Chinese Trade War: “Good” or “Bad” for Commodities?

Chinese Trade War: “Good” or “Bad” for Commodities?



Chinese Trade War: “Good” or “Bad” for Commodities?

Big Picture

The End Result Could be a Cash Cow for Option Writers

As if rising interest rates weren’t enough, widespread concern over a potential US trade war with China rattled stock investors this month. The whipsaw action in the DOW is once again causing responsible investors to ask – Are stocks really the best place for me to be in today’s age of turbulence?

For those seeking shelter in alternatives, commodities are always a popular choice. But despite a rise in a key group of commodities prices, concern amongst some has now crept into the sector as well.

Trump & Chinese Government

Trade War Jitters: Stock investors are nervous. Should commodities investors be?

How could a US/China trade war affect commodities? It’s a pressing question if you currently own, or are considering owning a commodities option selling portfolio.

The first question is, for what commodities would a trade war be “good” or “bad?”

The answer might not be what you expect.

“Good” or “Bad” for Commodities?

As an investor, you may be wondering if a trade war would present a “good” or “bad” time to invest in commodities.

The media has been presenting a narrative that it would be bad, scary and devasting.

Which is of course, wrong.

To understand this, you first must understand the difference between the stock and commodities markets.

In stocks, up is always good, down is always bad. For commodities option sellers, down can be just as good (or better) as up.

Imagine stocks as a heard of cattle . If a few get spooked and run one way, the rest tend to follow. If a few get sick, the malady can easily spread to rest of the herd.

Commodities are more like animals at the zoo . Varied and unrelated. The Panda Bear has little to do with the Zebra. If the Zebra spooks and runs, the Panda likely doesn’t lift an eyelid. If the Amazon Parrot gets sick, the Penguin will continue to ride the water slide unaffected.

Thus when the media says something would be “good” or “bad” for commodities, they are using what is at best, a misleading generalization.

The first question is, for what commodities would a trade war be “good” or “bad?”

Lets have a look.

Key Commodities

For the softs markets, very little if any effect. The US doesn’t grow coffee or cocoa. No effect there. Some sugar is grown in the US but not enough is exported to China to make a big dent. Cotton could be partially effected if China put a tariff on it. So far, there has been no talk of this.

Gold or Silver? No direct impact. Its Possible that increased investor anxiety could add some price support. But anxiety has been present in the metals market for some time. Gold and silver are more concerned with rising rates right now.

Energy Markets? Again, no direct impact. However, a slowdown in the global economy resulting from a trade war could crimp crude oil demand (See our feature article on page 5.)

Which leaves us with the grain markets. If any market is likely to be affected by a trade war, it would likely be the grains. The US is a major exporter of corn, wheat and soybeans to China. Soybeans in particular are a market in which the Chinese have a voracious appetite. A rising taste for meat has accompanied a growing Chinese middle class. This has produced an explosion in commercial hog and cattle operations in China. Soybean meal is a primary livestock food for these animals. And on the world stage, there are only two places to get it. The US and South America.

The Chinese are the US’ #1 customer for soybean exports . Last year, the US exported 32.9 million tons of soybeans to China. This represented more than 34% of China’s total imports.

The narrative has it that a Chinese tariff on US soybeans would be “devastating” to US soybean farmers. (Implying, apparently, a dive in US soybean prices.)

But would this be the case?

“Devastating?” Or Not?

China accounts for 60% of the total world soybean trade so a tariff on US beans is not small matter. However, China has already begun shifting more business to Brazil without tariffs. US soybean exports to China dropped 14% in January 2018 vs. last January. Imports from Brazil were sharply higher . China can and appears to be shifting what business it can to Brazil already. However, soybeans are a seasonal crop. When the US harvest comes in September, Brazilian supplies can be running low. American beans can be the “only game in town.” China cannot stop importing US beans altogether. Slapping a tariff on them could backfire.

Soybeans on a Cargo Ship

Who needs a tariff? US soybean exports to China were down 14% in January while Chinese imports from Brazil were sharply higher.

Assuming the Chinese would go through with a tariff, the “knee jerk” price reaction likely would be lower prices. But how low and for how long? Chinese demand for Brazilian and Argentinian beans would drive the prices of those soybeans higher. Thus, for the rest of the world export market, US beans would look like a bargain . What was lost in Chinese exports could at least partially, if not fully be replaced by new demand from other markets.

A bout of volatility? Potentially. But “devastating” to US soybean farmers? Highly unlikely.

Capitalism is a wonderfully self-correcting mechanism.

The Bigger Point

For an option seller, which I would assume you are or aspire to be if you are reading this newsletter, what commodities do as a whole is largely irrelevant to you.

As a seller of puts and/or calls, you can potentially generate returns in bull OR bear markets equally . It doesn’t MATTER which way prices are moving, as long as you’re on the right side.

…there are many ways to milk a market of profits and …most of those do not rely on upward price appreciation.

Its one of your biggest advantages as an option seller. And also one of the most underrated advantages.

A good example: Last month you read in this newsletter a suggested call selling strategy in soybeans. This trade was based on pure supply/demand fundamentals – and little to do with China. However, the piece suggested that if Chinese soybean tariffs did materialize, it would be an added bonus to the position. That is how you turn a bear market into a money machine. (A money machine completely uncorrelated to the stock market, I might add.)

Bear & Bull Graphic

Bull or Bear markets are largely irrelevant to commodities option sellers.

For you it means FREEDOM. Freedom from being held captive by utter and complete DEPENDENCE on never ending price appreciation – in stocks, bonds, real estate or the gold coins in the family safe. Freedom to potentially make excellent returns REGARDLESS of the market direction or economic condition.

What Financial Media Will Never Understand

This is what the media doesn’t get with their “good” and “bad” narrative.

In stocks, up is always good, down is always bad. For commodities option sellers, down can be just as good (or better) as up.

Theirs is a surprisingly simple way to look at markets. Yours is decidedly more sophisticated – not to mention flexible and consistent.

The next time you hear “trade war with China,” while the stock investors run and hide under their beds, you should be thinking one thing. You should be thinking about the jolt of volatility that might bring to a few, select commodities . Then you should look at how high the option premiums might be in that market.

And then, you should get ready to go shopping . News events that bring out the public can create cash cows for option sellers. Especially those wise enough to know there are many ways to milk a market of profits and that most of those do not rely on upward price appreciation.

In today’s uncharted market waters, such strategies are fast becoming a necessity.

Have a great month of premium collection!

– James

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