Investors will closely watch major central bank meetings in the next two weeks as market volatility heightens.

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After completing a head-and-shoulders (H&S) pattern, Natural Gas prices broke lower, eroding much of the initial rally in May, albeit a recent reversal can be observed.

The calendar spread has recently broken below a channel that has been in place since 2023. A similar break lower from the channel has been observed in March at a similar price volatility level.

After a rapid rally in May, Wheat prices have returned to support at the 530 level, a significant level representing pre-pandemic levels. This reinforces the validity of a reversal signal from the recent support bounce.

A similar traceback from a rapid rally in May is observed in Soybean Meal. A recent rounded bottom could also poise for a reversal. 

A sharp reversal is observed in Lean Hog prices as the price breaks above the recent descending channel, signaling a new uptrend.

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Before summer hit the Northern Hemisphere this year, there were many talks on how 2024 would be the hottest year in history. While warmer waters render watercooling for reactors ineffective, warmer air raises the need to run air conditioners. Coupled with the already tight liquified natural gas supply, natural gas prices were higher due to greater forecasted demand for cooling use. Hotter oceans could also create transit issues in key waterways and threaten to spawn tropical cyclone activities. Furthermore, long-lasting heat waves could cause devastating and lasting damage to crop yield. The projected hotter-than-usual summer threw many commodity prices into chaos in May.

As we are mid-way into the summer, the weekly tracking and reports of commodity stocks and weather forecasts helped to provide a more accurate picture. For example, despite the initial drought in Kansas, the recent rain came as a relief to wheat yield. This improved the potential for a good crop season in the United States (U.S.). With the actual summer heat being a little more bearable than expected, much of the fear surrounding commodity prices has abated.

As European natural gas storage levels are expected to reach 100% ahead of the heating season, traders previously planning on tighter stockpiles of natural gas are starting to give up. Moreover, many speculators were unconvinced by the fundamentals driving the rapid rally in May, leading to heavy shorts in the commodity markets. As a result, many commodity prices, such as wheat, Soybean-related futures, corn, etc., have retraced back to pre-summer levels.

Where are the commodities headed with a few more weeks to the end of summer in the Northern Hemisphere? We believe the agricultural and natural gas commodities are primed for an uptrend. Looking at the figures above, we see either a bounce from their respective support lines or a rounded bottom. This reinforces the validity of the support lines. From a flow perspective, these could be due to short speculators covering their trades at the support level. However, we believe there are stronger fundamental factors at play. Take Soybean meal, for example. The drier forecast in America acts as additional support for the market. Furthermore, the demand for Soybean meal remains strong, particularly for a protein-source staple in animal feed. As depicted in Figure 5, the sharp rebound above the descending channel indicates a new uptrend in the lean hog market. A booming livestock market creates needs for more Soybean meals, potentially providing additional support for Soybean meal.

While we have already accounted for the increased use of air conditioning due to continued excessive heat across much of the U.S., record-hot oceans are also likely to cause a shift to La Nina, a climate pattern expected to occur in August. This leads to increasing threats of hurricanes in the Atlantic and drier conditions in the est and outh of the U.S. Not only has it yet to take hold, but this will also likely impact other regions such as Japan and Southeast Asia, where much of the impact has not yet been felt.

In addition, as mentioned in our previous article, CME FedWatch suggests that the market has priced in the Federal Reserve to start the rate cut cycle in September. Given that most commodity futures contracts are priced in USD, as the USD weakens from rate cuts, more dollars would be needed to purchase the contracts, leading to an increase in prices.

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We consider expressing our views via the following hypothetical trades¹:

Case study 1: Long Natural Gas futures calendar spread

Considering the seasonality of natural gas, the Natural Gas futures contracts listed in winter typically trade at a premium because of the unpredictable winter demand. Likewise, to express the expectation of a weaker-than-usual injection during the summer, we can consider taking a long position in the Natural Gas futures calendar spread (NGV4NGF5), this is essentially taking a long position in the October 2024 and a short position in the January 2025 futures contracts. Currently, at the present level of -1.280, with a stop loss below -1.330, which could bring us a hypothetical maximum loss of -1.330-(–1.280) = -0.050 points. The calendar spread price has the potential to climb back to -1.000, a resistance level that has been tested multiple times since 2023, a hypothetical gain of -1.000 – (-1.280) = 0.280 points. Since each Natural Gas futures contract represents 10,000 MMBtu and each point move represents 10,000 USD, each point move in the calendar spread would also represent 10,000 USD. There is margin offset for Natural Gas futures calendar spread.

Case study 2: Long Soybean Meal futures

We would consider taking a long position in Soybean Meal futures (ZMV4) at the present level of 316, with a stop loss below 306, which could bring us a hypothetical maximum loss of 316-306 = 10 points. Looking at Figure 4, the Soybean Meal futures price has the potential to climb back to 333, a hypothetical gain of 333-316 = 17 points. Each Soybean Meal futures contract represents 100 short tons, and each point move represents 100 USD.

¹ Examples cited above are for illustration only and shall not be construed as investment recommendations or advice. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. Please refer to full disclaimers at the end of the commentary.

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