How and Why I Trade the Commodity Futures Markets – What I am Doing NowVictor AdairSenior Vice President / Derivatives Portfolio ManagerMF Global Canada Co. Mike Campbell’s Survive and Thrive Investment Conference Vancouver, BC November 1, 2008.
Program Outline • Macro Market Opinions • Why I trade Futures and Options • How I trade / manage risk • Markets I am watching now • Personal: Cautious. Savings. Trading. Income. In cash too early. No leverage. Wait for bargains.
Disclaimer • This presentation is for information purposes only • Trading derivatives (futures, options, foreign exchange) involves risk of loss • Investments can go up as well as down and involve the risk of loss • Past performance will not necessarily be repeated in the future • MF Global Canada Co. is a member of the: • Investment Dealers Association • Canadian Investor Protection Fund • Toronto Stock Exchange • Montreal Exchange • Winnipeg Commodity Exchange
Macro Market Opinions THEN: Credit Boom = Asset Boom + High Risk Tolerance • Many years of low interest rates / easy money / rising asset prices fuelled a consumer spending boom and an attitude • Reaching for yield / don’t want to be left behind • Borrowers and Lenders - pushed the envelope on risk • NOW: • Lenders: less willing or able to lend • Borrowers: less willing or able to borrow • Risk being avoided – not embraced
Macro Market Opinions • Asset price gains from 2001 to 2007 were extraordinary – not normal • Buy and hold is not good advice • Throw away your previous ideas about valuations and risk – this is a different world • Don’t buy something today because it is ½ price compared to what it used to be • Inflation is history – for now – deflation is the worry – for now • Inflation will come back • Be prepared for a lot more government in your lives • Stress = what’s the next shoe to drop? = Volatility • Something BIG will break…Euro? Country default?
Macro Market Opinions • Real estate prices will continue to soften • Unemployment will rise • Previous economic growth came from rising consumption based on rising asset prices, borrowed money and leverage. That’s over. • Expect a “L” shaped economy • Expect real interest rates to rise • Financial markets will have “relief rallies” but a weak real economy will keep a lid on gains • Expect lots of garage sales and booming thrift store business • Demographics = Boomers will try to save more, spend less
Marco Market Opinions • Commodities: bull market is over until the last “Johnny-come-lately” bull throws in the towel and promises to never return. Speculators fuelled most of the price increase • Currencies: incredible barometers of capital flows – 40% declines - will the Euro hold – US$ wins the least ugly contest • Stocks: a slow-motion (and sometimes not-so-slow) crash • Bonds: great battle ahead…Supply Vs. Demand • Volatility: new highs as a result of stress = opportunity. Learn option writing strategies
Macro Market Opinions • Inflation / Deflation? • Credit crisis induced slowdown = deflationary • Monetary reaction = inflationary • Credit tightness = deflationary • Fiscal action = bigger budget deficits = inflationary • Demographic trends in West = deflationary • Rising US$ (?) = deflationary • Weakness in global economy = deflationary • De-coupling? Will the “Rest of the World” continue to grow if USA goes into a real recession? No = deflationary.
Macro Market Opinions (Cont.) • We are all currency speculators now: • 6 years of US$ weakness = 6 years of commodity market gains • Currency trends overshoot + and make “V” shaped turns • Is the US$ rising? • Currency flows from risky to less risky – from the periphery to the center as the market seeks to avoid risk • 90% of Hungarian residential mortgages financed with Swiss Francs!
Why I Like To Trade Futures and Option Contracts • Mike Campbell interviewed Jim Rogers on Moneytalks Radio in October 2003 • Jim said, “The best way to trade commodities is with futures contracts. But most retail traders use way too much leverage.” • Following that interview I wrote “Five Reasons Why Futures Contracts Give You a Powerful Advantage” posted on: www.VictorAdair.com
Why I Like to Trade Futures and Options Contracts – (cont.) • Efficient • Transparent • Pure Play • Variety • Leverage • Easy to go short, open 24 hours, regulated market
What is a Futures Contract? • Specified unit of trade with an expiry date • Example: December 2008 Gold Futures Contract • 100 troy ounces / specified quality and delivery location • First Notice day: November 30, 2008 • Value of the contract at $800 oz = $80,000 • Minimum initial performance bond, approx. $7,000 • Leverage = 11:1
How I trade • I develop Global macro opinions • I may be100% in cash or up to 4x leverage • I read a lot of different research – www.VictorAdair.com – to form my opinions • I’m not a day trader but I watch the markets all day • Opinions – necessary (you have to have the courage of your convictions) and dangerous (you have to give up quickly when proven wrong) • I try to anticipate a trade before it is time to make the trade – then I’m ready when its time to pull the trigger • I need a technical confirmation that my opinion may be right before I execute
How I trade – (cont.) • I trade like a mercenary – (Dennis Gartman) when markets change I change • I challenge consensus – “what if” the popular idea is wrong, has run its course? • I try to judge the mass psychology – who has a weak / strong position in the market? • Changing psychology – not math – moves markets • All markets are spreads – try to think like a spread trader – what is X worth relative to Y? • Markets are inter-related – but relationships change • Options: Current I.V. relative to history - Use alone or in combination with futures
Managing Risk • I know practically nothing and cannot predict the future • Most likely risk: my opinion is wrong • Anything can happen • Patience – sitting in cash is OK • Add to winners, never add to losers • I know where I will get out (if I’m wrong) before I get in • Write down my reasons
Managing Risk – (cont.) • Max loss 1% – 2% per trade / use low leverage • Accept that most of my trades may lose money • No big losses, occasional big wins • Relationships between markets change, but markets always influence one another • Be aware of my prejudices – foundation of all opinions • Without risk management the road to the Poorhouse is paved with fine opinions • See: How To Be A Better Trader – www.VictorAdair.com
Options trading ideas • Option volatility is extremely high. Learn option selling (writing) strategies: • 1) you like a stock/commodity at today’s price. Write a put option on it, collect the premium. If you get put you own the stock/commodity at a better price, if you don’t get put you keep the premium. Repeat. • 2) you like a stock/commodity at today’s price. Buy it and write a call against it. if you don’t get called you own the stock/commodity at a better price, if you get called you make a short term profit. Repeat. • 3) Write both calls and puts at the same time – look for the market to trade sideways. Repeat.
Yield on US 10 Year Note Futures ContractFalling Interest Rates Helped Boost Asset Prices
Dow Jones Industrials Stock Index (Falling Interest Rates Helped Boost The Stock Market)
Average US Real Estate Prices (Falling Interest Rates Helped Boost Real Estate Prices)
Commodity Index: 6 years of a bear market in US$ = 6 years of a bull market in commodities – until Summer 2008!
Euro Vs. Japanese Yen: Risk thermometer, week to week ups and downs very similar to ups and downs of G7 stock markets
Gold Reciprocal – are we pre-programmed to see bull markets? If this is a bull market then gold price is falling
Gold / Crude Oil: At least a 25 year low this past summer: all markets are spreads. What is X worth in terms of Y?
Copper: Does copper have a Phd in economics? Base metals have been weak (no kidding!!) lately (Speculators exit stage left??)
Crude Oil – Did “Investors” pile into the energy markets? Did rising global demand account for a tripling of prices in 18 months?
Corn: global demand for better food, ethanol, funds – prices hit all time high prices – what changed to cause prices to fall 50%?
Deere & Company: Another way for the public to play the Agricultural boom – Yikes!!
Philly Bank Share Index: started to fall from all time highs before the “credit crisis” became front page news
Philly Housing Sector Index: The top was made well before the problems of the US housing market became front page news
Vix – CBOE Volatility Index Ultra-high option volatility creates new trading opportunities
Chicago Mercantile Exchange: it was a “triple play” on rising stocks, commodities and exchanges – what happened?
Summary • The Credit Boom produced an Asset Boom + a great Appetite for Risk – This fuelled a Global Economic Boom driven by Consumer Spending – the markets are now reversing this trade! • Why I like to trade Futures and Options • How I trade / manage risks • Ultra-high option volatility creates opportunities to write options • Markets I am watching now – looking for trading opportunities • Be cautious – things have changed – wait for bargains www.VictorAdair.com