BUYING THE COW

  

Keith is a cowboy

Research Edge Position: Long COW

I suspect that Keith is a Canadian cowboy at heart. I arrived at this suspicion based on several clues: 1) last Halloween he came in to the office dressed in full cowboy regalia, 2) when he and I first met it turned out that one of the few friends that we had in common was the former two-time national Bull riding champion of Canada (it takes one to know one principle, myself notwithstanding), and 3) his tendency to shout "Hoowah!" when trades work out better than anticipated.

Thus when he first asked me what I thought about the ETN COW last year, I realized that I had to take it seriously, because it might well end up in the portfolio.  Since then it has remained on the back burner of my market universe. Our decision to go long this week was based on a convergence of factors: Keith was attracted by the technical set up that it was presenting, several underlying fundamentals looked compelling, and it ties in with our overlapping macro view on reflation and the US consumer.

COW tracks an AIG commodity sub-index that consists of Live Cattle and Lean Hog front month futures contracts. The mix is currently 62.27% front month Live Cattle, 37.73% front month Lean Hogs. 

SEASONAL INFLECTIONS:

Although earlier today I wrote that I have a bias against historical comparables, for agricultural commodities, the seasonality is undeniable.

Traditionally, US beef consumption is greatest during cold weather months, and supply levels are driven by the spring calf breeding cycle/late summer slaughter cycle. The start of slaughter cycle coincides with lower consumption patterns to drive prices down in late summer, while prices tend to rise in March and April when demand typically is still  high but supply is at its lowest after the slaughter cycle has ended and the breeding cycle just begun.

In the chart below I illustrated the 20,15,10 and 5 year average indexed price returns for the front month LC contract under the current year. Although earlier today I wrote that I have a bias against historical comparables, in this instance the seasonal inflection is undeniable. Clearly the futures are currently underperforming historical seasonal averages as macro factors weigh on anticipated demand.

BUYING THE COW - cow

Pork demand also follows a seasonal pattern, but the price pressure inflections for that market are different because the breeding and slaughter cycle tends to be based on the corn harvest since farmers breed heavily in advance of the cheapest feed prices. As such, supply is at its lowest in midsummer during comparatively low demand.  Like cattle, Lean Hog futures are currently outside typical seasonal inflections.

Now keep in mind that these are just general rules based on long term historical observations (which I have stated on multiple occasions that I tend to discount), but in agricultural markets it is dangerous to ignore seasonality.

CURRENT ENVIORNMENT:

  • Current USDA forecasts anticipate that both Beef and Pork production will be reduced for 2009 based on statistical data showing declining slaughter and carcass weight measures.
  • Canadian Pork exports are forecast to decline more sharply than US production as overlapping local factors have driven feed prices higher simultaneous to a strengthening Currency versus the US Dollar. Next Friday's quarterly USDA Hog report should provide a better picture of the developing import situation.
  • Argentina's Ministry of Agriculture officially estimates that cattle production will decrease by 13% this year due to decreased demand from customers like Russia. Unofficially the disastrous policies pursued by the Kirchner regime have driven Argentine farmers to despair and it has been reported by some media sources that the country may become a net importer for the first time since 1871. Getting hard data on the impact will be difficult as the Ministry stopped generating monthly data in November of last year.
  • Although the work Howard Penney is doing in the restaurant sector shows that the dining industry continues to face a challenging environment, the data continues to suggest that the situation has not deteriorated to levels initially anticipated for mass market food retailers as cheap gasoline; cheap food prices and cheap money have left broad domestic consumption patterns relatively unscathed.

OWNING THE COW:

So now we have COW in our portfolio with supporting seasonal inflections, a solid technical setup and a some positive fundamental data points. That doesn't mean there aren't risks involved, primarily tactical in nature. For starters there is always a liquidity risk trading livestock futures, and during summer months the volume can get especially thin. Also, since the ETN tracks the Index, during each delivery month the product must "roll" into the next series: this roll impact will result in a divergence between the continuous front month levels and the ETN performance.

For now we remain long US livestock and will continue to own the COW for as long as the data supports our thesis.

Yipppie Kay Yay.

 Andrew Barber

Director


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