Second part of interview:
Q: "Just." How do you track what commercials and speculators are doing?
A: In part, by reading Barron's statistical section. Every two weeks the government
requires all commercial users of commodities to report what contracts they hold. They
have to tell exactly what they've sold or bought, the government accumulates the data --
and you print it.
Q: You assume that speculators hold everything that's left over?
A: Yes, but our speculator data stream is a proprietary combination of that calculation,
which we do by using the information in your pages, with data on the large hedge-fund
positions, which aren't normally reported in the press, and some proprietary data on the
mass psychology of the very small trader. So our speculator data stream is basically a
connect-the-dots theory. But if you take a long period of time and watch the ebb and
flow of the commercial and speculator positions, you can see the extremes in emotion
set up very easily.
Q: Can you be a little more specific about how you gauge speculator sentiment?
A: We deal with a whole series of outside contractors, who literally go from one end of
the spectrum to the other of ways to understand what the small trader is up to. Some of
the psychology-driven data sources actually sample, every day, 200 or 300 traders
across the country. They literally go down a checklist:
"How do you feel about corn today?"
"Well, I feel bearish or bullish."
But you'll get some markets -- like coffee right now -- where they say, "Don't even talk
to me about coffee, I hate that market."
Well, when the speculators hate a market and the commercials are long, we want to be
looking for an entry point to buy. That's what we see as a loaded gun for a change in
trend. At any one point in time you may have half a dozen of those unfolding. What
this proves is that trading on emotion is exactly the wrong thing to do. You must trade
on a fundamental understanding of the position of the market. If you cannot do that,
you might as well go to Vegas, where you'll have a little more fun losing your money.
Nonetheless, Mike and I have watched, for years now, as speculators literally kept
fighting a war they can't win.
Q: Why is that?
A: I think it has to do with the emotional makeup of a trader, when he's in a position that
isn't working. The one thing it's difficult for the speculator to do is admit that he was
incorrect. I mean, he becomes married to a position in the commodities market much
more strongly than he becomes married to, say, IBM.
Q: Because of the mesmerizing effect of leverage?
A: Good point. What I've observed is that a trader will do a lot of work to decide if
soybeans are a good buy at $5.25 a bushel. Once he's decided that's a good value, he's
made a subconscious decision that soybeans are the right thing to invest in. If he's not
willing to admit to being wrong, what does he do when they hit $5? Unfortunately, the
small trader most of the time decides beans are an even better value, and buys more.
Quite rapidly, the financial pain turns into emotional pain -- and becomes quite awful,
because of the leverage. And when they get emotional, I can't tell you how many times
they'll sell right at the bottom. The most difficult thing for most traders to do is to cut
their losses when they're small. That's why a very common mistake people make is
going into the commodities market with the idea, way in the backs of their minds, that
just like Uncle Harry -- or better yet, Mrs. Clinton -- they'll turn $1,000 into $100,000 in a
trade or two. They think it's almost like the lottery, yet the true odds of it happening are
like those of winning the lottery -- almost zero. So they hold on for the wrong reasons,
buy and sell for the wrong reasons. The easiest way to deal with that difficulty is to
decide -- before you make your trade -- that you're willing to lose X-dollars to find out if
you're correct. Because the commodities game is a game of staying alive. If you lose all
your money in two trades, you didn't give yourself a good chance of succeeding. And
-- I can tell you -- even with the best research, most of your trades will still get stopped
out at a loss. It's just the dynamic of the market. You have to be able to say, "I'm willing
to take small losses to stay alive for the possibility of the future big gain."
Q: Are you implying that even when you see speculator and commercial positions at
extremes, you can't tell when -- or at what level -- a price trend will reverse?
A: Commodities prices can take volatile swings and the trends can take a long time to
unfold. The reason is that the commercials are taking positions based on the supply and
demand fundamentals of the commodity. They don't particularly care about price.
They're not there to make money on cattle. They're there to buy it when it is valuable
because they know what their clients are demanding and what the available supplies
are. Whatever the price, they are going to pass it on to their customers. So only the
speculator is buying a commodity based on price. And there are only four possible
outcomes in a commodities trade: We can lose a great deal of money. We can lose a
little bit of money. We can make a little bit of money. Or we can make a very large sum of
money. So the first thing we've structured our research to do is negate, as much as
possible, the possibility of losing a lot of money. If we can do that, the odds are very
high we'll be successful in the long run. We can take small losses because the small
losses will be offset by the small gains. Then we'll be around to catch the trends, which
we know exist. So we don't take a position until these emotional extremes set up on the
charts. And even when they do, still use very short-term entry techniques to trade. For
example, after our charts showed the emotional extremes setting up in the soybean
market recently, we entered the market three different times -- and got stopped out three
different times for very small losses -- before we finally entered at the right time and
made those losses back, plus three times as much, in very short order. So clearly, once
you have the loaded gun, you have to be willing to practice very dynamic risk
management. Commercials can be long for a long time before the market turns around --
and if the market sinks another 10% in the interim, the leverage inherent in commodities
contracts could kill me. I'd rather get stopped out for a small hit, clear my senses, look at
the market again for another entry point.
Q: Then your indicators tell you nothing about timing?
A: Not nothing. The longest I've ever seen something go before it turned in the
direction of an extreme long or short position by commercials is probably 90 days. An
interesting thing about the commodities markets is that they spend a good part of their
time in range-bound trading, at a top or a bottom. Then they'll rapidly move between the
two. When a trend starts, it moves fast, which is why you have to get positioned ahead
of it.
Q: Where are your charts telling you
the next major moves will come?
A: What our research is beginning to
tell us is that all of the stories about no
inflation and continuously dropping
interest rates are about to prove fairy
tales. We've reached the trough in
psychology about inflation now -- the
opposite of that extreme back in the
mid-'Eighties. Now the theory is that
productivity will lick inflation forever.
But what I'm here to tell you is that
while I'm no wizard, and Mike and I
don't know anything more than anyone
else could, if they studied it long
enough, there is something different
taking place here.
Q: But virtually every commodities
market is still trending down, much as
it has been for at least the last decade.
A: What's different is that on all these
lows, almost across the board, the
commercial users are buying more than
they have ever bought -- and they are selling bonds. I'm no market guru, but I can tell
you that's not a good sign for the bull market in stocks. Our charts show commercials
selling more bonds than they have in 12 years -- at the same time the financial press is
telling us that rates are going to 5% or even 4 1/2 %.
Q: Not all of it. But so what?
A: I like that -- I can't tell you how many times the press chorus has gotten loudest, just
as the market's direction was about to change. Meanwhile, what's fascinating here is
that this short in bonds by commercials isn't just a fairly large position, this is a huge
position. As you can see on the chart, it is about twice the size of their largest short
position in the last 10 years. That's a pretty strong statement about interest rates.
Q: The bull market in bonds is kaput?
A: I can't say that. The chart could be pointing to a change in the direction of rates that
lasts only four or five months. This could be a four-point correction in bonds -- on their
way to 3%, who knows? But the position of the commercials says that they don't see
rates going to 4 1/2 % right now. They may go back to 7% first. I'm not calling an
interest rate here.
Q: It sure sounds like you are.
A: What I'm telling you is that they are putting their money on interest rates going up,
for the foreseeable future, until they change that position. And I wouldn't bet against
them and hope the commercials are wrong.
Q: So you are short bond futures?
A: Yes. In fact, we shorted them up at 123.26, to be exact, which was about a point off
the high. Not only are the commercials extremely bearishly positioned, but speculators
have only been this bullish on one other occasion -- and they were wrong then. So I
would not be going long bonds today. There's just too much evidence that you either
stand aside or go short. This is not going to end well for bonds. And until bonds trade
back above their high, say clear 125, this signal won't be negated.
Q: And you see similar disparities in the commercials' and speculators' positions in
other commodities?
A: Yes. Take the deutschemark, which has just experienced three or four little legs
down. We were looking for that move a month ago. It happened almost on cue. There's
been hardly any notice of it, but it amounts to several thousand dollars a contract. We
knew the odds were good for a good move when the commercials reached a 10-year
extreme in being short the deutschemark about six weeks ago, while the speculators just
loved it. Now they are not buying it any more. In fact, they are selling it probably at a
bottom. The even bigger story is what's going on in the yen.
Q: The intervention, you mean?
A: Well, it's interesting that while many market watchers say the yen went up
because [U.S. Treasury Secretary Robert] Rubin stepped in and protected it,
our research says that's putting the cart before the horse. Long before Rubin
stepped in, the commercials -- who know more about the dynamics of the
yen than we're ever going to know -- had placed an extreme bet that the yen
had gotten low enough. In five days, that move was worth over $6,000 a
contract. Especially in currencies, these moves can happen very fast. We saw
the same sort of thing in silver, well before Warren Buffett's position was
announced. I suspect that we've probably heard the last of the really bad
news about the yen. The more people talk about how bad it can get, the more
likely it is not to get worse -- that's what the commercials are saying, not just
in the yen, but in about every hard asset.
Q: They are?
A: Our gold chart is actually frightening to me because I like to watch the
stock market go up. But our data are telling us that the commercials are very
long gold and very short bonds. That tells me that they don't see these
deflationary trends lasting for the next 10 years. Money is flowing into
crevices that are saying interest rates might have gotten about as low as they
are going to get right now. They may get lower in the long term, but not right
now. And gold isn't going to $200 an ounce. In fact, it may not go much
lower than it is right now. We are long gold and profitable.
Q: What about the ag commodities?
A: The same sort of interesting picture is starting to form, whether you look at
sugar or coffee or soybeans or all the grains-commercial positions at or near
long extremes, while speculators can't stand the stuff. In coffee, for instance,
these current price lows are being bought by the commerical users. That
implies that the next trend in prices will be bullish. The same with sugar, where
the move has already started. We read the commercials' position as at a long
extreme when sugar was at seven cents a pound. It's already almost nine
cents, producing a gain of a couple thousand dollars per contract.
Q: And oil?
A: It's funny, but the one thing that fixes low prices is low prices. A natural
dynamic unfolds when a price gets too low. If I'm an OPEC country and the
price of oil gets too low, I'm going to do one of two things. I'm going to stop
selling it, or I'm going to have a meeting and convince all the other producers
to stop selling it, too, because I can't make a profit at current levels. So we
are going to stop getting so many barrels out of the ground. Then psychology
changes, people start fearing a shortage and, bang, prices go up. Right now,
commercials are buying the dips in oil, heating oil, natural gas and unleaded
gas -- they're not at bullish extremes like in some other hard assets, but the
speculators absolutely hate these markets. They've been beaten to death in
crude for the last six months as every $2 rally has been followed by a $2.50
drop. It's a classic bottoming. These markets are setting up for trends to the
upside, not the downside.
Q: Are you long?
A: We're long crude oil. Went long about a dollar ago. But most speculators
are short -- and probably will be until we get back up to the $15-$16 area.
I'm making the bet because I can't find a place, in any market, on any chart,
where speculator sentiment has been above 90%-95% in one direction where
betting against their position hasn't been the right thing to do.
Q: Thanks, Mike. |
