The volatility term structure hit a new high today displaying the fear in the markets at this moment. A possibility of tapering by the Federal Reserve could be one reason for the rise in volatility hedging. Gold and Silver prices are also down significantly with Gold spot down -2.16% and Silver spot down -4.03%. Earlier this year, Gold and Silver prices where heavily sold off with Copper prices eventually falling significantly as well, marking a period of deflation in global markets.
By-products of processing soybeans include soybean oil and soybean meal. The crush spread is created to measure the profit margin of the soybean processor.
The crush spread currently being monitored is the January (buy 2 contracts) soybeans/March (sell 5 contracts) soybean oil/March (sell 22 contracts)soybean meal. This ratio creates the greatest accuracy for real world soybean processing margins.
The crush spread has been on an upward incline since the beginning of September. This upward move would imply soybean processors are offsetting risk by selling soybean oil and soybean meal. An increase in the crush spread would also imply soybean processors are expecting expanded processing of soybeans. With record projections of 3.42 bushels of soybeans harvested this year and Brazil on pace to pass the U.S. in Soybean production this year as well, soybean processors should stay very busy for the forseeable future. If this is the case, major profits from the soybean crush spread could be ahead.
Four warehouses in Brazil’s Santos Port holding over 300,000 tons of Sugar went up in flames this previous Friday. A high volume shockwave hit the Sugar futures spread market where commercial players hedge Sugar positions. The Mar 2014 vs May 2014 Sugar spread spiked 0.26 points from 0.16 to 0.42 or just under 300% on Friday alone. Later in the day on Friday, the spread came back down to earth closing at 0.27 still up just under 200% on the day.