‘It’s Not Going to End Well’ for Investors Who ‘Get in Too Late’ to Volatile, Meme-Like Commodities. How to Trade the Chaos Instead.

I joined Michele Steele of Stocktwits TV earlier this week to discuss TACO Tuesday, finding predictable patterns in seemingly irrational chaos, trading dangerous commodities like natural gas and wheat, and where the best opportunities lie now. WATCH THE VIDEO HERE. 

Natural Gas “Widowmaker” and Wheat “Poverty Grass”: Don’t Start Here

Michele: Markets are breaking records, then breaking down, then breaking records again, sometimes all in the same week. My next guest has spent four decades in commodity markets, nearly, nearly four decades. I don’t want to age you there, Darin, and has a pretty simple explanation for all of it, if I am not overstating the case, but chaos can be predictable if you know how to read it. Darin Newsom now, a senior market analyst at Barchart, is on Stocktwits TV. Great to have you on, Darin.

Darin: Well, I really appreciate you having me on. I'm looking forward to this conversation.

Michele: Yeah, and from the heart of commodity markets, I think, over in Omaha, and I'm in Chicago, and so we can talk about commodities, I think, with some level of geographic wisdom, I think.

Darin: That's right. I mean, those are two of the hotbeds of the commodity world, particularly Chicago, with all of its history, the Chicago Board of Trade, Mercantile Exchange, and so on.

Michele: Yeah, yep, I started as an intern a very long time ago at the Chicago Board of Trade, and remember all the open outcry between the CBOE and the CME, and the Board of Trade traders, of course, but let’s get into kind of a big picture thought here. You wrote a really interesting article this week over on Barchart that essentially said that the irrational market behavior we’re seeing has become a little predictable, and I think what jumped out to me was this idea that stocks have become commoditized. So what did you mean there?

Darin: Yeah, it is an interesting issue because we look at this situation, it doesn’t seem like it makes any sense at all. Everything is tied to the latest social media posts, to the latest headlines, and so just on that, anything could be said at any point, and so that is the true definition of chaos, which is an unexpected event at a key time creates a different result, but what we can add to that is if we watch these markets, if we’ve watched how this has evolved over the last decade, going back to 2016, we can see there’s been a pattern, and a lot of it depends on the type of headlines, the type of news that’s coming around here at home, then we can start to expect, okay, this is what’s going to be posted, this is what’s going to be said, because the net effect is the current administration views U.S. stock indexes as the economy. I’m not, that’s nothing new, I mean, that’s what’s been said. They equate, and so at the end of the day, and if not each day, at least at the end of the week, as we head into Friday session, we have to be expecting the social media posts that’s going to say, oh, we’re going to have, there’s going to be a trade talk, there’s going to be peace talks, there’s going to be cease fires, whatever it is, to get markets that are putting pressure, say the energy sector that’s putting pressure on U.S. stock indexes, they’re going to come down, and U.S. stock indexes are going to lift into the weekend, get set a higher weekly close, and then immediately into the weekend, we see all of the reality of the news change. Bombs continue to fly, missiles are going back and forth, boats are being sunk, all of these things, and so then when we get to Monday, the markets take off and go right back where they were. So this is the predictability of the irrational markets. Markets aren’t acting rationally, like there’s rational human beings in charge of them, but within that, there is a pattern.

Michele: There absolutely is a pattern, and I think it’s worth sort of emphasizing in this conversation, because when people hear this, when people hear the sentence, chaos is predictable, it does sound like an oxymoron, but what we have seen, but if past precedent is an indicator of future performance, we can absolutely sort of track this almost as you just did down to the day. So let’s make this concrete. Walk us through exactly what you just called this weekly cycle in this article. So at first it starts with a post, right? Sort of a bullish weekend post.

Darin: Right.

Michele: And then the markets rally off of that. Right. And then reality comes, sort of reasserts itself, energy spikes, stocks fall, and then what happens on Tuesday?

Darin: Well, I mean, let's just look, I mean, let’s just look at what happened this past Tuesday. As we speak, we came into this morning, we came into the morning, and all the headlines started talking about, oh, you know, Dow is up 200 points, Dow futures are rocketing higher because there’s hope. There's quote, unquote hope that the U.S. president has talked about. There's going to be more peace talks, you know, ahead of the end of the ceasefire. There's going to be all of this. And so we get to stock markets rallying, we have energies, you know, not really doing all that much. Some of the other contracts outside of crude oil were still staying strong. And so this lasted possibly through mid morning, and then all of a sudden the headlines change, and then all of a sudden the headlines start coming in, you know, all of a sudden the Dow starts breaking down again and why? Well, the headlines now read, you know, fears that Iran talks are breaking down. So, I mean, what usually doesn't happen within the same day, this is what we would have expected after the close through Wednesday morning. But again, this is all within the same day. So we were, you know, we were up to 300 points in the Dow, and down to 300 points, all because the headlines changed. These are the sorts of things that we can start to anticipate and start to predict are going to happen.

Michele: It's called Taco Tuesday. It's almost as predictable as the days of the week. And yet most people, Darin, I think, are being whipsawed by it rather than by using it. Why do you think that is?

Darin: Well, because, you know, there’s still a lot of folks who are, a lot of folks who are trying to use this as a long-term investment. And as we talked about in the open, the commoditization of stock markets means these are short-term entities. You cannot, I can’t say that, but you should not try to trade these things long-term because we are going to see this type of activity. So if you’re going to be holding long-term positions and say you’ve got long-term stocks that you’ve been holding for years, decades, whatever, it puts you in the uncomfortable position of using futures then as some sort of hedge. And so you start doing the short-term futures, maybe some options to protect yourself from what this cycle of posts and headlines, what we’re expecting each and every week.

Michele: Yeah, you know, we were talking a little bit before the show about how stocks are commoditized and now it’s sort of flipped, right? Where, and commodities were seen as the wild west and now it’s kind of flipped. Stocks are so sentiment-driven and then these commodities are whipsawed by all these headlines coming out all the time. Let’s bring in though your area of expertise, commodities, because Stocktwits actually just started carrying CME futures so it’s very timely. A lot of our audience, Darin, is looking at commodities for the first time. And there was another thing that you wrote this week that I thought was a perfect warning label, can I call it that? Natural gas, the widow maker. And you called wheat, poverty grass. You said prediction market traders are piling into both of them there. What happens next?

Darin: Yeah, what happens next is a lot of folks are going to learn why these two markets, these two markets in particular have these well-earned nicknames. We can look back over the history of natural gas and it’s one of just leaving people in its wake. And everyone was going to come in, they’re going to outsmart the natural gas market and they never do it. It’s just one of those markets that makes no sense. And then wheat has its own idiosyncrasies. And if you didn’t grow up in a wheat field or out in the middle of South-Central Kansas or anything like that, and you just view it as this opportunity to jump in and out of, and it’s going to be so easy and it’s going to go up all the time. Again, it's called poverty grass, not just for those who grow it, but for those who actually try to trade it and make money off of it. So, I mean, these are the hard realities that people are going to have to learn. And commodities is a different beast than stocks. And a lot of these long-term investors that are all of a sudden interested in commodities, again, we saw it about 20 years ago. So all of these long-term investors, they’re going to have to learn the reality. So, okay, what does a forward curve mean? What does it tell us? Can we use the forward curves to tell us what long-term fundamentals are? Do we even need to know what fundamentals are at this point? So all of these things are the little nuances that folks have to learn when they start getting into commodities. And probably two of the markets that I wouldn’t start with would certainly be natural gas and wheat.

Michele: Let’s talk about soybeans, though. I’d heard earlier in the year that's a trade that’s worked out for some people. Was it actually a soybean trade or was it really an energy trade sort of dressed up as a soybean trade?

Darin: Yeah, I think you're right.

Michele: At least a biodiesel, yeah.

Darin: Yeah, yeah, I think you’re right. I think this was mostly, this mostly came from the energy side and it’s really picked up gas here over the last couple of months. No pun intended. No pun intended. We saw diesel, the distillates market just take off. And there's connections to the oil seed complex through both soybean oil and canola. And with soybean oil moving higher, soybeans don’t really have much choice, but to tag along. Usually it’s soybeans and then the products of oil and meal kind of ride the coattails, but not this time around. And that's what's interesting. I was just talking about forward curves and how we can read those if we still choose to look for fundamentals and long-term investors may want to try to weigh out the markets that they’re interested in by using forward curves. But over in soybean oil, it’s in backwardation. So nearby contracts are higher priced than deferreds. And that tells us it’s a bullish supply and demand situation again, coming from the energy sector. Soybeans, not so much. There’s still plenty of soybeans around the world. They’re just looking at the possible uptick in demand for U.S. soybean oil.

Michele: Is that trade over given some of the larger macro moves in the energy markets?

Darin: I don’t think so because I don’t think we’ve reached the peak here in the energy sector yet. And I think it’s going to continue to pull bean oil higher. We saw it take a little bit of a breather and this is another kind of quirk of the commodities is that we saw bean oil get to, I think it was record large long futures positions in the CFTC reports. And so that led to some liquidation. Nothing had changed. Fundamentally, the markets had changed, but when you get increased volatility in large positions, sometimes you have to take some of the pressure off of, like a steam bag, you have to take some of the pressure off the market and you’ll see funds start to sell, drop it back down, create another buying opportunity and off they go again.

Michele: So where is the trade in commodities right now? I know that you wrote this week, I believe, about something that was really fresh and it wasn’t soybeans, it was beef. Mm-hmm.

Darin: Yeah. You know, the U.S. livestock, excuse me, live cattle and beef markets have exploded over the last two or three years. And so what we’re looking at now, what I’ve been looking at now is how long can U.S. consumer demand continue to pay for high price beef when we’re seeing energy prices going up, gasoline prices going up. And when there are other opportunities, say bean oil or possibly wheat, possibly natural gas, though I doubt those seriously, but there’s going to be other opportunities in commodities where you have those inverted forward curves that are telling us maybe there’s a long-term fundamental situation brewing. So I think you could start to see some money begin pulling out of the livestock and beef markets and rolling over into some of these others and that creates a vacuum under the cattle market so it could start to pull these things lower. And then there’s also this connection between beef and, as I talked about, with the U.S. stocks and the overall economy. So if stocks start to slide, I think that could be another reason for those long futures start to get sold in the beef market.

Michele: Yeah, well, like they say, the cure for high prices is high prices. I know you mentioned a cold storage report coming out on Friday. What are you looking for in that?

Darin: Yeah, what’s interesting there is, I’m not much of a government report person. In fact, I usually spend more time making fun of them than I do actually analyzing them. But if we’re looking for some sort of economic indicator, I think we can find it in the cold storage report. What we’re going to be looking for, there wasn’t much change in the February numbers. So now we’re here at the March numbers and we’re going to see a full month’s worth of higher-priced gas. So do we start to see a build in beef stocks and, say, a drawdown in chicken or poultry, possibly even pork stocks? And if it is, is this indicating to us, particularly as we’re going into this time of year when it’s usually seasonally bullish for beef, are we starting to see U.S. consumers rolling over and looking for cheaper proteins? So this is what I’m going to be looking for. We’ll see if we can see some sort of economic indication of that in this March report coming out at the end of the week.

Michele: Yeah, I mean, the resilience of the American consumer to sort of keep spending no matter what else is out there is remarkable. And I know that you wrote about your friend from Italy, your other Michelle friend, Michele, I think is how it’s pronounced over there, who said that the American consumer, you know, talked a little bit about this dynamic with gas prices and beef. You're saying beef is going to be the first crack, sort of, in consumer spending when gas prices stay regularly above $3 a gallon.

Darin: I think so. And, you know, we’ve had the energy secretary come out and say, you know, gasoline prices aren’t coming down below $3 for the rest of this year. And so that’s most likely the case. And so I think one of the markets that will crack, and I think it will seriously test U.S. consumer demand for beef. And within that sector, we could see possibly a switch from the higher price cuts to more of the lower price cuts, still demand for beef. And so that, you know, what they can ultimately do is push, you know, lower price cuts like hamburger and so on, hamburger and sirloin up against those higher price cuts. So while I’m looking for overall demand just to start to come down and roll over to other proteins, I think we could see it split initially. And then by the end of the year, see more of an absolute change.

Michele: Between live cattle futures, you know, even, you know, lean hogs, I sound like Orion Samuelson now. If they’re looking at CME futures for the first time, is there a setup there or is it too early?

Darin: Well, it could be too early, but one of the, it’s interesting you should mention that because one of the things I was just looking at was if we look at the cash indexes for those two markets, live cattle and lean hogs, it’s at record high in favor of the cattle market. And while that’s not bearish, it also is, we just talked about when funds get, you know, overloaded, what I like to call, you know, the Poseidon predicament, when everybody’s on one side, the boat tends to roll over. And that could certainly be the case in this cattle and hog spread, where we see both the cash market and the futures market far out distancing where we are in the lean hogs, you know, based on history. That could lead this spread to roll over, particularly if we start to see increased consumer demand for hogs start to support the cash market. And then again, start to weaken the cash market over in beef.

Michele: You know, I want to end on a question that you raised in your writing this week. And one thing I enjoy about your analysis is really how direct you can be. And you said quite frankly, that most of this probably doesn’t end well for some investors. You’ve watched these markets for nearly 40 years, as I said, you know, these markets disconnected from fundamentals, commodities feeling like they’re turning into meme stocks to an extent, the weekly cycle, right, of the bullish statement, and then the markets open, and then, you know, reality hits and Taco Tuesday. So how do you think this all ends? Where do we go from here?

Darin: Well, again, I’ll say it. It's not going to end well, because what we tend to see is folks get in too late. They hesitate, they get in too late. And then with the rapid change in these things, again, as we just saw today, how quickly these things can change. People are going, and they don’t understand how commodities work, things are going to change rapidly. And then all of those longs are going to start getting out, being forced out through either margin calls or changes in policy positions and so on. And it’s going to, you know, it’s just going, it could lead to a lot of collapses here in the market as money rolls back and forth. So, you know, as far as markets that used to be tied to underlying fundamentals, I think that’s broken for the time being. We certainly can’t use classic technical analysis. You know, the algorithms don’t care about trends. They don’t care about, you know, head and shoulder patterns and all of these sorts of things that we were all taught as kids. You know, it’s all about volatility and momentum. And when that turns, it can turn in a hurry, and it can be very volatile, and it can be very violent when it does turn. We've seen it in the soft sector over the last couple of years, and I do think that we're setting it up for the cattle and the beef. And who knows how many other markets, how many other market sectors this could ultimately affect.

Michele: Saw it in precious metals at the beginning of the year.

Darin: Yes, we did. Yes, we did.

Michele: You know, so if fundamentals still exist somewhere, and I like to believe they do, I think you do too. Yes. You know, at some point, the gap between that and reality, between price and reality creates a trade. Where is that gap the biggest right now? Where is an edge?

Darin: You know, right now, I would say, you know, that's where we have to, that's where we have to look at what's called the basis of the market. And that's either the difference in the cash market and futures, or in the spot market and the deferred futures contracts. And so right now, you know, even though they're high price, they've sold off, I would say basis is probably strongest in the energy sector, because there's no knowing how long this is going to last. And so I think this is going to continue to attract some money. I think the actual cash value of metals, particularly gold and silver, are going to start to attract, we continue to hear where global central banks, central banks around the world, continue to load up on gold. And so I think that is a, I think that’s a play that’s just waiting to start to move the other direction again. Grains, I just really don't see anything overly interesting right now. I don’t see the setup, maybe in some of the smaller markets, like again, like bean oil, where you’ve got the inverted forward curves and so on. But other than that, I think it’s just going to be very quick moves one way than the other. But for longer term investments, I think we do have to try to, you know, if and pretend that we could still use fundamentals and look at some of these things we've always used.

Michele: Well, great insights there and a really fascinating conversation. I don’t get to talk commodities enough. And so it was a real treat for me to get to sort of pick your brain here, Darin. Darin Newsom, Senior Market Analyst at Barchart. Follow him there and at, can I say your website, DarinNewsom.com?

Darin: Absolutely, I appreciate it.

Michele: Terrific, Darin. Appreciate you doing that. This was great. Come back soon, please.

Darin: I look forward to doing that.

Michele: All right. We will link to all of his work in the show notes. And if you’re new to CME Futures on Stocktwits and everything he talked about, check it out on our platform.