Opportunity in Commodities – Michael Melissinos –

By Anonymous

Trend followers have a hard time making money in commodities over the past few years. Prices coil within tight ranges and make several false breakouts.

Recently, I notice a change — many commodities breaking out. Crude Oil, Grains (Soybeans, Canola), Gold and a few Softs (Cotton, Cocoa) stand out.

Despite the psychological difficulty in sticking to the system during losing periods, not buying into the next the break accompanies the risk of missing a big winner. Taking positions in a low volatility environment following a poor performance period gets me very excited. A similar thing occurs in mid 2014 when metals break down and Energy prices fall 70%.

I believe we have a fertile environment for a profitable run in commodities.

From Congestion Comes Trends

Trend Followers experience losing streaks in commodities before — 1992, 1995, 2007 and 2012–13. Each period includes lots of congestion and whipsaws, which means losses and pain.

Thankfully, such periods end and markets trend once again. The pain comes from sitting impatiently through it.

I track the rolling 12-month Sharpe Ratio of the PnL of each sector I trade; the commodities chart is below. The chart tells us the story of how our system performs over time. In late 2014, a Sharpe Ratio of ~3.50 makes sense since we earn large profits from shorting energy prices and metals — lots of gain while experiencing very little pain (volatility). Following this period, profits decline and volatility increases so the ratio decreases to the point where we are today.

Today, I believe we’re near the bottom of this cycle and that we’re in the early innings of making handsome profits in commodities.

Markets to Watch

Crude Oil

Prices break out late last year and steadily climb since. Crude also weathers the early February volatility well, which I think increases the probability of the trend continuing upward.

Gold

This one has trouble staying above $1,350/oz. Prices stall out at this level numerous times over the past five years. My firm currently holds a small long position and plans to increase the allocation if prices can break through this important level.

Soybeans

Well well…where have you been, Soybeans? The grains sector, in general, displays a similar sideways choppy pattern for the past few years. Many agriculture markets display similar breakouts over the past month or so. Soybeans leads the way higher for now.

Canola

Another agriculture market that shows flashes of strength only to come back down in a broad base ~480. I believe the probability of higher prices remains high, especially if they can hold above 520.

Corn

Welcome to the party, Corn. Again, look at the price pattern over the past four years — disgustingly sideways. Prices are trying to break out of a long term range again. I don’t hold a position right now, but my long triggers sit above the most recent highs. This is another market that can get legs if the breakout occurs.

Conclusion

I believe the odds are high for a profitable winning streak in commodities for trend followers. The combination of a multi-year congestion, low volatility, a rolling Sharpe Ratio near historic lows and new price breakouts make me confident that trends are getting started.

I’ve been wrong before. Maybe I will be again, but let’s keep an eye on these markets (among others I haven’t listed above) over the coming months and make the final call then.

Disclosure

Past Performance is Not Necessarily Indicative of Future Results. There is always a risk of loss in futures trading.

This communication is for information purposes only and should not be regarded as an offer to sell or as a solicitation of an offer to buy any financial product, an official confirmation of any transaction, or as an official statement of Melissinos Trading LLC. All information is subject to change without notice.

These charts show examples of trends. Inclusion of a chart as a trend example does not imply any kind of recommendation to buy, sell, hold or stay out.