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Most weeks I prefer to talk about the stock market, ETFs, the bond market, gold and gold stocks, interesting indicators, trading systems, trends that drive the economy or my general overall disdain for politicians of all stripes. You know, all the stuff that most readers find interesting. Still, every once in awhile I get this uncontrollable urge to plumb the depths of the darker side, and to dive headlong into the murky waters where most dare not - or do not care to - tread. For example, how about that soybean market (IMPORTANT MESSAGE: if the mere mention of the word "soybeans" causes your eyes to glaze over or your brain to momentarily disengage, DO NOT STOP READING!) For one of the most important things for any investor or trader to do is to at least consider ideas that are typically outside the realm of their comfort zone.

As I like to remind people, just because you read an article about soybeans does not mean that the trading police will kick down your front door and force you to sell short a soybeans futures contract. In fact, the correctly functioning trader's brain needs to consider new ideas from time to time. The correctly functioning trader's brain serves as - among other things - something of a filter. It takes ideas in, it sorts through the possibilities, accepts those ideas that makes sense and discards the rest. The only real problem arises when one stops considering new ideas.

OF SEASONAL AND CYCLICAL TRENDS

As you might guess, as the author of a book on seasonal trends in the stock market, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing I have a keen interest in all things "seasonal." This is true even for non-stock market related areas. Very few markets are more "seasonal" than soybeans (and several other grains for that matter). This is due in large part to the essentially inviolable soybean planting and growing cycle. In the Midwest - where the bulk of all soybeans are grown - beans go into the ground in April to early May. The first signs of growth typically show up in June and July, and harvest takes place in September and October.

It's sort of like clockwork, thanks to the fact that farmers in the Midwest cannot arbitrarily one day decide to plant in January, for the simple reason that the ground is frozen and there is snow on it. So there is no choice but to wait until early spring - every year, without exception. Likewise, no one has figured out how to make a soybean seed grow into a stalk, sprout and be harvested in anything under five to six months or so. As such, Mother Nature pretty much dictates when planting and harvesting will take place each and every year.

This "seasonal cycle" has some interesting implications for traders. If you stood on a busy street corner and asked passersby when they thought soybean prices would be most likely to rally, the majority would likely respond "in the summer." OK, in truth, the majority would likely go out of their way to avoid you and the authorities would probably show up at some point to ask you a few question of their own. So don't try this at home. Just take my word for it, most of those who do not try to avoid you altogether would immediately think "drought" and shout out "summer." (Or more accurately, "summer, now leave me alone".."). And they would be wrong, because of"...

THE "ANCIENT" CONCEPT OF SUPPLY AND DEMAND

As a function of the workings of the investor's mind, markets tend not to focus so much on the "here and now," but rather more on the hopes and fears for the future. In the commodity markets this means a fairly strict adherence to two immutable rules:

1. If there is much concern about the impending supply for a given commodity and its ability to meet demand, then the price will rise.
2. If there is much concern about the impending supply for a given commodity and its ability to meet demand, then the price will fall.

A few "old timers" may vaguely recall learning something about this "supply and demand" stuff from back in the day when schools actually taught that kind of "old fashioned" stuff that has nothing to do with the Internet. An old fashioned quaint idea to many, but still the primary driving force in the pricing of commodities.

SEASONALITY AND THE SOYBEAN

So when is concern the greatest for our beloved soybean? Simple. When there are no beans in the ground. After harvest and through some of the winter months a lot of people kind of forget about soybeans (OK, yes I know, most people never think about soybeans at all). But in the early part of each year, some turn their attention to the impending soybean growing season. And the primary question they ask is, "how big will the crop harvest be this year?" And while there is no shortage of pundits willing to offer their "forecast," it remains a little hard to get a true handle on impending supply when there is not a single soybean plant planted anywhere in the Midwest. Sure, if we are coming off of an extremely mild winter it might make sense to expect an above average harvest. Still, for the most part one is left to consider "weather patterns," "field conditions," and the "forecasted acreage" devoted to soybeans, etc. In other words, fairly nebulous stuff.

To put it another way, early each calendar year there is "much concern about the impending supply for soybeans and its ability to meet demand." Hmmm, now where have I heard that concept before? To be accurate, it was about three paragraphs ago. And it suggests a rise in price.

The Actual Trading of Soybeans

A Soybean futures contract is for 5,000 bushels of soybeans and each one-cent movement in price is there for worth $50. Therefore, a full $1 gain in the price of a bushel of soybeans equates to a $5,000 profit for a trader holding a long position in beans and a $5,000 loss to a trader holding a short position in beans. Now let's consider the impact of "seasonal concerns."

Figure 1 displays the growth of equity that a trader might have achieved since 1977 By holding a long position of one soybean futures contract from the close of the 8th trading day of February through the close of the 18th trading day of March.

 

Figure 1 - Profit/Loss from holding long position in Soybeans from Feb. trading day 8 through March trading day 18

As you can see in Figure 1, this is by no means a "perfect trading system." Likewise, there can been some substantial drawdowns along the way. Still, the primary point to be made is that the overall trend is fairly unmistakable. In fact, if we extend out to the 15th trading day of June (see Figure 2), the gains are even greater (albeit with the commensurate risk associated with holding a futures contract for three additional months).

 

Figure 2 - Profit/Loss from holding long position in Soybeans from Feb. trading day 8 through June trading day 15

SO NOW WHAT?

The purest way to play changes in soybean prices is simply to buy or sell short a soybean futures contract. No surprise there. Of course this involves opening a futures trading account and assuming the risk associated with holding a long or short position in a the futures market (in other words, if you have never traded futures before in your life, please do not make this your first attempt). For those who are pretty certain that they will never trade a soybean futures contract, remember that there are options on soybean futures that allow traders to enter into soybean related trades with limited risk and a potentially high reward-to-risk ratio.

Pure stock traders might consider PowerShares Agricultural fund (DBA), which tracks, well, agricultural markets, what else? Please note that this is not a pure play on soybeans as the portfolio is is designed to hold 25% soybeans, 25% corn, 25% wheat and 25% sugar. Corn charts a seasonal course very similar to soybeans (because it to gets planted in spring and harvested in fall), however, wheat (which is planted in late fall and lies dormant in the ground all winter) and sugar do not. Nevertheless, the bottom line is that if soybeans rally sharply, DBA will almost certainly follow suit.

SUMMARY

Investors and traders - particularly those new to the game - are endlessly in search of "the sure thing." Anyone who has been around the game for awhile knows that there is "no such thing" (or if they do have such a thing, they wisely are not talking). Still, certain trends are fairly immutable. Soybeans simply cannot be planted in the ground in the Midwest early spring at best, and soybeans must be harvested before the next winter comes around or they won't survive. Same as it ever was. Likewise, the laws of supply and demand work in an extremely efficient manner (barring government interference). As such, there is a better than even chance that the recent decline in soybean prices is setting up a buying opportunity.


Jay Kaeppel
Staff Writer and Author of Seasonal Stock Market Trends
Optionetics.com ~ Your Options Education Site 

Questions for Jay? Please visit "Ask the Traders" through the discussion board on the Optionetics.com home page.

NOTE:
Jay's latest book, Seasonal Stock Market Trends: The Definitive Guide to Calendar-Based Stock Market Investing, was ranked among the Top 10 Investment Books for 2009 by the venerable The Stock Trader's Almanac 2010. For more info, please click here.

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