DTN Six Factors: Price, Probability or Value in Commodity Markets

To understand a commodity market, we have to start with a basic understanding of the two main players involved: the producers and the end users.

Because the market needs both players to function over time, prices in a healthy, balanced market rotate up and down, distributing advantages back and forth. The Price Probability of these swings within periods of time is a simple representation of commodity’s value.

Commercials

The second of the DTN Six Factors that relates to a commodity’s value comes from commercial net holdings in CFTC’s weekly Commitment of Traders reports. Commercials are in the business of handling grain. Firms like Cargill, ADM, Bunge, ethanol plants, etc. report their large futures positions weekly and we can generally see if this group is net long or net short. In my experience, commercial firms know more about demand than anybody. It pays to notice their positions. When commercials go net long on the futures board, it is often a sign of active demand from end users.

Seasonals

I’ve seen countless trading approaches come and go, but there is one consistent market phenomenon for cash corn and soybean prices, and it has earned its place on the DTN factors list: Seasonal trends.  Over the past 50 years, corn and soybeans typically trade near the lowest prices in early October and near their highest prices in early June for corn and late June for soybeans. Yes, there are exceptions, but statistically speaking, this pattern is extremely helpful in the most confusing of years.

Volatility and Trend

Volatility and trend are two of the DTN factors that fall under the heading of technical analysis. These two factors also work well together with seasonality. In a typical winter, for example, grain prices tend to be quiet, showing low volatility and are not apt to take off in a directional trend. There is no doubt trend is a powerful market factor, but like dynamite, it needs to be handled carefully and with adult supervision.

Noncommercials

Noncommercial positions are the final DTN factor to discuss and play a big part in helping us understand when a trend can be trusted and when it cannot. To understand the role of noncommercials, or speculators, in the market, think of them as a bad poker player with a lot of chips.

Don’t get me wrong, when speculators are betting in the direction of an obvious fundamental change, noncommercials can drive a strong trend. We saw this when noncommercials went long in corn in 2006 as more acres were needed for ethanol.

However, most of the time, like our newbie poker player, noncommercials are simply following trends without a strong understanding as to why. Because they have a lot money, they can drive prices, just as we saw their futures positions drive corn and soybean prices higher in the spring of 2018 and corn prices lower in the spring of 2019.

Without strong fundamental backing however, those trends didn’t last and noncommercials quickly found themselves on the losing end of rising margin calls. They liquidated positions, folding their once-confident poker hand. Noncommercial failure is a frequent event in markets and, when considered along with the other five factors, gives DTN a better understanding of what to expect from prices.

Read more about the Six Factors Market Strategies.

Next: Market coherency