Trend Following - Week in Review - June 1, 2024

Welcome to "This Week in Trend", where each week, we cover key movements and trends in the futures markets, offering insights on commodities and indices shaping the economy. From price surges to notable declines, we provide an overview of the factors driving these changes. Stay informed about the latest developments and navigate the market with confidence. Join us weekly to explore the dynamic world of futures trading and the trends that matter most.

The Bears are Back in Town

Trend Barometer

This week, the Trend Barometer dipped from 55 to 50, signalling slightly weaker trending market conditions. Nevertheless, the reading this week remains in favourable trending market conditions.

The Top Traders Unplugged (TTU) Trend Barometer is a proprietary tool that measures the percentage of markets with medium to strong trends. Just as a thermometer reading of 0 degrees Celsius equates to freezing, when the TTU Trend Barometer reads a value that is less than 40%, market trendiness begins to get “colder” or weaken. Likewise, when the TTU Trend Barometer gets above 55%, the environment gets “hotter” (better).

Weekly Asset Class Snapshot

This week saw the bears coming back to town, with most asset classes experiencing declines. The energy sector experienced a notable decline of -2.05%, primarily driven by falling crude oil prices due to increased inventories and demand concerns. The buildup in crude oil stocks has raised concerns about oversupply in the market, exacerbated by sluggish demand growth projections amid global economic uncertainties. Additionally, geopolitical tensions in key oil-producing regions have added to the volatility, contributing to the sector's decline.

Metals also faced a significant drop of -1.71%, as gold and silver prices fell amid a stronger dollar and reduced safe-haven demand. The strengthening of the US dollar, driven by rising Treasury yields and expectations of tighter monetary policy by the Federal Reserve, has made dollar-denominated metals more expensive for foreign buyers, dampening demand. Furthermore, improved economic data from major economies has reduced the appeal of safe-haven assets like gold and silver, leading to sharp price corrections in these metals.

Soft commodities were not spared, declining by -1.42%, with notable drops in orange juice and soybean meal. Orange juice prices saw a significant decline due to improved weather conditions and increased supply expectations, reversing the gains driven by earlier supply disruptions. Soybean meal prices fell as favourable crop yield forecasts and lower demand projections weighed on the market. The decline in soft commodities reflects a broader trend of improving supply conditions and reduced speculative activity.

Equity indices saw a slight decrease of -0.19%, influenced by mixed economic data and earnings reports. The uncertainty surrounding corporate earnings, coupled with ongoing macroeconomic concerns such as inflation and interest rate hikes, has kept investors cautious. Despite some positive earnings surprises, the overall sentiment in equity markets remained subdued, leading to a marginal decline.

Bonds saw a marginal decline of -0.12%, reflecting modest market adjustments to changing interest rate expectations and economic data. The anticipation of continued monetary tightening by central banks has kept bond yields elevated, putting downward pressure on bond prices. However, the decline was limited as some investors sought the relative safety of fixed-income assets amid equity market volatility.

Currency markets showed a small positive change of 0.24%, driven by movements in the AUD and NZD. The Australian and New Zealand dollars benefited from positive economic data and a slight risk-on sentiment in global markets. The AUD was supported by strong commodity prices, particularly in the iron ore and coal markets, while the NZD gained on the back of robust dairy exports and expectations of further interest rate hikes by the Reserve Bank of New Zealand.

This week presented a challenging environment for trend followers, leading to significant dispersion in returns. Performance varied among trend followers, depending on the extent of diversification and the speed of their trend-following models. Well-diversified portfolios across multiple asset classes and regions were better able to buffer against sharp declines, while faster models were more likely to adapt swiftly to volatile conditions. The week's events underscore the critical importance of diversification and model agility.

Top 10 Bear and Bull Price Moves

Here's a detailed analysis of the key market movers for the week.

What’s Moving Up

Cocoa prices have once again surged by 12.13% this week, driven by ongoing supply disruptions in major producing regions and corrective responses to previous selloffs. The supply chain for cocoa has been significantly strained due to political instability in West Africa, particularly in Ivory Coast and Ghana, which are the world's largest cocoa producers. These geopolitical issues have heightened fears of supply shortages.

Additionally, adverse weather conditions, including prolonged droughts and unseasonal rains, have negatively impacted crop yields, further tightening supply and pushing prices higher. This significant rebound follows a drop from its peak of approximately $12,000 per US tonne in mid-April. The retracement has been beneficial for trend followers who maintained significant exposure to cocoa, helping to offset losses from the recent downturn. Over the past year and a half, cocoa’s meteoric rise has been consistently fueled by these supply-side concerns, illustrating the commodity's vulnerability to geopolitical and environmental factors.

Oats prices increased by 2.66% this week, driven by concerns over adverse crop conditions and strong demand. This rise, while significant, does not yet signal an end to the prolonged sideways congestion experienced since late 2023. Unfavourable weather in key growing regions and robust domestic and international demand have contributed to this recent upward pressure on prices. However, despite this positive movement, the broader market context indicates that oats remain in a prolonged congestion phase characterized by mean-reverting swings within a sideways consolidating market.

While it might be tempting to conclude that an end to the sideways congestion is in sight, it is still prudent to be cautious about this move. The oats market has shown volatility with frequent price oscillations within a defined range, suggesting that short-term gains often do not lead to long-term trend shifts. Historical data supports this, showing several similar spikes since late 2023, each followed by a return to the previous range. Thus, while the recent price rise reflects immediate market reactions, it should be seen within the context of the ongoing congestion phase, where the market continues to exhibit mean-reverting behaviour.

The Volatility Index (VIX) increased by 2.4%, reflecting heightened market uncertainty and volatility amidst mixed economic data and geopolitical tensions. This uptick, often viewed as a leading indicator of future price movements in the US stock market, signals greater levels of forecast uncertainty.

For globally diversified trend followers, this surge in the VIX, despite originating from a very low base, is particularly beneficial. An increasing VIX typically indicates higher levels of market fear and uncertainty, leading to larger price swings and more pronounced trends that trend followers can exploit. However, while this week's move is significant, it does not yet constitute a material shift in the broader context of historical VIX levels.

Known as the "Fear Index," the VIX measures investor sentiment by gauging market expectations for near-term volatility in the S&P 500 Index. A higher VIX suggests increased market stress and anticipates future volatility, providing trend followers with early warnings about potential global market movements.

The US stock market's role as a leading indicator means that changes in the VIX can offer valuable insights into upcoming market conditions. As the VIX rises, it reflects both current market stress and future volatility expectations, enabling trend followers to adjust their strategies to capitalize on these opportunities. This adjustment helps them manage risk more effectively and capture profits during periods of market turbulence, enhancing their ability to navigate uncertain markets.

The Swiss Franc (CHF) appreciated by 1.29% this week, benefiting from its status as a safe-haven currency amid global economic uncertainties. This rise prompts the question: Is this the end of the protracted bear trend observed in the Swiss Franc since early 2024? The appreciation is driven by factors including rising geopolitical tensions, economic slowdown concerns, and fluctuating market conditions. Investors seek stability in the CHF, known for its reliability and low volatility. This move could also indicate further volatility ahead as markets react to ongoing global challenges.

Coffee prices rose by 1.17%, driven by supply shortages in Brazil due to unfavourable weather conditions and logistical challenges. Frost and drought have significantly impacted coffee plantations, reducing output. Additionally, increased shipping costs and logistical issues have further constrained supply, supporting higher prices. Coffee has been a favourite for trend followers since mid-2023, with the bullish coffee trade adding to their gains. This recent surge suggests a potential resurgence of the upward trend, indicating that coffee prices may continue to rise as supply issues persist and demand remains strong.

What’s Moving Down

Orange juice prices fell sharply by -8.25% towards the tail end of this week, driven by improved supply conditions and a correction following a prolonged period of high prices due to citrus greening disease and adverse weather in major producing regions. This decline overnight might be attributed to increased production forecasts and favourable weather conditions, particularly in Brazil, which has alleviated some of the supply constraints that had previously driven prices to record highs​.

However, this sharp reversal was not well received by trend followers who have been long on the bullish trend in orange juice since early 2022. Orange juice had been a favourite for trend followers, recently reaching new highs just last week due to ongoing supply concerns and strong demand. The sudden drop in prices highlights the volatility in the market and suggests that while there may be periods of price correction, the overall trend can still be influenced by long-term supply and demand dynamics. As a result, trend followers need to remain vigilant and adaptable to such rapid market changes to maintain their positions effectively​.

Natural gas prices dropped again by -6.92 % this week impacted by rising inventories and expectations of milder weather, which are likely to reduce heating demand. The market remains volatile, with supply dynamics and weather forecasts playing critical roles. The ongoing tug-of-war between buyers and sellers continues as natural gas prices persist in mean reverting within a congestion phase that began in early 2023. This period of price consolidation reflects the uncertainty in supply-demand fundamentals, with both short-term fluctuations and longer-term trends influencing market sentiment.

Palladium prices dropped by -6.25% this week, influenced by reduced demand from the automotive sector and a stronger US dollar. The decline in demand from the automotive sector is primarily due to the increased adoption of electric vehicles (EVs), which do not use palladium in their production. Additionally, automakers have been substituting palladium with the less expensive platinum in catalytic converters to reduce costs​​.

The stronger US dollar has also put downward pressure on palladium prices, making it more expensive for holders of other currencies, which in turn reduces demand. This continuation of bearish sentiment has been favourable for trend followers who have been enjoying a sustained bear correction in palladium prices since mid-2022. The bearish trend has persisted due to a combination of factors, including high above-ground stockpiles and a consistent shift in the automotive industry towards more cost-effective and sustainable alternatives​​.

The recent price drop highlights the ongoing challenges for palladium, especially as the market adjusts to the evolving landscape of automotive technology and the broader economic conditions. Trend followers who have maintained short positions in palladium are likely to continue benefiting from these dynamics as the metal faces ongoing headwinds.

Soybean meal prices fell by -5.59% this week, influenced by improved crop forecasts and increased supply availability. The overall trend for soybean meal remains bearish, following its peak in early 2023 yet its decline has been highly volatile providing difficulties for trend followers. This decline is largely driven by record-high global soybean production, particularly in major producing countries like the United States, Brazil, and Argentina.

For the 2024/25 marketing year, U.S. soybean production is forecasted to reach near-record levels of 4.45 billion bushels due to increased planted acreage and higher yields. This surge in production has led to higher carryover stocks and consequently increased supply availability of soybean meal, contributing to the downward pressure on prices​​.

Additionally, global soybean production is expected to set new records, with significant increases in South America. Brazil's soybean crop, for instance, is forecast to reach a record high, further amplifying global supply. These factors have kept the prices of soybean meal low, and the bearish trend is expected to continue unless there are significant disruptions in production or changes in demand dynamics​.

While there may be short-term fluctuations, the overall outlook for soybean meal prices remains subdued due to these robust supply conditions​.

Cotton futures fell by -5.43% this week, driven by favourable weather conditions improving crop outlooks and weaker demand from the textile industry. This decline continues within a broader pattern of sideways congestion that has persisted since late 2023. This congestion phase reflects an ongoing balance between supply and demand, with no clear signs of a breakout in either direction.

The favourable weather conditions have contributed to improved crop forecasts, increasing expectations for higher yields. According to the USDA, the U.S. cotton crop for 2024 is expected to benefit from these conditions, which have led to higher projected production levels. Additionally, global cotton production is anticipated to increase due to expanded acreage in major producing countries like the United States and India​​.

On the demand side, the textile industry has been facing challenges, resulting in weaker demand for cotton. Economic pressures, such as inflation and reduced consumer spending, have dampened the demand for textile products, leading to a slowdown in orders for raw cotton. The National Cotton Council highlights that the anticipated recovery in cotton demand has been slow to materialize, with economic uncertainties continuing to impact the market​.

Despite these dynamics, cotton prices have remained in a sideways congestion phase, showing limited movement within a narrow range. This pattern has been ongoing since late 2023, as market participants await clearer signals that could drive prices out of this range. Factors such as geopolitical events, changes in trade policies, and significant shifts in global economic conditions could potentially trigger a breakout, but as of now, no definitive trends have emerged.

Overall, the cotton market remains in a state of flux, with balanced forces of supply and demand keeping prices stable within the congestion phase. Traders and investors continue to monitor weather patterns, production reports, and economic indicators for signs of any significant market shifts that could provide new trading opportunities.

Summary

This week in the futures markets, the Trend Barometer dipped slightly to 50, signalling weaker but still favourable trending market conditions. The energy sector saw significant declines, with natural gas dropping by 6.92% due to rising inventories and expectations of milder weather. This volatility underscores the critical role of supply dynamics and weather forecasts in driving price movements​​.

Metals faced headwinds, with palladium prices dropping by 6.25% influenced by reduced demand from the automotive sector and a stronger US dollar. The ongoing shift towards electric vehicles and the substitution of palladium with platinum in catalytic converters have further pressured palladium prices. This decline has favoured trend followers who have been short on palladium since mid-2022​.

Soft commodities showed mixed results. Cocoa prices surged by 12.13%, driven by ongoing supply disruptions and political instability in West Africa. Coffee prices rose by 1.17%, benefiting from supply shortages in Brazil due to adverse weather and logistical challenges​​. However, orange juice prices fell sharply by 8.25% due to improved supply conditions and favourable weather in Brazil, marking a correction after a prolonged period of high prices. This decline was not well received by trend followers who had been long on orange juice since early 2022​.

Equity indices saw a slight decrease of 0.19%, influenced by mixed economic data and earnings reports. Bonds saw a marginal decline of 0.12%, reflecting modest market adjustments to changing interest rate expectations and economic data. Currency markets showed a small positive change of 0.24%, driven by movements in the AUD and NZD, supported by positive economic data and strong commodity prices​​.

This week presented a challenging environment for trend followers, leading to significant dispersion in returns. Performance varied among trend followers depending on the extent of diversification and the speed of their trend-following models. Well-diversified portfolios across multiple asset classes and regions were better able to buffer against sharp declines, while faster models were more likely to adapt swiftly to volatile conditions. The week's events underscore the critical importance of diversification and model agility.

Stay tuned for next week's update as we continue to track and analyse the trends in the futures markets.

List of Resources used in the Week in Review

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