Growing Financial Success

IT IS TIME TO BUY COMMODITIES

The commodity markets have now reached an extreme diametrically opposed negative bearish psychological condition from the extreme bullish psychological condition that pervaded most commodity markets in early June. You must be a contrarian and buy markets when bearishness is ever-present and sell them when bullishness overwhelms rational thought: we have reached that point now on the bearish side. As bearish as I was in early June and hence my warning to reduce risk, I am equally bullish now. This is a time to start investing money back into commodities aggressively. I would like to go over some of the reasons why.

The above two seasonal graphs show the general behavior of the two most prominent commodity indices in the market today in the Continuous Commodity Index and the Goldman Sachs commodity Index. As you can clearly see from looking at the purple line which is the 30 year seasonal pattern, commodities in general reach a major low in mid July. From mid July to October is one of the most profitable periods consistently to go long commodities. Now not every commodity will bottom at the same time and not every commodity will rise the same amount. However, the backdrop environment for those commodities that have bullish underlying fundamentals, technicals and Money Flows should be able to realize significant upside potential.

Continuous Commodity Index-Spot Futures Prices

The CCI has come down to long term support near 385 that I suggested in my last update that we would likely see before a major bottom could be expected. Also the RSI has reached an oversold condition at exactly the time that the 30 year seasonal pattern suggests a bottom is often seen. The stars are clearly lining up for another major bull move higher.

In fact many commodities are seeing some of the most oversold conditions in 20 years!!!!! We had the exact reverse condition in early June. You must buy oversold markets and you must sell overbought markets if you are going to be successful at commodity investing. If you find yourself buying overbought markets and selling oversold markets and taking the losses that come with such investment actions then please stop doing it!!!

You can still lose money buying an oversold market but the probabilities are that the losses will be much smaller and less frequent and the gains will likely be much larger and more prevalent then deploying the herd mentality investment style that so many investors get caught up in. You pay a heavy price for buying into an optimistic commodity scenario.

You must also know yourself. I cannot tell you how many times an investor will come to me and say that they want to own sugar, let’s say, for a positional long term investment. They say to me that they have the money set aside to hold the position and pay for it in full (meaning no leverage) if need be. They say to me that they want to ride out the ups and downs. Then a major down comes and a margin call becomes initiated and magically their emotions get the best of them and they sell instead of sending more money in. If you want to trade commodities then trade them. If you want to invest in commodities then invest in them. But starting off as a long term investor if you are going to react in a short term traders mentality is guaranteed to include large losses.

I would also like to make another point. In commodity investing we are trying to make a decision to buy where the fundamental probabilities favor a major move higher in price. However, just because the odds favor successdoes not mean that the bullish scenario will in fact play out. I would like to make a great case and point with comparing sugar and coffee.

Six months ago sugar prices were $.1050/pound, we had the largest sugar glut in history and even with reduced planted acreage, a normal weather pattern in Brazil and India would still only create a balanced market and the huge glut would continue. This was also happening at a time of a global financial system crash that cratered economies and made investors flee even the most fundamentally bullish of commodities. To buy sugar 6 months ago one had to bet that a catastrophic sugar crop failure would occur in either India or Brazil. Now that condition would only alleviate the glut but to become truly fundamentally bullish (supplies tight) you would have to also expect another poor sugar crop again the following year in either country. The probabilities of such a scenario, although possible, were remote at best. Of course we now know that India did have a cathartic failure sugar crop this year and is now likely going to have another poor crop next year due to a poor monsoon season. So the most improbable scenario occurred and sugar prices have skyrocketed 80% and it has been a phenomenal commodity investment.

Coffee on the other hand has continued to experience record low supplies as demand has outstripped supply for the better part of 10 years. Six months ago a catastrophic crop failure occurred in Colombia/Central America that created a supply crisis never seen before for mild washed Arabica coffee. This scenario against record tight overall supplies certainly made the probabilities of a major bull market to unfold highly likely. To believe that the bullish scenario would NOT occur, you would have had to believe that the drought during the fall of 2007 had no detrimental impact on Brazil’son-season coffee crop. Not only that but you would have had to predict a record on-season crop. You then would have had to believe that the mild washed Arabica shortfall would be able to be fully substituted by Brazilian natural coffee (never done before)and that an all time record off-season crop would occur that would be 5 million bags larger than any other off-season crop ever before. To say that this was highly unlikely is an understatement. Of course we now know that all the above in fact did happen and the bull market in coffee has been kept in check for now.

This is a great example of the chance/risk part that all investors take in not knowing the future fully. Jack Nicholas came in second more times in golftournamentsthan any other golfer in history. He also won more majorsthan anyone else. He always said that he wanted to be in a “position to win” every Sunday. The same holds true for commodity investing. If you put yourself in enough fundamentally bullishcommodities where the probabilities of success are in your favor, you will be very successful although there will be disappointments along the way. The key is to keep your leverage reasonable. In fact, just pay for the commodity 100%. If you want to buy coffee then deposit $45,000 in your account and buy 1 contract and put it away and you will never get a margin call and you will never be forced to sell at the lows which is what too much leverage does most of the time.Very few commodity investors are able or willing to do that. Most want to make a lot of money without putting up a lot of money. If investors only approached commodities like they do stocks and paid for them in full then most bad commodity experiences would have been avoided. But I digress.

Given my belief that we are near a major bottom in commodities, I would like to go over specific markets that I feel would be the most fundamentally soundto profit from the next phase of the renewed commodity bull market.

Let’s get started.

COFFEE-

2-YEAR SPOT PRICE FUTURES CHART

Notice that the coffee market has been in an oversold condition for the better part of the last 30 days. It is very rare for bearish sentiment to last more than a month without out some type of a short term rally. Coffee is primed to go higher. Also given the current level of the Brazilian Real against the U.S dollar as it has strengthened over the last several months, Brazilian famers today are seeing cash prices that would have necessitatedaround $.92/pound back in March on ICE futures. In effect today’s currency regime means that you can buy coffee at a price equivalent of .92/pound back in March!!!

As a result, the cash markets have been shut down in Brazil as farmers refuse to sell at such silly levels. Once the seasonal slow demand part of the summer subsides, come August, roasters will have to move prices up to a level that will break some of this cash coffee away from tight fisted farmers.

The Brazilian government has recommitted to buying 3 million bags from farmers between now and the end of the year at U.S. prices exceeding $1.50/pound. This will help alleviate the record off season crop and provide incentive for farmers not to sell. Remember, that demand for Brazilian coffee for next year will be around 50 million bags so even a 43 million bag record off-season crop will create a 7 million bag deficit!!! This is bullish.

Both Arabica and Robusta coffee prices tend to put in 30 year seasonal lows in mid July absent adverse cold Brazilian weather (frost). In the case of Arabica, once a bottom has been established, prices typically rise for the rest of the year and tend to peak sometime during late winter. During off-season years the upside tends to be even more pronounced.

So with a dramatically extended oversold market, the 30 year seasonal pattern indicating a propensity for bottoms in mid July, record tightness slated for next Spring, cash markets shut down, the Government buying 3 million bags over the next 6 months for $1.50/pound, the likelihood of another disappointing Colombian coffee crop due to another poor blooming phase and the possibility that Mother Nature may still deliver a lethal bullish blow this summer in a frost or in the fall with a drought during the blooming phase, the probabilities favor an investment at this time and at these prices to likely be very prosperous indeed.

I think coffee is a fantastic buy right now. Brazilian coffee supplies will be record tight in the spring of 2010: even tighter than the record tight supplies in spring of 2008 when prices peaked at $1.65/pound. It would seem likely to me that, in the least, similar prices would likely be seen again if not higher.

Of course maybe Ben Bernanke will figure out a way to print coffee beans and the bull market in coffee will be thwarted once again. But I will take my chances that he would rather print money instead. I remain a coffee bull.

The other markets that I would be buying now as we approach a major bottom in commodities would be Oats, Rice, Milk and Natural Gas. I will go over in more detail these commodities in my formal report over the week-end.

Have a great day and if you have any questions or would like to open an account with Hackett Financial Advisors, Inc. please call 888-535-5525.

Shawn Hackett

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