Soybeans and the Sound of Snapping Rubber Bands
- Those who understand how markets work have known the soybean market's fundamentals have been bullish for more than a year, based on its futures spreads.
- Despite this, noncommercial traders have been consistently selling the market for the last six months, creating what I like to call a Rubber Band Disposition between the two sides of the market.
- Monday we saw the Rubber Band break, as it usually does, with noncommercial traders rushing back to get in line with the market's fundamentals.
That sound you heard coming out of the soybean market Monday following the release of the latest round of USDA supply and demand silliness was of rubber bands snapping. Recall from previous discussions one of the market situations I look for is called the Rubber Band Disposition. This occurs when the two sides of a market have diverging opinions. What are the two sides you ask? The structure of any market is made up of commercial (those who are actively involved in the cash trade of the underlying commodity) and noncommercial (investment money, funds, speculators, etc.). These two sides tend to spend most of the time moving together, generally speaking, but it’s when they don’t things start to get interesting. Newsom’s Rule #6 tells us “Fundamentals win in the end”, so as we watch these two sides pull apart, like a rubber band being stretched, we know at some point the rubber band will break, snapping back to its base. Again, that base is fundamentals.
At the end of each month, I post the latest Cost of Carry tables for the three wheat markets, corn, and soybeans to show how real market fundamentals change over time. In the case of soybeans, we can go back to the table for August 31, 2021 and see the Nov21-July22 futures spread closed at a carry of 21.75 cents and covering 26% calculated full commercial carry (cfcc). Keep in mind that the scale I developed decades ago has 33% or less cfcc as bullish. Fast forward six months to the end of February 2022, the midpoint of the 2021-2022 marketing year, and all of the soybean market spreads were in the red, or inverted, meaning real fundamentals had grown more bullish. Another quantum leap forward to the end of August 2022 and we find the Nov22-July23 at a carry of 7.25 cents and covering 6% cfcc. The bottom line is the commercial side was bullish, is bullish, and will likely be bullish for the foreseeable future.
On the other hand, noncommercial traders have spent most of the past 6 months (or more) reducing their net-long futures position (blue line on chart), as reported in weekly CFTC Commitments of Traders reports[i]. Here we see noncommercial traders have been consistently liquidating long futures (green line) since late February, reducing their holdings from a high of 274,000 contracts to a low of 143,700 contracts (week of July 26). Also note this group has been adding short positions (red line) since the end of June, their holdings growing from 47,300 contracts (week of June 14) to a recent high of 71,900 contracts (week of August 30). The end result of all this activity saw the net-long futures position (blue line) decrease from 226,500 contracts to 81,251 contracts in last Friday’s report, all while futures spreads have remained bullish.
We knew the rubber band was going to snap, for it nearly always does (recall the Absolut Truth in commodities that tells us the only absolute is vodka). A look at daily trade volume for Monday shows activity in the soybean market jumped to roughly 310,000 contracts, its highest level since June 23. Additionally, total open interest increased by 18,400 contracts indicating noncommercial traders were adding new long futures contracts rather than just covering short futures as some market bears suggested late Monday afternoon.
In the end, the rubber band snapped and allowed Nov22 to break out of its trading range between roughly $14.89 and $13.76. Simple math now tells puts the upside target near $16.00, but much will depend on how aggressively the rubber band snaps back to its fundamentals.
[i] Recall I look at legacy, futures only reports. This is the only set of CFTC numbers that really matter. Sure, I know the disaggregated breaks things down more, and includes option positions, but we have to remember investors and traders who use options do so for more reasons than being bullish or bearish. Therefore, if we want a read on investor bullishness or bearishness, futures only is the best place to look.
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