Mike Norman, anchor, HardAssetsInvestor.com (Norman): Hello everybody, and welcome to HardAssetsInvestor.com. I’m Mike Norman, your host. Well, today we have a floor trader – yes, you don’t find them too often – Jurgens Bauer of PitGuru.com and soft commodity analyst from the Intercontinental Exchange.
Jurgens, thanks very much for coming by; really, it’s great. Like I said, you’re sort of an anachronism, and you and I go back. We know each other from the days of the COMEX and the NYMEX back in the ’80s, so it’s great to see you again; I haven’t seen you in a long time.
It’s great to have you here because you cover an area … the soft commodity area – we’re talking about coffee, sugar, cocoa, orange juice, cotton … really a specialized focus there. First, I’m very curious to find out: What’s it like down on the floor? Everything is electronic nowadays.
Jurgens Bauer, PitGuru.com/soft commodity analyst, Intercontinental Exchange (Bauer): Well, it’s a lot different from the old days; the futures pits are electronic. I’ve always been an options guy, and one of the things that’s still available for floor traders is the option markets, so we still have pits.
Norman: Why is that? Is that because the options are just such a specialized thing that you really need to have a human, somebody in there to work with?
Bauer: Don’t I wish. I think probably a better answer to is that the information flow that has to go back and forth every time there’s a minute change in the price … when you’re talking about not just hundreds of options … then you’ve got the multiple combinations of this option against that option, this spread against this spread, you’ve got fences and straddles and strangles and all this stuff, and there’s too much information.
Norman: It’s not a plain-vanilla type of purchase … a futures contract, short a futures contract.
Bauer: If one of the exchanges has come up with a successful option platform which could be then utilized to transact business, I wouldn’t be doing what I’m doing on the trading floor. Currently that doesn’t exist. That’s not to say that it won’t happen at some point, but it just doesn’t exist. And for now I think the window of opportunity, shall we say, is going to continue for at least another three, maybe seven more years.
Norman: All right. Let’s talk about your markets. You are the soft analyst for Pit Guru, and we’ve seen recently again some of these markets really start to perk up. What is behind this? It’s sort of a curious thing to watch, because you look at economic activity here in the United States, around the world – still very tepid, very weak. Why are these commodity prices rising? Is there a fundamental reason behind this, or is it again fund speculation?
Bauer: It’s a good question. I would have to answer that by looking at each individual market, and I can provide you with fundamental reasons, for instance, for sugar.
Norman: Let’s go; let’s run them down.
Bauer: Sugar price has gone up because the production on a world scale is lower, and consumption is certainly going to remain the same if not go up – increase as populations increase, and diets go up, diets improve. So I would have to say there’s a powerful fundamental force at work.
Norman: Is sugar also involved in this alternative energy theme, because don’t they use sugar in Brazil for the making of ethanol?
Bauer: Yes; in Brazil they do. In this country, we’ve been … how do I say this politically correct now … we use corn, OK? My understanding is it’s less efficient and more costly than it would be from sugar. Yes; so that force is at work as well.
In cotton, we had pretty good exports going, we had much-reduced crop size, not only in this country but tapered off around the world.
Norman: Is that because when we had the boom in the commodities like corn and wheat and soybeans two years ago, cotton acreage was reduced so that farmers used it to plant the more-lucrative crops?
Bauer: Sure, right. Not only that, you had … so those are markets … in coffee – right now my personal favorite market.
orman: Now coffee is at, what, like a four-month high right now?
Bauer: Yeah, coffee, made a high just shy of 140 last week; pretty much up every day last week until Friday, and then we saw some profit-taking. You remember those days when you get a little profit-taking after an up week all week? Today it was down, but you can’t keep it down.
Norman: Well, I certainly drink a lot of it, not that it’s so much of a contributory factor.
Bauer: And that’s why it’s bullish: because Mike drinks a lot. No. But in addition to all this, you also have a weaker dollar, and that’s been a major factor in the soft markets. We’ve also seen a lot of commodity fund investment.
Norman: Yeah; that’s what I want to talk about, because you deal a lot as a floor broker, you deal with people in the trade, people in the physical business of either producing or merchandising these commodities that you’re talking about. What do they say about the speculative element in the markets? Are they concerned about it, do they think it’s a good thing; what’s their view?
Bauer: I would have to say the overwhelming majority, especially in cotton, were very much opposed to the enhanced speculation.
Norman: What’s happening? Is it creating a distortion, is it making it harder for them to run their own business in terms of hedging and planning?
Bauer: Well, I don’t want to say that the traders used to use the market as an ATM machine, but I will tell you that they had a distinct advantage because they knew what was going on and they could use that to their advantage. You don’t want to say it’s insider trading or anything, it’s their business, and these markets were created for them to offset their price risk.
Norman: Nobody could know the market better than someone who’s physically involved in either producing or merchandising it, that’s clear.
Bauer: When you had this big influx of all this fund money, it became overwhelming to some of the boutique markets that we really have in the softs; they’re not the huge big-volume markets that you have. Sugar might be an exception when you compare it to some of the average daily volumes in cotton, coffee, cocoa and orange juice, but they’re certainly not as large or as deep of a market as oil or gold – what you used to trade.
Norman: It’s much easier to manipulate, in other words, to push around, absolutely, and the amount of money flowing into these funds and also these new instruments – ETFs that allow investors to buy into it like a stock. These are these passive long-only commodity investments that tremendous amounts of money are flowing into. So how does the outlook now … let’s give a little bit of an outlook now, let’s say, for the next six months or the remainder of this year … is this rally going to last, is it going to extend or are we going to plateau out?
Bauer: Well, I really wish I knew the answer to that, but I would have to say - from my own perspective right now - I believe coffee has got 1.50, 1.70 in it before the year is over, in all likelihood, because we do have a legitimate supply problem there. We’re approaching the season where you’re going to have the potential for frost in the Southern Hemisphere, which is where Brazil and etc. … and again you’re seeing the added component of the weaker dollar. In the case of cotton.
Norman: What about orange juice and cocoa?
Bauer: All right. First let me tell you that OJ had been undervalued last year; it’s a smaller market. I think that there’s concerns this year; we had a lot of concerns about drought conditions, although there had been rains this past week pretty much every day in Florida in the growing areas, which ought to take care of a lot that moisture concern. Demand had also fallen off, but I think demand is returning to its historical levels. I tend to believe that, again, we’re going to see prices kind of return to a normal level; in other words, head north of a dollar, head towards $1.15, currently trading in the low 90s.
Norman: Did it surprise you when we had that big run-up in commodity prices and then the collapse, and in some cases the retracement gave back all if not more of the original move? Did you think that was going to happen?
Bauer: I didn’t think the run-up was going to be as dramatic as it was; in particular, in cotton there was a two-year move in two days, and what happened is a lot of the legitimate farmers, producers who were depending on ... they’re selling their crop before it’s even planted, and all of a sudden the price goes up dramatically they get a margin call, and typically the bank would meet that margin call, but now the bank …
Norman: They got the credit crunch.
Bauer: … they got a credit problem. The bank is saying, OK, we’ll loan you the money, but at X outrageous percent. The farmer is never going to make a profit on his crop if he does that. So a lot of the merchants got caught with large short positions that needed to be financed and in going to the banks, they just discovered that there was a credit crunch, and so positions had to be covered at the top. That brought the thing right back down.
Norman: When you and I were traders – well you still are – but I mean back in the ’80s where you had … the markets were … you had the trade, you had people in the business, and then you had the professional speculators and they were there; they traded on the long side, they traded on the short side – there seemed to be more of a balance. Now what you have, it seems to me – and it came about with the advent of these index funds, these long-only vehicles – like a form of almost … you can call it hoarding. I mean, billions and billions of dollars, and you talked about how small these markets are relative to gold and oil, and certainly relative to equities or bond markets which are limitless.
Bauer: Sure, and then the currency markets.
orman: Right, so there is that danger there, isn’t it?
Bauer: Without a doubt. I think the danger expressed itself when we saw the dramatic price rise last year. It’s almost like there’s a vacuum created on either side of the marketplace. The cotton market hasn’t been the same since last year and we’ve seen another run-up of 20 cents this past couple of months. We peaked a little over 60-some-odd cents, and now it’s backed off. Today it was down; when I left it was down about $2.40, and they still have limits in cotton, believe it or not, of 3 cents. So that market is being pushed around purely by speculation, and the long liquidation is what’s causing it to come off right now.
We were talking about coffee, we talked about sugar a little bit, and cotton, and a little bit about OJ. Let me also mention cocoa. Cocoa was a market that was much higher last year, actually reached some very high levels. This year it’s the only component of the soft markets that is actually lower over the course of the year.
Norman: Is it attractive from a buy perspective now? If you wanted to get in – if that’s the one relative under-performer to the others – would you want to get into that or you stay?
Bauer: It’s interesting you would ask that.
Norman: I only ask interesting questions.
Bauer: I’m of the opinion that cocoa is probably not as friendly, let’s say, as the other markets. I would actually be looking on the short side of the cocoa market. It’s kind of being brought up because of the weakness in the dollar. The weakness in the dollar has dictated a lot of the near-term action in these markets in addition to the flow of funds, and the flow of funds is coming in because, as you pointed out, long only, long only.
Norman: Here’s something I’m curious about. Last year, last July, there were several bills in Congress to limit speculation; none of them passed. Are the exchanges concerned about that? Because obviously it would hurt their businesses. But by the same token, these bills could come up again, if we start to see prices of gasoline and other commodities and food start to go through the roof. There’s political pressure that is brought to bear by the citizenry on their representatives to do something. Do you think we’ll see something like that where there will be restrictions put in place on speculation?
Bauer: I really don’t want to see anything like that happen. These markets need speculation in order to exist.
Norman: But do they need it to this degree? I agree that speculation serves a function.
Bauer: In the old days, speculation was someone willing to take the risk. Today when you have, say, pension funds investing in the marketplace, the pension fund might be backed up by the taxpayer in some instance, believe it or not, so there’s almost like a built-in put option against the guy’s portfolio. If he loses money, well, the taxpayers are still going to have to pay. That doesn’t make any sense.
Norman: These things are long-only again. Again, going back to the day when you and I were trading, we go up, we shout, we go long-only.
Bauer: It’s great as it’s going up, but when you try to get out, you need a speculator on the other side.
Norman: All right; well there you have it. Jurgens, it was great; it was a pleasure seeing you again. Jurgens Bauer here, from Pit Guru and also from the IntercontinentalExchange. That’s it for my interview today, but a lot more on this interview series as we have brought to you. In the meantime, this is Mike Norman. Have a great day, take care.
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