In This Issue:

Feature Article | Interest Rates | Agriculturals | Energies | Softs | Currencies |
Metals | Ask a Strategist | Futures Trading Basics

Feature Article

U.S. Ethanol Output Increased 33% in 2007

By Jerry Gidel, RJO Futures Senior Trading Advisor

U.S. ethanol output continued to advance on a recent government update, with record daily and monthly production levels reported for the final month of 2007. According to the U.S. Energy Department, daily U.S. ethanol output rose to 489,000 barrels per day (up 10,000 per day from November), while U.S. overall output pushed to 637 million gallons (up 34 million gallons from the previous month’s record output).

Firming crude oil prices (which neared $100 per barrel) and ethanol’s discount to gasoline prices helped keep the U.S. ethanol plant capacity utilization firm. Based on the Renewable Fuel Association’s (RFA) operating plant list for the beginning of that month, capacity utilization was 104.2%, down only 0.2% from November’s strong level. Even with U.S. ethanol output increasing, this biofuel’s stocks slipped for the third month in a row to 10.509 million barrels—down 685,000 from November. This is a positive sign that ethanol blending is expanding into new areas of the country—as energy firms try to remain competitive by using ethanol to reduce costs, as crude oil prices pushed toward triple digits that month.

During February, three new bio-refineries came online, totaling 270 million gallons of capacity. However, two plants also suspended operations recently (one in California and one in Kansas, with listed capacity totaling 80 million gallons), citing feedstock costs and operational problems. Overall, U.S. biorefinery capacity is about 8.05 billion gallons when making the adjustments to the RFA’s plant list (on its Web site), with this month’s startups in Ohio and Iowa. For the fourth month in the last five, the RFA didn’t add any plants to its list of new construction.

In the last year’s atmosphere of declining processing margins, regional gasoline regulation issues and gasoline distributor inertia about investing in additional facilities, America’s ethanol output in 2007 still increased 33% to 6.485 billion gallons vs. 25% during 2006. Current high gasoline prices, the passage of the 2007 Energy Bill (with a higher renewable formula standard of 9 billion gallons for 2008), and some changes in state regulations in the Southeastern U.S. will boost ethanol output this year. However, the high cost of corn and the likelihood of excess plant capacity still overhang this industry. With 2 billion to 2.5 billion gallons in new plants possibly coming online, margins will remain very tight—and could result in significant plant shutdowns later this year, if recessionary economic conditions develop.

Because of these challenges, corn’s 2007/’08 ethanol demand could be overstated by 100 million to150 million bushels. But the U.S. Department of Agriculture probably won’t make adjustment until the March 31 stocks report, when corn’s domestic feed usage will also be monitored. The recent strength in soybeans and wheat prices is also prompting more signs of corn acres declining by more than 5.5 million acres from 2007. This suggests that growing season concerns could open price potential to more than $6 later this year. Hold old-crop sales for now, and keep new-crop coverage at 35%-40%.

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Interest Rates

By Donna Heidkamp, RJO Futures Senior Trading Advisor

Confusion reigns in many markets, as confidence continues to decline and volatility increases. Many investors were humbled as a result of the extreme volatility and significant corrections made last week. Many investors are also asking if we have made a low in the stock market, since the potential buyout of Bear Sterns has surfaced. In an effort to try to bring some clarity to the market direction, I am reviewing where we stand with some of the major economic reports.

The Fed has certainly been proactive since the last eView! Earlier in the month, the Fed made an announcement that it is pumping money into the credit market by lending up to $200 billion in exchange for mortgage-backed securities. This move was expected to relieve lending pressures in the mortgage markets, and it makes capital more readily available to banks. It proved to be insufficient as the Fed came in the alleviate bankruptcy pressures of Bear Sterns and made a surprise rate cut, opening the discount window to financial institutions other than banks. A move of this caliber has not taken place since the Great Depression! As a result, many economists and traders believe that this will signify the bottom of the bear stock market. Time will only tell! In my opinion, we need to see improvements in housing, sales, employment, and business growth.

The monthly unemployment report is just around the corner once again. If the weekly reports are any indication, the monthly report coming out April 4th will likely be negative. Businesses are still in a contracting mode, and therefore are not adding jobs. At this point, the monthly unemployment report is expected to show a decline of 40K jobs. That is an improvement to the last report showing a decline of 63K jobs created, but still lacking. Further declines are expected in the next few months, as employees at financial companies such as Bear are likely to lose jobs.

Even though several markets sold off heavily last week, global demand continues to remain high. As the prices of goods such as crude oil, metals and grains continue to make new highs, the concern and risk of inflation continue to rise. The risk increases even more, as people lose jobs and can’t afford to make payments. Therefore, on the back of a declining jobs picture, the Fed continues to be committed to doing everything it can to promote growth first, and fight inflation second. It is my understanding that the Fed believes that a slowdown in the economy will slow inflation growth as well. The producer price index (PPI) came out +.3% as expected. The core PPI, though, came out much higher than expected +.5% vs. +.2%. Surprisingly enough, the consumer price index (CPI) and core CPI were unchanged. In other words, the producers are slow to pass on cost increases to consumers. In my opinion, it is normal to see a lag between increases in PPI and CPI—especially since retail sales declined .6% last month vs. +.2% expected, and industrial production has been declining.

The existing home sales number surprised the market on Monday, coming out higher than expected at 5.03 million homes vs. 4.85 million homes expected on an annualized basis. I am not quite ready to say that the trend has reversed, because this is the start of the high season for buying homes. New home sales are expected to come out between 570K - 580K units on Wednesday, vs. 588K and 600K units sold the previous two months. The trend is still pointing down, and is not likely over. The decline in home values is still concerning as well. As value decreases, the household percent of debt relative to assets increases—creating more economic growth pressure. This decline in assets is further increasing the risks that lending institutions face as a result of many high risk loans given in recent years.

Fed Watch: The March Federal Open Market Committee meeting is behind us and the Fed has made some drastic moves, including making the discount window more readily available to improve liquidity issues. The Fed’s focus will likely start to shift to potential inflationary risks, as the liquidity issue improves.

Technical Update for June Ten-Year Notes:
Near-Term Trend: Sideways to Lower
Long-Term Trend: Higher
Support: 117-22.5; 115-25.5
Resistance: 118-21.5; 119-29.5
The longer-term trend is still pointing higher. The sideways action in the market is indicative of the sideways tug of war between growth and inflation. The increased inflationary pressures are supporting longer-term yields, and in turn could pressure the TY price—even more so, since the much awaited FOMC meeting is behind us and the odds of further aggressive rate cuts are declining.

Upcoming Key Reports:

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Agriculturals

By Jerry Gidel, RJO Futures Research Trading Analyst

After a bout of profit-taking caused by U.S. financial market concerns, the corn market’s focus has now returned to fundamental factors. This includes next Monday’s U.S. planting intentions and quarterly grain stocks reports, as well as increasing concern that recent cold, wet conditions in the central U.S. could delay spring seedings.

After last year’s dramatic 15.3 million acre jump in U.S. corn plantings, the corn area could fall in 2008—due to last winter’s high soybean prices, the high costs of corn growing inputs, and producer desire to return to previous crop rotations. The size of this decline is a concern, however. If too many acres switch back to beans, 2008/‘09 U.S. supplies could put corn’s numerous feeding, export, and ethanol needs in jeopardy. Because of the timing of this year’s producer survey, we anticipate this first projection of 2008 corn plantings to be 87.3 million acres—down 6.25 million from 2007. Based on seed sales and country sources, expectations are for high-percentage declines in southern and western areas of the belt and modest reductions in the central Midwest.

The U.S. Department of Agriculture’s (USDA) quarterly stocks report also will be scrutinized to see if the recent high prices have impacted U.S. domestic demand. Higher cattle-on-feed and hog and poultry numbers suggest plentiful demand. However, other factors suggest that last winter’s feed demand could be down 3.5% vs. 2007. These factors include: (1) higher ethanol byproduct (DDG) availability; (2) high-end user sourcing last fall; and (3) a significant amount of the U.S. southern harvest moving into feeding and export channels late last summer—which wasn’t possibly registered as utilized until the fall quarter. Tight processing margins over the winter also likely limited ethanol/food/industrial demand to a yearly increase of 22.5%. But export shipments at 650 million, 26.5% higher than last year, remain corn’s bright demand star. If our corn stocks estimate for March 1 of 7.14 billion bu. (the highest in 20 years) is on target, old-crop corn’s demand levels might need adjustment on the USDA’s April 9 update with feed and ethanol demand being lowered 100 million—while exports are raised 75 million -100 million, resulting in higher ending stocks of 1.56 billion.

Even with possibly higher old-crop stocks, 2008 corn plantings need to be in the 88 million - 89 million range to have minimal adequate supplies for the 2008/ ‘09 crop year. The recent sharp decline in the bean/corn price ratio might prompt some producers to want to switch back to corn, but the current cool, wet weather outlook for the central U.S. into the first half of April will keep the trade nervous. End-users should use setbacks toward $5, to have cash needs covered through June. Hold old-crop sales at 90% and new-crop coverage at 35%-40% to see how this spring’s U.S. planting season develops. Note: Starting March 28, corn has a higher daily price limit of 30 cents.

For more information on 2008 plantings, get a FREE copy of What Will America’s Farmers Plant in 2008? Click here.

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Agriculturals

By Stephen Davis, RJO Futures Senior Trading Advisor

What a difference a week makes. Wednesday opening call is sharply higher to limit up once again. Continued weakness in the U.S. dollar and higher outside inflationary markets—coupled with the backdrop of export demand, due to a farmers’ strike curtailing Argentina’s exports—is expected to keep speculative money flowing back into the market. Tuesday’s synthetic options close (well above the limit up settlement in the futures pit) set the tone for overnight trade, with strength in Asian markets providing further support to extending the recovery bounce from last week’s heavy losses once again.

The U.S. Department of Agriculture is slated to issue its prospective plantings estimates Monday, and the markets and traders anticipate the market will start to see some positioning ahead of that release.

Corn futures on The Chicago Board of Trade are expected to begin Wednesday’s day session on firm ground, continuing the recovery bounce on a combination of supportive outside influences—spillover from soybeans and bullish underlying fundamentals. The overnight theme will set the tone in early action, as the absence of fresh bearish news, speculative money flow returning to the market (in conjunction with the weak U.S. dollar), and supportive acreage and demand outlooks support prices. One corn producer we work with reports a 15% reduction in corn seed sales from a local independent seed dealer. The corn charts certainly look different from the other grain charts.

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Energies 

By Christy Olin, RJO Futures Trading Consultant

The energy futures markets, like most of the commodity markets, saw increased volatility last week. Some of the geopolitical turmoil in oil-producing regions has calmed down, and the vice president of the U.S. visited the king of Saudi Arabia last week. It appears crude oil is headed lower, while reformulated gasoline blendstock for oxygen blending (RBOB) and natural gas markets seem poised to trade higher.

Crude oil futures have carved out a near-term downward trend, after making a strong move higher since the beginning of February. The fundamentals for this market have been indicating there should be weakness, and after the equity indexes sold off hard last week with the Bear Stearns scare, the market finally broke as well. The U.S. dollar was up hard at the end of last week, but traded lower on Tuesday of this week. The crude oil market continues to be linked closely with the equity indexes and inversely with the U.S. dollar—and will likely continue to do so.

As mentioned, Vice President Dick Cheney met with the King of Saudi Arabia who vowed that Saudi Arabia would keep the market adequately supplied with oil. The market has traded in a sideways to lower range ever since. The market is reasonably supplied. And with the drop in U.S. stock markets and consumer confidence in February, it is reasonable to expect the crude oil market to continue to decline over the coming week.

The RBOB market appears to be consolidating, poised for a breakout, but the 27600 has proved tough to break. The refineries were running at a lower capacity last week (compared to this week) and the inventories for RBOB were down last week, whereas the inventories for crude were higher. The market looks poised for another run at 27600 and if it breaks and holds that level this time, there is little resistance above there on the chart. The market is still closely tied to the crude oil market however, and so might have difficulty breaking above that level if crude continues to trade lower.

Last Thursday, natural gas retraced back about 50% of its most recent run up that began in December—and it has since traded higher from there. The weather forecasts are for continued cold weather across the Midwest in the U.S. for at least the next 10 days. Additionally, it seems institutions are beginning to look at using natural gas for their heating and cooling needs, because natural gas is much cheaper in comparison to oil. The increase in demand that this could cause would eliminate the current oversupplied situation in the natural gas market, and could see the market trading much higher.

Support/Resistance:

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Softs

By Joe Nikruto, RJO Futures Senior Trading Advisor

Orange Juice

Since our last eView, harvest pressure and a lack of any bullish news have weighed heavily on the Orange Juice futures market. This is the time of the year where stocks begin to build. And even with what seems to be a never-ending winter here in Chicago, consumption should be on the decline. We have mentioned a few times that the consumer is faced with high prices at the grocery store, and has many other beverages to choose from. I recently saw a press release from one of the larger companies that said they are coming out with an ultra premium alternative, made with only the best of the best oranges they harvest. Savvy marketing for sure, but I have to wonder if that will do anything to counter the downtrend in consumer interest. As you can see from the relative strength index reading from the chart below, OJK8 was recently showing oversold and had been for some time. Look for higher prices near term, to correct that oversold condition and bring this market up to test the 18 day moving average in the area of 121.00. Those of you who are still long the OJK8 130 puts and short the 2 OJK8 120 puts should be looking to cover one or both of the 120s on this rally, should it arrive. If you have any questions, or if there is anything I can do to help, just give me a call!

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Currencies

Earlier this week, the U.S. dollar enjoyed a seemingly brief comeback against its major worldwide currency rivals: the Euro, Sterling, Kiwi, Loonie, Swissy and Yen. That comeback however looks to have stalled now. The last three days we have seen the Dollar lose a little ground; technically this looks to be a correction. EUR/USD is currently trading at 1.5712, with the most recent high within the trading bar being 1.5756. The 78.6 fibonacci retracement level is 1.5783. If price and time hold, we should see the Euro hit the 1.5783 level by tomorrow some time.

While I am anticipating a move to at least 1.5783 (which would a retracement of the seven day high of 1.5903), there is still a possibility with the U.S. Dollar (because of the state of the economy and that fact we may not be out of the woods yet) that the market may surge past 1.5783 and make new highs past the 1.5903 potential to 1.6056 or 1.6251.

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Metals

While it seems that the prices of Gold and Silver are headed back in the direction they originally came from, I think it may be a little premature to say this is now the time to short (as I write this on March 19th).

I think I would rather look to buy a little more on these pullbacks. The Fed has just cut rates by 75 basis points, and reports have said that a full basis point had been factored in the market, which is probably why most traders and financial pundits said it was a relief.

However, immediately after the recent cut, there were talks of another 50 basis point cut. This leads me to believe there is still more room for the dollar and the U.S. equity markets to drop, thus causing more investing and a stronger push in the price of gold and silver. Silver is currently at 19.450 on a pullback from its high of 21.320; there is in fact a double top that has occurred in this market (silver), and as a result we had a drop in prices. But I do not think this drop will be sustained. Gold has a slightly less dramatic drop, and seems to be making a typical, technical retracement before a major move back up. My thought on gold is that it will eventually reach 1,100 before we see a serious change the overall direction.

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Ask a Strategist

Question for Linda Zid, RJO Futures Writer/Editor:   What is meant by Contango and Backwardation?

Answer:    Thanks for your question. Contango is a condition when the front month prices are lower than back month prices, which is normal for most markets because back months include carrying costs. Backwardation is the opposite: A futures market in which the front month is higher in price than the back months.

Futures Trading Basics

Are You in the Money?

By Linda Zid , RJO Futures Writer/Editor

In this issue of eView, we will take a look at “moneyness,” which Investopedia.com describes as looking at the “value of an option if you were to exercise it right away.”

Also according to Investopedia: “Moneyness tells option holders whether exercising will lead to a profit. There are many forms of moneyness, including in, out or at the money.”

First, let’s review some previously discussed options terminology: Options, by definition, give buyers the “option” or right to buy or sell an underlying futures contract—but not the obligation. A call option gives the buyer the right to go long (buy) the underlying futures market at a stated price (“the strike price”), anytime prior to option expiration. And a put option gives the buyer the right to go short (sell) the underlying futures market at the strike price, anytime prior to option expiration.

Furthermore, the price of an option (the premium) is made of two components: intrinsic value and time value.

Intrinsic value is the difference between the underlying stock's price and the strike price—or the in-the-money portion of the option's premium. So if a call options strike price is $25 and the underlying stock's market price is at $35, then the intrinsic value of the call option is $10.

According to Investopedia.com, time value is the portion of the option premium that is attributable to the amount of time remaining until the expiration of the option contract.

In the money. The Great Depression era song, “We’re in the Money” is rumored to be a referral to this term, which means that options have achieved strike price. A call option is in the money if the strike price is below the price of the underlying future. A put option is in the money if the strike price is above the price of the underlying futures. In-the-money options have positive intrinsic and time value.

Here’s one example of a put option that is in the money, given in The Options Strategy Guide from RJO Futures:

A July soybeans 575 put option is in the money if the underlying futures market is below 575. If the futures market is at 560, the option is in the money by 15 cents.

At the money. An option is at the money if the strike price is at the same price as the underlying futures, and only has time value—no intrinsic value.

Out of the money. Out of the money means an option would basically be worthless if it expired on the day in question. A call option is out of the money if the strike price is above the price of the underlying futures. A put option is out of the money if the strike price is below the price of the underlying futures. Out-ofthe-money options also have no intrinsic value.

I hope that this gives you a basic understanding of moneyness—and that you are in the money as much as possible. For more options terminology, you can order a FREE Options Strategy Guide from RJO Futures. This helpful resource also includes an intro to trading options, real-world examples of trading strategies, information on determining the break-even point, a comprehensive "strategies-at-a-glance" chart, and much more. Click here to get your free copy today.

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