A good example at present is thermal coal, where a massive ramp-up in production since 2000 led to an oversupply situation, exacerbated by prices falls and lower demand in the post-GFC period. While price and demand recovery is still a couple of years away, the world’s major thermal coal producers have implemented production cuts over the past three years that have led to a stabilisation in prices and ultimately will lead to modest price recovery.

The situation in the iron ore industry is vastly different. Rather than reacting to plummeting prices with significant supply cuts, Rio Tinto and BHP Billiton have continued with their implementation of new mine expansions, further dampening prices.

The rationale for this is threefold: firstly, they can weather the iron ore price downturn because they’re used to operating at even lower price levels (as evidenced by the price chart below); secondly, it’s a great opportunity to drive competitors to the wall; and thirdly there’d be a huge loss of face in reducing output after hundreds of millions of dollars have been spent on expanding infrastructure over recent years.

The lower prices of iron ore have appeared to be inevitable for much of 2014. Supply side growth has looked likely to outpace demand growth in China, and steel production has been slowed as the government looked to tackle over capacity in the industry.

So the medium-term outlook for iron ore producers isn’t hugely appealing. Chinese steel production is expected to moderate due to a combination of slower macroeconomic growth rates and transitioning away from investment-led growth to consumption-led growth. All of this will coincide with a sizeable growth in world iron ore supply between 2014 and 2018.

Global iron ore exports are expected to increase by 10% (or 144 Mt) during 2014, whilst the period from 2015 – 2018 is also expected to generate continued strong growth, with annual supply increasing by 5.7% (or 88 Mt). This growth will essentially be led by the Big Four miners, which are expected to average 85 Mt of annual production increases for 2013 – 2015, compared to 45 Mt average annual growth during the course of the previous decade. The chart below highlights the location of new sources of iron ore supply:

In terms of the pricing outlook, iron ore prices are likely to trade between $140 on the upside and $110 on the downside, but with an overall weakening of prices. The reason is that supply is growing to meet demand, meaning the iron ore market surplus will most likely expand. This surplus is forecast to persist during 2015 and 2016, driven by continued large supply increases out of Australia and Brazil combined with slower steel production growth in China.

The iron ore business has for decades been dominated by three major players – Rio, BHP and Vale – which together have accounted for as much as 80% of the world’s seaborne iron ore trade. There’s a simple reason for this – iron ore is a bulk commodity, which means it’s typically a low-margin business, requiring mining and movement in enormous volumes to generate a reasonable profit. Being a bulk commodity, infrastructure costs are huge, with returns typically generated over a significant period of time.

The fundamental characteristics of the iron ore business – high capex/ low-margins/large volumes/massive funding requirements/medium to long-term pay-back – are not features that typically attract smaller players into the industry. The ultra-high pricing environment of the past decade or so that encouraged smaller hopefuls into the sector is in no way typical. Prices leveled off and have since receded sharply as supply catches up with demand.

As a result, iron ore is predominantly the domain of mining heavyweights that can utilise their sizeable balance sheets to minimize exposure to potentially crippling debt levels and periods of price volatility.

The big miners however appear to have badly miscalculated in terms of future iron ore demand. As Richard Knights, a mining analyst at Liberum Capital Ltd told Bloomberg this week: “I’ve always taken the view that the miners had the best intelligence on this as large investment decisions are based on it. But if they get it wrong by a just a small margin, that has major implications for profitability and the share price for years to come.”

What he’s referring to are predictions by the Big Three that China’s demand for iron ore wouldn’t peak until around 2025 – 2030. However, Wolfgang Eder (Chairman of the World Steel Association and chief executive officer of Voestalpine AG, Austria’s biggest steelmaker) this week commented that China’s steel output would peak in as little as three years, prompting plant closures rather than expansions.

“There has to be a restructuring of the Chinese steel industry,” Eder said. “The iron-ore producers are getting more and more aware that their growth expectations have to be redefined. There are enormous over-capacities and more is coming on stream. This will increase the pressure,” he said.

To put things into perspective, every year for the past decade, China has added new mills with the capacity to exceed the annual production of Germany, the largest steelmaker in Europe.

But iron ore production has risen at an even faster rate, to the point where the market shifted to a point of structural surplus during the middle of this year. Citigroup forecasts that this surplus will widen to almost 300 million tons by 2017. Against such a background of excess supply, it is difficult to see a significant and sustained recovery in iron ore prices, particularly if Chinese demand is set to peak and residential construction growth continues to cool.

Fed action (or a lack of it)
For several years now there have been calls for Fed action on interest rates. For example during February 2012, President and CEO of the Federal Reserve Bank of St. Louis, James Bullard, argued “the Federal Reserve should start raising interest rates next year.” At the time he disagreed with the Fed’s decision during January 2012 to keep interest rates exceptionally low through to late 2014 to bolster the US economy.
As Bullard argued back in 2012, many years of near-zero rates risks causing “disaster.” Keeping rates low for several quarters is very different from keeping them there for years, which punishes savers.
Charles Schwab took the argument further, arguing back in 2012 that rock-bottom interest rates were destroying confidence in the economy and were unwisely forcing older savers to take risks with their money in search of decent investment returns. This greater risk-taking has manifested itself in the form of US share and property bubbles, incentivized by the zero-interest rate environment and the Fed’s easy money policies.
In the US, older savers’ and pensioners’ incomes have been squeezed by falling rates leaving them poorer. Savings rates have lagged behind inflation, reducing real incomes, eroding the real value of savings and lowering consumer confidence.
The Fed’s easy money policies have distorted market prices, encouraged destabilizing financial speculation, as well as unfairly punishing savers. But the far bigger concern lies in the future: the economy and financial markets have become so dependent on QE and artificially-suppressed interest rates that it will be very difficult for the Fed to reverse these policies without major repercussions.
The danger is that they won’t be reversed in time – resulting in a different (but equally serious) set of potential consequences. The Fed has a well established tendency to not recognize the effects of its loose monetary policy, nor to tighten, until it’s far too late.
On top of having many unintended negative consequences, ultra-low rates may also be ineffective in addressing the real economic issues. The continuation of low rates points to a worrying lack of growth and also highlights the increasing risk of deflation and a potential contraction in economic activity.
As Stanley Yeo, portfolio manager at IOOF commented recently, “Given that growth and inflation are among the primary requirements for a relatively painless reduction in elevated debt levels globally, the enthusiasm with low rates and quantitative easing among investors is curious.”
“The clear hope is that low rates will revive the economy. The theory predicts lowering rates will boost bank lending and increase access to credit for purchases of homes or other goods and services, ensuring economic recovery. However, the reality is quite different. In Australia, Reserve Bank research indicates that the savings from lower mortgage rates are simply being used to retire debt, rather than for consumption. While the reduction in debt levels is necessary, lowering rates will, of itself, do little to boost demand and economic activity,” he says.
Another problem that low rates might provoke is to tempt borrowers into ignoring their balance-sheet problems. The result could be that the problems are left to fester, making it difficult for central banks to raise interest rates to a more normal level in future years, for fear of the damage this might cause.
Banks might also become too optimistic about the ability of borrowers to repay, and fail to make adequate provisions for bad debts. When investments are made during a period of artificially low interest rates they are often ‘malinvestments’ as the low rates may send false signals to entrepreneurs and home buyers that the economy is good and investments/purchases should be made.
The term ‘malinvestment’ is a concept developed by the Austrian School of economic thought that refers to investments of firms being badly allocated due to what they assert to be an artificially low cost of credit and an unsustainable increase in money supply, often blamed on a central bank.
The unprecedented moves by central banks which were necessary to stabilise markets have had the desired effect of stabilising the financial system in the short-term. The big picture issue involves the unintended consequences of these ultra-low rates.
Large amounts of existing and borrowed capital have flowed into the stock and real estate markets chasing assets that are rising in price, not necessarily based on fundamentals but on the notion that they are rising and the potential returns are greater than low interest-bearing investments.

A golden opportunity?
Thisultimately brings us to gold. Yet again, sections of the media have been in a frenzy suggesting that gold has lost its safe haven status. The reactionary herd punished gold in the aftermath of the Fed’s September commentary, but the price is showing resilience.
Last year the gold price crashed once it became clear that the US Federal Reserve was looking to cut back on its Quantitative Easing (QE) program, on fears that it was QE that had been supporting the gold price. What had been forgotten was that the gold price had advanced strongly prior to the term QE even being coined, but the market – with its ultra short-term viewpoint – seemed to have assumed that QE and the gold price were inextricably linked, thus marking the yellow metal down.

This chart is fantastic because it demonstrates that despite perceptions of gold being an arcane relic, it has outperformed the Dow Jones Index since 2008 and the NASDAQ Index since 2005. In fact, only with the Dow at its current all-time high has it managed to recently surpass gold.
And to all the doubters that believe a rising US interest rate environment is bad for gold, in fact the opposite is true. The real driver of gold prices is negative real interest rates (defined by nominal interest rates minus inflation).
Central bank policies of inducing negative real rates to ‘incentivize’ borrowing, expand the money supply and devalue currencies – have forced investors (especially mums and dads) into real assets like gold and silver. Debt is inherently inflationary if you have the ability to print your own currency.
Gold of course rose along with interest rates during the 1970?s and this is sufficient to prove that gold doesn’t always fall when interest rates rise. The gold bull market of the 1970s was dominated by inflation – interest rates rose steadily to keep up with it, but real interest rates were mostly negative the entire time.
It’s possible to remain positive on gold and remain confident that the flow of gold from West to East will continue. China and India continue to be major buyers, but over recent times they have been joined by the Russian central bank. In fact the latest figures show that the country’s central bank purchased another 37.33 tonnes of gold during September, bringing its gold holdings to almost 1,150 tonnes – the seventh month in a row it has increased its gold reserves. It was also its biggest monthly increase overall.

Of course, many ordinary US investors like retirees and those saving for retirement, have been hugely disadvantaged by the Fed’s low interest rate policies since the GFC. The value of savings has been wiped out due to inflation, with investors forced to chase higher-risk opportunities in the sharemarket and the property sector. This has led to greater risk taking and led to speculative bubbles in both shares and property.

A good example is recent Bloomberg data that shows that only twice in the past 25 years have new apartment buildings in the U.S. been constructed as quickly as they are right now. And that’s not necessarily a good omen. The first occasion during February 2000 was right before the dot-com bubble burst. The second time, January 2006, came just before the housing bubble burst.

What’s interesting is that since the GFC, a lot of popular theories relating to the demise of gold have been proven false. A popular theory during 2009 was that a “green shoots” recovery would cause gold prices to collapse – but they didn’t. Then there was the popular “contrarian” argument that the real threat was deflation, and that gold would sell off as a result. But gold didn’t follow the script, rising instead of falling.

Now it’s the notion that rising interest rates will kill off gold.

One of the major reasons cited by commentators and financial experts for gold’s recent sell-off has been the prevailing view that interest rates will inevitably rise as economic growth builds. Central banks (the US Fed in particular) are also concerned about the long-term implications and economic distortions caused by a low interest rate environment.

There is a widely held view that a rising interest rate environment is negative for gold. While there may be a question mark over the robustness of the overall recovery scenario, let’s assume that interest rates will rise in line with perceptions of economic growth. Why shouldn’t gold benefit from a rising interest rate environment, just as it has done in a low interest rate environment since 2008?

Let’s examine the evidence of recent history. Significantly, gold rose with interest rates during the 1970s and this is sufficient to prove that gold doesn’t always fall when interest rates rise.

The real driver of gold prices is negative real interest rates (defined by nominal interest rates minus inflation). Central bank policies of inducing negative real rates to ‘incentivize’ borrowing, expand the money supply and devalue currencies, have forced investors (especially mums and dads) into real assets like gold and silver. Debt is inherently inflationary if you have the ability to print your own currency. As the chart below highlights, it’s happened before.

In a gold bull market that has been fueled by negative real rates, conventional thinking would suggest rate increases would, at the very least, halt the rise of gold as negative real rates get closer to turning positive. However, history actually says the opposite is true. The gold bull market of the 1970s was dominated by inflation. Interest rates rose steadily to keep up with it, but real interest rates were mostly negative the entire time.

Peaks in gold prices since 1975 have usually been associated with rising real interest rates. Occasions when real interest rates fell in tandem with gold prices include the period from 1987-1990 and from 1996-2001. Even though real rates have risen slightly, they remain below their historical average and levels below 2% have still been supportive of rising gold prices.

As the chart below from Goldman Sachs demonstrates, gold prices languished from 1980 to 2000 and had declining correlations with debt levels, because GDP growth was sufficient to suppress fears about budget and deficit issues. The current economic recovery has been too weak to support a sustained rise in real rates above the 2% level that has acted an inflection point for gold prices.

With energy and food inflation deepening and soon to affect consumer price indices, interest rates may have to rise significantly in order to restore real interest rates above 2%. This is exactly what ex-Federal Reserve Chairman Volcker did during the late 1970s, when he increased interest rates above 15% in order to protect the dollar and aggressively tackle inflation.

Despite the lower gold price (or perhaps because of it), central banks outside of Western Europe and North America are continuing to increase their gold holdings. According to the latest World Gold Council statistics, central banks have been buying gold at a higher rate than last year, with a reported 240 tonnes of purchases during H1 2014 compared to 180 tonnes during H1 2013.

The above chart highlights the strong relative performance of gold compared with both the Dow Jones and NASDAQ indices since 2000.

You could remain positive on gold if you remain confident that the flow of gold from West to East will continue. There is robust price support around the US$1,200 mark, a situation that may continue for the foreseeable future.

EIA officials have admitted that previous estimates of recoverable oil within the Monterey shale reserves in California of about 15.4 billion barrels were vastly overstated. The revised estimate has slashed this amount by an extraordinary 96% to just 600 million barrels of oil. The assessment cut US national reserves by 39%.

The Monterey formation, previously reported to contain more than double the amount of oil estimated within the Bakken shale in North Dakota, and five times larger than the Eagle Ford shale in South Texas, was slated to add up to 2.8 million jobs by 2020 and boost government tax revenues by $24.6 billion annually.

The main reason for the downgrade was that the original 2011 estimate mistakenly assumed that California’s shale oil and gas could be recovered with as much ease as it is elsewhere in the country.

However, the geology of the Monterey Shale is much more complex than in the Marcellus, Bakken, or Eagle Ford Shales – the three formations principally responsible for the surge in oil and gas production within the USA. The layers of shale in the Monterey are folded in such a way that drilling is difficult, and test wells thus far have come up disappointing.

The Los Angeles Times quoted a downbeat assessment from an official with the EIA. “From the information we’ve been able to gather, we’ve not seen evidence that oil extraction in this area is very productive using techniques like fracking,” said John Staub, a petroleum analyst with the EIA. “Our oil production estimates, combined with a dearth of knowledge about geological differences among the oil fields, led to erroneous predictions and estimates,” he added.

The oil and gas industry was quick to point out that the calculation could change once again if drillers could improve technology to access the Monterey. After all, no one saw the shale revolution coming only a few short years ago. But as Staub, the EIA analyst noted, for now oil and gas production in “the Monterey formation is stagnant.” And it could remain that way.

The sharply downgraded numbers come amid a heated debate within California at the present time over whether or not the state should permit oil and gas companies to use hydraulic fracturing (“fracking”) – the process in which a combination of water, chemicals and sand are injected underground at high pressure in order to break apart shale rock and access trapped natural gas.

Of course, issues over fracking are nothing new to industry participants, residents, landowners and activists on Australia’s east coast, where the ‘social licence’ of the industry to operate is an extremely hot topic of conversation and much debate at the present time.

The parallels between Australia’s east coast and America’s west coast are significant. Like NSW and Queensland, California is home to an enormous agricultural industry and with the Monterey Shale being situated beneath the fertile Central Valley, fracking is competing with agriculture, grazing and other commercial and residential users for water use.

On March 20, Santa Cruz became the first county in California to ban fracking. The move may have been symbolic though, since there isn’t much of a presence by the industry in that locality. It was aimed more at putting pressure on Governor Jerry Brown to stop fracking within the water-starved state. That follows a unanimous February vote by the city of Los Angeles to ban the practice, the largest city in the USA to do so.

But the issues with respect to California’s Monterey Shale are, in my opinion, even more significant from a broader industry perspective.

Just recently, the cover of Barrons magazine read “Here Comes $75 Oil”. The article argues that due to several new ‘game changers’ within the oil production industry, the oil price would fall to $75 a barrel within the next five years.

The three main reasons it argues that would contribute to cheaper oil are deep-water oil, shale oil and oil sands. All of these new-found resources are estimated at roughly 1 trillion barrels in newfound oil. When added onto the existing global oil reserve that’s currently estimated at 1.5 trillion barrels, this newfound oil is potentially a major factor in the future of oil pricing.

The article also references Citigroup energy analyst Eric Lee, who believes that most of this new oil could be recovered for around under $75 per barrel, leading to a global decrease in price.

The reality however does not marry up with such an optimistic outlook. After examining existing extraction cost data, it is hard for the supply-side economics to actually work out and support $75 oil for a sustained period of time. According to the EIA, worldwide consumption of petroleum products is forecast to grow by 1.2 million barrels per day during 2014 and 1.5 million barrels per day during 2015. This increased demand would put worldwide oil consumption at 91.60 million barrels per day during 2014 and 92.97 million barrels per day during 2015.

Last year, total world oil production came in at 90.33 million barrels per day, compared to a global consumption of 90.38 million barrels per day. The EIA would agree with the Barron’s article that new-found oil reserves will offset the current deficit, but current estimates show that newfound oil reserves would only add 1.3 million new barrels of oil to the existing world oil market.

This would put total supply estimates for 2014 and 2015 at 91.67 million barrels per day and 93.0 million barrels per day, a slight surplus, but not enough to justify a 25% decrease in price. The below graph highlights the EIA’s estimates for global oil supply and consumption over the past two years and its forecast for the next two years:

With respect to shale oil and gas, its method of extraction and production is difficult and costly. The primary reason for this is due to the fact that the oil is heavier and flows more slowly. This ultimately drives up the costs of production compared to more conventional oil extraction methods used by OPEC nations. Given the necessary time, difficulty, and cost, shale production break-evens within the US can range anywhere from $60 to $80 per barrel. At current oil price levels, there is room for healthy profits, but if prices were to contract, that healthy margin would evaporate, impacting production.

As oil price contraction becomes a possibility, several of the area’s largest producers – Continental Resources, Statoil, and Hess Corp – are all working to try and bring down the costs of production. Thus far, these firms have been successful at decreasing costs, but given the overall difficulty in extraction, those costs can only come down so far.

This should come as a signal that any significant downward change in the price of oil would be a major headwind for the continued operations of these firms, especially as they continue to push to increase output.

The EIA estimates that this year the U.S. will produce an average of 8.54 million barrels of oil per day. Compare this to the EIA’s estimate that the U.S. on average consumes 18.49 million barrels of oil per day. Even with the strongest domestic oil output since 1986, the US is still short by almost 10 million barrels per day of just meeting its own demand. When comparing total estimated US oil output during 2014 to the EIA estimates of global oil demand, US oil production in 2014 will only make up 9.32% of total global demand.

Some might argue that as more wells come online, US production will increase and make up a bigger piece of the pie. However, one of the biggest criticisms of standard shale wells is the short lifespan of the wells. Global Sustainability estimates that the US will need to drill 6,000 new wells per year at a cost of $35 billion just to maintain current production levels. Given this, the firm believes that by 2017 the US will hit its max production levels and ultimately return back to 2012 production levels.

Essentially, strong overall oil prices have encouraged the advent of shale energy and are continuing to facilitate its sustainability. Whilst shale can produce vast new volumes of oil, this comes at a cost – and relies on a strong underlying oil price for its sustainability. Shale can supply vast new oil supplies, but we must be aware of its limitations in terms of cost and other impacts.

A unique beast

The meat and livestock sector is the least popular part of the commodities market. This is for a number of reasons.
Firstly, agricultural commodities are generally shunned by retail traders because of their lot sizes. While exchanges and brokers have responded to the demand for metals and energy trading by producing smaller contract sizes, this has yet to occur for most of the agricultural space.
The meat and livestock sector was traditionally the domain of producers and industry insiders and this has also caused retail traders to steer clear of these markets.
Markets experts also say there is a higher level of knowledge needed to be comfortable trading livestock – even if technical analysis is your primary tool.

Hold it there, buster!

If you think you are going to rush out and start trading pork bellies, think again. We’ve got some bad news for you.
In recent years – certainly since the turn of the century – there was a marked decline in the amount of volumes we saw in the pork bellies market.
In July of this year, the Chicago Mercantile Exchange, or CME, announced it was bringing the trade in pork bellies to a close.
This is a far cry from the heyday of the contract back in the 1960s and 1970s, when it was the most traded contract on the CME. It’s for this reason why the pork bellies contract was so often part of popular culture in that bygone era.
Before the days of an integrated food industry, frozen pork bellies were used to provide bacon to hungry US consumers all-year round.
In particular, pork bellies were produced and stored during the winter months for use during summer when tomatoes ripened and Americans of all creeds and colours munched down on their bacon lettuce and tomato (BLT) sandwiches.
However, a stark reduction in demand has seen the pork bellies market disappear from trading screens.

The three that matter

With pork bellies gone the way of the dodo, there are only three major meat and livestock commodities.
Feeder cattle are those steers or heifers that are mature, usually at least a year old, and can be placed into a feedlot. A feedlot is where they are brought out of the pasture and into an area to be fattened prior to slaughter.
Of course, the majority of the information needed to trade is US-centric.
In the case of feeder cattle, most of the data is contained in individual state reports. However, the Feeder Cattle Index is published by the US Department of Agriculture (USDA) and comes out on a weekly basis.
The weather is a major determinant of price. In very hot weather, cattle are moved along the supply chain more rapidly, resulting in lower supply and therefore higher prices. Feeder cattle are traded in US $12.50 lots.
As they move further along the production line, they then become classified as Live Cattle. The monthly “Cattle on Feed” report is seen as one of the most important economic releases.
Like feeder cattle, live cattle contracts are influences by the weather, but over the longer term, the natural life cycle impacts on cattle prices in the same way as other agricultural commodities. Live cattle are traded in lots of US $10 per point.
Lean Hogs also trade at US $10 per point. Lean hogs prices are closely tied to the price of corn as this commodity is most often used in feed.
The major economic release in lean hogs is the “Hogs and Pigs” report released by the US government near the end of the quarter.

Specifications

All contracts are traded for virtually 24 hours per day (with a one-hour break each day).
One of the reasons retail traders had previously not been overly interested in the sector is because of the shortened trading hours in the US pits. However, the move to electronic trading has made access to trading and information far more efficient.

“Okay, pork belly prices have been dropping all morning, which means that everybody is waiting for it to hit rock bottom, so they can buy low. Which means that the people who own the pork belly contracts are saying, “Hey, we’re losing all our damn money, and Christmas is around the corner, and I ain’t gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain’t gonna make love to me if I got no money!” So they’re panicking right now, they’re screaming “SELL! SELL!” to get out before the price keeps dropping. They’re panicking out there right now, I can feel it.”

Billy Ray Valentine, Trading Places

The most obvious example is for perishable commodities. For commodities such as wheat, rice and orange juice, there are periods of the year that are more crucial than others.
For example, in wheat, we usually see prices decline in the early part of the year as famers in the northern hemisphere sell their crop and prepare for the next planting.
As hopes grow for a solid crop, the price usually falls into the middle of the year.
However, after the harvest, in mid-August, prices often rise as the harvest disappoints.
So, we can clearly see there’s a real world influence on the markets. As supply increases, for example, after the harvest, prices fall.
On the other hand, several months after the harvest, with growing uncertainties about how the crop will perform, prices can often rise.

Time for gold
From this example, we can see there are plenty of reasons for the calendar to affect our trading.
In gold, there are several important seasonal influences.  Most obviously, gold tends to move in line with the cycle in equity markets.
Equity markets often experience losses in the middle of the year as investors in the northern hemisphere go on holidays. This is the reason you might hear the old saying “Sell in May and go away”. Equity markets are often weaker mid-year and stronger from September to April.
So, the major cycle in gold is to weaken during the northern hemisphere’s summer doldrums and push higher for the rest of the year.
Weddings, love and Diwali
But it’s not just the equity markets that influence the gold price.
As we lead into the end of the year, demand for jewellery really picks up.
As we all know, the major time for jewellery in the western world is Christmas and then Valentine’s Day.
Of course, it takes time to produce jewellery, so the majority of gold is bought in September and October.
Additionally, markets experience huge demand from India at this time of year. First of all, we have the Diwali festival of light which, along with fireworks, has gold as one of its centrepieces.
Immediately after Diwali, we have the Indian wedding season, another time that see a large amount of gold purchased. The wedding season continues until April.
And don’t forget China!
And, added to all of this, we have the Chinese New Year in February! By the time April rolls around, we’ve had weddings, Diwali, the Chinese New year and Valentine’s Day.
From there, it’s time for gold to take a pause until it picks back up again in September.
Of course, there’s a whole lot more to do with how gold moves than just seasonality, but it’s certainly an important part of the mix.

Sitting pretty
Evans & Partners senior research analyst Cathy Moises says gold stocks aren’t undervalued according to her analysis, but they haven’t exactly outshined other stocks either.

Moises said that apart from Newcrest Mining, Australia’s largest gold miner, most of the Australian market’s gold shares are currently trading at an appropriate valuation.
Moises said Newcrest traditionally trades at a much higher valuation because of its position as the only large, blue-chip gold miner on the local market. As a result institutional investors really have only one option if they want to own gold stocks.
Therefore, the large institutional investors are happy to pay a premium for exposure to the gold sector via Newcrest.
This is certainly different from the 1980s, when gold miners typically traded around 100% to 150% above their valuations.

High Aussie Dollar
While gold prices have surged in US dollar terms, that hasn’t been the case when gold is priced in Australian dollars. In fact, while the US dollar gold price rose from about US$850 at the start of 2009 to more than US$1400 currently, the Australian dollar gold price has gained less than 10% for the same period.

This is because the Australian dollar is closely tied to the gold price. As gold prices rise, so does the Australian dollar, and this causes local gold miners to miss out on some of the benefits of the higher gold price.
Moises agreed that the gains in the local currency have also hampered gold prices: “The higher Australian dollar have definitely had an impact, because the miners gains earn their revenues in Australian dollars.”

Move unsustainable?

According to Moises, another reason for the lethargy in gold shares is because the market might not be convinced that gold will stay at these lofty levels.
The way investors traditionally value companies is by typically taking a very long-term view of their future earnings.
To use the lingo, a company’s share price is the current value of their future cashflows discounted over time to account for interest charges (which you would receive if you just put you money in the bank).
So, when looking at gold stocks, it’s up to investors to figure out whether high gold prices will stick around.
This is one reason why mining stocks are so volatile: no one knows how much they will be selling their wares for in six months’ time – let alone ten years!
“One could say that people are anticipating that this gold price won’t be around for ever,” Moises said.

Not all stocks are created equal

Australia is struggling for the kind of large-scale mining stocks that the big institutional money managers, such as the superannuation funds, can get a decent sized position in.
“The other major issue is that there have been quite a few takeovers in recent times. In the big cap space, apart from Newcrest Mining, there isn’t really much left in that space,” Moises said.
Of the many gold takeovers in recent years, Newcrest’s takeover of Lihir Gold was the most prominent.
With most stocks currently trading broadly around their valuations, Moises said the best opportunities would emerge from stocks with exploration potential.

Game over

Australian gold shares haven’t provided the bang for the buck that many investors would have hoped for as gold surges towards US$1500 per ounce.
So should investors think about alternative options for gold exposure? Investors can consider taking margined positions in the gold futures market, getting exposure through the locally-listed GOLD ETF, or even taking physical delivery.
While these options reduce the stock-specific risk of owning gold shares, investors still have exposure to currency risk, and even greater risk to the downside if holding margined positions
That said, there’s an old Australian sharemarket folklore that says the share price of Newcrest is a leading indicator of the gold price. If that is so, then gold might have its best gains now behind it.

A short (black) history of coffee

Coffee futures first traded in New York in 1882 on the Coffee Exchange of New York. While metals trading had been always been dominated out of London, coffee development was guided from New York, with other international exchanges taking their lead from New York.
There are two different coffee contracts. The most actively traded contract is the Arabica contract. This is the benchmark “C” contract. Arabica, the more difficult plant to cultivate, is grown at higher altitudes, produces a milder, more aromatic and more complex coffee than the alternative, Robusta.
The Robusta coffee is made from the hardier Robusta tree and has higher caffeine levels and a stronger, more bitter taste. Robusta has traditionally been traded out of London.

Trading in

Soft commodities differ from energy and metals. They are generally grown and include cocoa, sugar and coffee. Soft commodities can also include other products such as grains, cotton and orange juice, although these can also be characterised as agricultural commodities.
Traders and analysts view these types of commodities as a specific sector. While each are unique, they also share a number of qualities.
After the acquisition of the New York Board of Trade in 2007, the centre of coffee trading became the ICE (Intercontinental Exchange).
The contract trades from 8:30am to 7pm GMT. So we can easily watch the opening of the day, with it starting in the Australian evening.
The main contract traded is the Arabica contract out of New York. Coffee is priced in US cents. One pound of Arabica coffee started the year trading at 244.50 cents.
The tick value, or the amount it can move each trade, is 0.05 of a cent, and each move is equivalent to US$18.75 per contact. Therefore, each full cent is US$375.
The coffee contract can easily move five or ten cents in a session and that equates to days on which you could be up or down as much as $3750. As you can imagine, it’s not for the faint-hearted.
CFD providers offer a number of smaller contracts, for example IG Markets offers mini contracts that are half the standard size.

Price drivers

Orb Investment Management managing director Akhilesh Kamkolkar said the best way to understand prices is through fundamentals. This is because one of the major drivers in the market is supply.
“The amount of coffee people drink doesn’t really change. If demand doesn’t change much, then supply becomes the major driver of price,” he said.
“Rainfall is all important. If you see a large amount of rain in Vietnam for example, which produces a large amount of Arabica, then a good crop could really cause prices to fall.”
Seasonal factors also play a part. Some market analysts believe different forces throughout the year particularly influence the agricultural commodities. June and July are often seen as periods of weakness for coffee futures.

Daily heart-starter

As well as being one of the most-traded commodities, coffee is also one of the most volatile.
One of the major reasons for coffee’s volatility is the high probability of supply disruptions. This is because virtually all production is outside of the OECD group of countries. In less stable countries, such as some in Latin America and sub-Saharan Africa, political strife can cause supply disturbances.
Also, throughout the 1990s and 2000s, governments such as Vietnam pushed prices higher by buying supplies as they attempted to increase market share.
Kamkolkar said the nature of the coffee market means that trade is generally fairly thin.
“Coffee contracts trade in London in the hundreds, so if there is a sudden rush of funds into the market, we can see price rise higher very rapidly,” he said.
So is there a place for coffee in a trader’s universe?
The trader with limited funds or the technical trader might consider giving this market a miss.
Kamkolkar said he find technicals give only part of the story in a market that is often driven by unpredictable events such as freak weather conditions or political unrest.
Also, the large position sizes can cause a trader with a small account to be wiped out pretty quickly.
But traders that are driven by fundamentals, with larger accounts, or a weather fetish, might start investigating further.

When will it end?

According to Briganti, gold is likely to remain buoyant as long as the US Federal Reserve continues to try to encourage growth and inflation through policy.
Most recently, the Fed’s move to buy $600 billion worth of bonds, in a measure known as quantitative easing, has signalled that the Fed remains resolutely on the path to drive inflation higher.
“When we hear that the Fed is looking to rein in inflation, then we might see gold start to ease,” he said. We are unlikely to hear such commentary from the Fed until late 2011, Briganti said. “Until then, the most likely trajectory for gold is sideways or higher,” he concluded.