Fundamental Momentum

Fundamental Momentum: the driving force behind trends.

In every commodity market traders rely on the auction process of bid and offers to satisfy the buying and selling activity and for every buyer there is a seller. The traders joke is “Why is the market going up? Answer: More buyers than sellers”. But the joke is a joke in itself because for every buyer there must be a seller. There can never be more buyers or sellers in any commodity market.

So why do prices tend to trend?

Because at various times during the trading year buyers will be more aggressive than sellers, and at other times sellers will be more aggressive than buyers.
Being aggressive means that traders are so confident that they know the likely direction of the price trend that it is more important to have a position than it is to sit on the sidelines.

Being aggressive also means that traders are willing to give up the bid/offer spread to hold that position. In short confidence leads to aggressiveness which in turn leads to commitment to the trade.

How do commodity traders become so confident?

Experienced commodity traders know that commodity markets have seasons and cycles. They follow the seasons or cycles closely and trade with the cycle, with the season and never against it. In the non-financial commodity sectors we at Jennings Futures Trader follow the supply and demand dynamics of every market on our list and advise our clients of any imbalances that are likely to cause price rationing.

Price Rationing Cycle:
“The distribution or allocation of a limited commodity using markets and prices. Rationing is needed due to the scarcity problem. Because wants and needs are unlimited, but resources are limited, available commodities must be rationed out to competing uses. Markets ration commodities by limiting the purchase only to those buyers willing and able to pay the price”.

We live in a world of finite resources and commodity traders know that with increased demand for limited commodities prices must rise in order to create a supply response, in other words as commodity prices rise producers make more money and will therefore produce more to take advantage of the opportunity.
Under normal conditions, once the increase supply is anticipated by the market the price premium created by the need to ration tight supply will be discounted as the market moves toward price equilibrium.

Supply shortage can be created by either, an inability to produce enough of a given commodity to meet immediate needs, or an increase in demand (“longage” of demand) that is so great that even a supply response is made to look tight by comparison. This was the situation in the crude oil market between 2003 and 2008 as a spike in global demand drove the price of West Texas Intermediate Crude Oil from USD$30.00 dollars a barrel to over USD$140.00 dollars a barrel. The crude oil producers and refiners could not keep up with demand. The production capacity of the world was exposed as incapable of finding any spare capacity from which to increase production. If it wasn’t for the global financial crisis who knows where the price of crude would have risen to?

In non-financial commodity markets the fundamental momentum created by supply and demand imbalances is the driving force behind the price trend.
What of the financial sector of the commodity markets?

These include stock indexes, bonds and foreign exchange futures and just as with non-financial commodity sectors they too are governed seasons or cycles except that in the case of financial markets the cycle we watch is the economic or business cycle.

The Boom Bust Cycle

Everyone knows of the boom bust cycle, we know when times are good and when times are bad and we know what we have to do with our money during both those times. However if we look at the big picture we see that the real impact of the boom bust cycle is blunted by the actions of central banks around the world. Central banks have a number of financial tools that they can use to soften the impact of a hard landing after a period of economic excess. One of the tolls available to central banks is the interest rate lever, and how the bank uses that lever can have a major impact on the financial commodity markets.

The financial sector cycle tends to be longer than the non-financial cycle and therefore needs to be monitored closely for the major turning points that will determine our favoured trend direction trades.

In the financial commodity sectors it is the fundamental momentum created by the economic cycle that is the driving force behind the price trends. Fundamental momentum is covered in detail in the Jennings Futures Trader Commodity Report. We analyse and monitor market sensitivity to the current fundamental momentum and determine how much influence it is likely to have on the trend strength and direction of each market in our portfolio.