GOLDEN RULES FOR MAKING PROFIT IN COMMODITY CYCLE

The price of commodities is influenced by both natural and man-made cycles. By understanding the prevailing cycle (expansion or recession) to which a commodity is associated, a trader can make better decisions related to the trade entries and exits. Additionally, the study of cycles and the correlation between stocks, bonds, commodities and the US dollar would enable a trader to confidently shuffle and maintain the right-mix of portfolio. Thus, experienced individual traders and fund managers constantly look the cycle (most suited to gauge a commodity) scenario before making investment decisions.

The following are the widely recognized strategies adopted by traders, focused on different financial markets, to gain from the well-known market cycles.

Annual / Seasonal cycle

Climatic conditions affect the planting, growth and harvest of crops. This in turn impacts the supply thereby leading to a change in price. Thus, commodity traders monitor the seasonal influences to forecast the future price. A seasonal trader identifies the rhythm of price movement and timing of tops and bottoms in price. The data is then used to enter and exit the seasonal cycle. Traders use the seasonality to enter and exit as follows:

1. Corn: An entire corn season (in USA) can be divided into three recurring periods:
1. Late spring to midsummer
2. Mid-summer to harvest time
3. After harvest.

Price of corn tends to decline from mid-summer to harvest time. The price stays near the peak in June and July on expectations of new crop harvest. After harvest period the price starts recovering. The price of corn, however, remains under pressure in February. To sum it up, a seasonal corn trader should look for buying opportunities between August and October. Selling (or shorting) should be done between June and July.

2. Soybeans: Seasonal price behavior in relation to growth and harvest is seen in Soybeans as well. The price of Soybeans usually shows weakness in the months of June, July and August. The last week of June will have prices lower than previous weeks. Similarly, the traded price in the last week of July and August will be generally lower than the previous weeks. In comparison to the last week of December, the price tends to remain higher in January. The ‘February Break’ phenomenon keeps the price of Soybean subdued. Thus, June, July and August are months to remain in short while the last week of December is ideal for accumulation.
3. Wheat: The cyclical period of price weakness usually begins in January or February. The period between harvest low and early winter (October /November) is the best period to go long. Wheat prices tend to decline during the last weeks of winter and spring (final stage of harvest). The wheat prices in the futures market also remain weak from winter to summer harvest period.
4. Live and feeder cattle: Live cattle prices remain on the higher side from January till May where it touches the seasonal peak. The prices then start to retrace slowly for the rest of the year. Thus, it is better to take long position between January and May in the futures market. Short position is ideal for the rest of the year. The seasonality factors related to live cattle prices affect the feeder cattle cycle. The, feeder cattle prices remain stronger from late winter to spring. The price starts dropping during the summer. A feeder cattle trader should look for long trade opportunities from winter to spring. Short selling opportunities should be given priority during the summer season.
5. Live hogs: The price of live hogs increases from March to May and decreases from May to August. This cyclical price change is attributed to the seasonal declines in slaughter levels from March-April into July-August. Additionally, the price fluctuation is also because of the seasonal increase in farrowing between August and September in comparison to other months. Thus, a live hog trader is advised to take long position from March to May and short positions between May and August.
6. Cocoa: The price of cocoa usually begins to rise in May or June and continues its upward trend till late fall and start of winter. However, the demand starts to wane in the last leg of the year thereby putting downward pressure on the prices. By January, cocoa prices hit their cyclical low. It should be noted that cyclical impact is not very much strong in cocoa. So, a trader should be very cautious while taking a long position in the month of January or short position before the start of winter.
7. Coffee: Brazil is a major producer of coffee. Thus, intensity of frosts, which occurs between May and early August in Brazil, affects the price of coffee. The price generally rises from January to June and starts declining later on. During winter season in United States, coffee consumption rises. This cyclical pattern results in a price rise as well. It should be noted that yields from other major coffee producing countries such as Mexico should be taken into consideration before entering a trade.
8. Cotton: It is one of the most traded commodities with price depending heavily on the deliveries made against the expiration (December, March, May and July) of futures contracts. The seasonal cycle is such that price declines to low level in January and recovers (after harvest low) in November.
9. Orange juice: In the case of frozen concentrated orange juice the cyclical factor is a function of harvest, production and demand. The price sees a decline from November to January. This is quite different from other seasonal cycles in the sense that it does not entirely follow the frost period, which is from December to February in the southern part of USA.
10. Sugar: Traders who are well aware of the seasonal price cycle of sugar know that prices usually reach the peak in November. So, it would be the ideal time to close the long position or even go short. The reason for the high price is attributed to the northern hemisphere’s demand coupled with a lack of supply (Shipments from Europe would not have started).

11. Unleaded gas: The seasonal cycle also affects the price of unleaded gas. The price usually rises from February until May. This is because of the purchases made ahead of the Memorial Day (May end) which marks the arrival of the summer driving season. Seasonal cycle traders prefer to take long position between February and May, to gain from the price rise.
12. Natural gas: It is a raw material used by power sector to produce energy. Natural gas is also used in residential homes. A strong economy and extreme cold can increase the demand. Considering the production and demand level, traders usually buy between June and August and sell between December and January.
13. Treasuries: There exist an inverse correlation between Treasury bonds and equities. The cyclic nature of the Treasuries is such that the price undergoes a decline in the first half of the year and rises in the second half of the year. The lowest price is usually recorded in the month of May. Traders who track seasonal cyclic patterns generally look for a purchase opportunity in May.
14. Copper: The price of copper increases in the month of May and declines in the month of September. This is because construction activity generally peaks during the spring and slows during falls. Correspondingly, there arises a seasonal change in the price of copper every year. Futures traders take these details into consideration before entering a trade.
15. Equity: There is a seasonal cycle associated with equities as well. The equities tend to perform better between November and April. The decline begins in May and continues throughout the summer period. Stocks are again bought in autumn, usually around the Halloween. Traders prefer to remain liquid (with cash) between May and November. The reason behind the trend is unclear but certainly puts a question before the efficient-market hypothesis, which says that stock market returns should not be lower than the short-term interest rate.

Additionally, there is something called ‘Calendar effect’ in equities. Most of the small stocks outperform broader market in January compared to other months. Thus, traders tracking seasonality buy small-cap shares in the last week of December to profit from the cyclic behavior of stocks. The disparity between small and large stocks reaches the peak during the mid-January period. The largest ‘January effect’ is seen on the third year of the US Presidential term.

Production cycle

16. Palm oil: The low production cycle spans between January and March while the peak production period of palm oil is between June and September. Thus, prices tend to move upwards from January until March. The arrival of additional supplies results in a price decline from April onwards. In a case where the production falls below the average, the price tends to remain strong for the rest of the season.
17. Heating oil: The price of heating oil generally goes up during summer (July to October). This is because the price of heating oil is much affected by demand rather than supply. Refineries and commercial establishments build inventory during summer to meet winter’s demand. The price drops when the stocks are liquidated during normal winter season. Traders take advantage of such a seasonal cyclical pattern and take long position during summer season and short position during winter season. However, there is a note of caution. The price can also go up during a harsh and prolonged winter season.
18. Crude oil: The price of crude oil usually rises in the extreme winter season. Furthermore, vacation period (active driving season) usually results in higher crude oil prices. On the other hand, the demand for heating oil during harsh winter indirectly propels the price of crude oil. Other than the two factors, traders watch for production increases or cuts by oil producing and exporting (OPEC) nations. An increase in the supply results in a sharp price decline and vice versa.
19. Equity market: GDP (gross domestic production) leads corporate earnings by one quarter while corporate earnings lead stock market cycle by one quarter. Thus, GDP leads stock market cycle by two quarters. A decline in GDP is usually reflected in the price of stocks in two quarters. Traders following the GDP can accordingly time the entry or exit from the market. Equities begin to perform well after recession low passes. Traditionally, second and third quarter earnings would be strong for companies. However, the prices of commodities gain when inflation is near its peak.
20. Bonds: When business cycle is low, bonds tend to perform well. In other words, bonds gain in value during deflation. Thus, a bond trader should look for indications of sluggishness in business cycle to exit from stocks and invest in bonds.
21. Platinum and Palladium: These two precious metals are often overshadowed by gold and silver. Both platinum and palladium are more of an industrial metal. As economic activity increases, the price of platinum and palladium surges. They have an inverse correlation with the US dollar cycle.
22. S&P 500 index: The price of industrial metals is less susceptible to supply shocks (unlike stocks linked to oil). As the economy expands, the demand for industrial metals grows and this leads to a rise in the stock price of companies producing the respective metals. The industrial metals share a positive relationship with the S&P 500 index. Thus, traders use economic cycles to forecast the top and bottom of the S&P 500 index and profit from it by taking long and short position at the ideal time.

23.  Gold: The US dollar shares an inverse relationship with gold. A fall in the US dollar is reciprocated by a gain in the yellow metal. This is because, gold is considered as a safe haven investment. Additionally, the currencies of other countries gain in value when the US dollar declines. This increases the demand for commodities including gold thereby resulting in a price rise. Precious metal traders monitor the US dollar to enter and exit from gold. Gold normally touches a low in August.

24.  Silver: Similar to gold, the US dollar shares an inverse relationship with silver. Additionally, traders monitor the silver-gold ratio to determine whether to buy gold or silver in the case of decline in the US dollar. On an average, the silver-gold ratio (price of gold / price of silver) stands at 55:1. Silver is considered to be a better choice to buy if the ratio is higher and vice versa. Silver usually hits a low in January and high in March.

25.  Bonds: The US dollar cycle also impacts the rise and fall in the price of bonds. As US dollar rises, bond prices also tend to rise and vice versa. This is because a strong US dollar discourages US exports thereby bringing down the valuation of stocks. Ultimately, the price of bonds will increase as investors flock to bonds whose valuation will become more attractive. Bond traders track the US dollar index (compares the movement of the US dollar against a basket of currencies) to enter and exit the bond market at the right moment.

26.  Crude oil: The US dollar has an inverse relationship against the commodities and crude oil is no exception to this. Internationally, all the commodities are priced and traded in US dollars. Thus, a strengthening US dollar would naturally mean that it takes less amount of the currency to buy the same amount of physical assets. Crude oil and the US dollar usually have a ratio of minus 0.88. Traders use the data to identify price divergence and take a suitable buy or sell position.

27. Corn & wheat: A 28-day cycle represents 28 calendar days, which translates to twenty trading days. The commodities, in particular corn and wheat, exhibit 28-day cycle. As per this theory, a break out above the four week high confirms the beginning of a new uptrend. The inverse is true for a downtrend.
28. S&P 500, DAX and STRAIT indices: A lunar cycle is the sidereal orbital period of moon which spans around 27.5 days. Scientifically it has been observed that a full moon imparts pessimism while a new moon advocates optimism in human beings. A study of lunar cycle effects on major indices has proven that almost all the gains made by the financial markets are during the positive lunar period. The disparity is seen more in the DAX (Germany) and STRAIT (Singapore) indices. Thus, lunar cycle traders take long positions during the beginning of new moon period and liquidate the position on or before the full moon period. Statistically, it has been proven that a trader who had taken only long position during the positive lunar cycle in the Singapore market would have made 124% returns between 1994 and 2013. The percentage is even higher at 149% in the case of the DAX index. However, it must be noted that commodity prices are very less influenced by lunar cycle.

29. Equities: When equities do not perform well in the first month of a year then the same trend is reflected for the rest of the year (& final months in particular). Such a phenomenon is known as January cycle. There is a popular statement which says “As January goes, so is the rest of the year”. If the stock market did not have a great opening in January then traders who are well aware of the January cycle remain cautious and stay away from making large commitments. It should be noted that “January cycle” and “January effect” are not related to each other.
30. S&P500 index : The January cycle also influences the performance of S&P500 index. The first five trading days of January are closely watched by S&P 500 traders since the performance gives an idea of what the rest of the year would be. If the beginning of the year is not encouraging then traders would remain cautious and avoid taking large positions. On the other hand, traders following January cycle would take large positions if there is an appreciable gain in the opening of the year.

The Presidential cycle

31. Equities: The four year presidential period has a cyclical effect on the performance of the US equity market. Equities tend to perform better in the pre- and election years. On the other hand, performance of the equity market in the 1^st post- and 2^nd post-election year is weak.
32. The DAX (Germany) index: Historically the DAX index remains flat and subdued in the election year and 2^nd post-election year respectively. However, the index rises in the first post-election year. The same trend is seen in the pre-election year as well. Traders monitoring the US presidential cycle take the discussed fact into consideration before making a trade in the market.
33. Dow Jones index: Most of the major indices around the world experiences the presidential cycle. The impact, naturally, is seen in the US as well. The Dow Jones index always remains cautiously optimistic in the election year. The first post-election year sees a rise in the Dow Jones index. On the other hand, the Dow Jones index remains essentially flat in the 2^nd post-election year. Finally, the Dow Jones again rallies in the pre-election year.
34. The US dollar index: The presidential cycle impacts most of the currencies directly or indirectly (through the US dollar) as well. The US dollar index generally rises in the election and first post-election year of the presidential cycle. The final two years (2^nd post-election year and pre-election year) sees a decline (most of the decline happens in the 2^nd post-election year) in the US dollar index.
35. Gold: The yellow metal remains calm in the election and first post-election period of the presidential cycle. The 2^nd post-election year and the pre-election year have a positive effect on the price of Gold. Invariably, all the uptrend in price is seen during this period.