Annual and Perpetual Production Markets

To understand commodity futures prices, you need to understand the production and consumption of  the commodity in question. Some futures contracts are based on annually produced commodities: Corn, Wheat, Soybeans, Cotton, Cattle, Hogs, etc.  An annually produced commodity tends to have supply available at one time (harvest) while demand is variable, and segmented throughout the year.  Other futures contracts are based on a market with variable production cycles, and more constant demand components: Petroleum Products (Crude Oil, Unleaded, Heating Oil), Metals (Gold, Silver, Platinum), etc.  

This transitioning between "certainty" and "uncertainty" is key to understanding futures prices. Because anticipation of changes in supply and demand can create fear or greed, markets tend to move much farther than would be thought- and can stay at these emotional levels longer than most people would anticipate. It is this factor which constantly buoys prices, creating "irrational exuberance", to quote the Chairman of the Federal Reserve.       It is these reoccurring periods of  potential changes to future supply or demand which are our primary focus. By placing these reoccurring events into the context of supply, demand, and the current market one is able to narrow down potential speculative situations into areas where the most opportunity exists.

Annually Produced Commodities

These commodities tend to exhibit the most strength historically at the beginning of their production cycle.  For example, Grain Futures are typically the most likely to rally during field preparation until planting is completed.  This is because if planting goes poorly- too much rain, too little rain, too hot, too cold - then yield will be lower, and supply will be less.  Because nobody can tell the future, the market tends to build a "risk premium" into prices, to compensate producers for the risk involved.

Historically the weakest time of the year for the above commodity futures contracts is when the risk associated with the crop lessens: For example, most field crops are much less vulnerable to weather- rain and temperature- after they pollinate.  So after "normal" pollination, prices tend to be weak as market attention turns to the eventual flood of supply, which will be hitting the market.

The above are general guiding principles for commodity futures traders.  Some years they correctly foreshadow tops and bottoms and other years they don't!  Traders should always use other forms of analysis in conjunction with seasonality, because seasonal events can be early or late depending upon the uniqueness of each year.

Perpetual Production Commodities

Because these commodities tend to have constant year around production, the demand or usage cycle is more important.  These commodities rely upon a distribution network, and the behavior of wholesalers dictate prices in most years.

Historically the strongest times of the year are when wholesalers begin to build inventory:

For example, Heating Oil distributors start to build inventory in March through May.  They need to purchase the Heating Oil for distribution before the public starts to buy it.  Therefore, prices have historically been strongest well before the cold snaps hit.  Gold wholesalers buy in July ahead of Christmas jewelry demand.  

Historically the weakest times of the year is when wholesale demand has peaked, and retail demand is starting to grow: For example, by October Heating Oil distributors own all the product they need, and they are worrying about selling their inventory!  This causes them to run specials, and have very little appetite for buying more.  If you have owned a retail store and bought a large amount of a product, you know the feeling of hoping you can get rid of it now, versus the feeling of counting your money when you bought it.  The same goes for Gold; jewelers buy before the Christmas shopping season, knowing that if they don't sell it all before the end of the shopping season, they will sit on it for months.

The above are general guiding principles for commodity futures traders.  Some years they correctly foreshadow tops and bottoms and other years they don't!  Traders should always use other forms of analysis in conjunction with seasonality, because seasonal events can be early or late depending upon the uniqueness of each year.

General Conclusions on Using Seasonals

This transitioning between "certainty" and "uncertainty" is key to understanding futures prices. Because anticipation of changes in supply and demand can create fear or greed, markets tend to move much farther than would be thought- and can stay at these emotional levels longer than most people would anticipate. It is this factor which constantly buoys prices, creating "irrational exuberance", to quote the Chairman of the Federal Reserve.

It is these reoccurring periods of potential changes to future supply or demand which are our primary focus. By placing these reoccurring events into the context of supply, demand, and the current market one is able to narrow down potential speculative situations into areas where the most opportunity exists.  Warren Buffet, in his 1998 Berkshire Hathaway annual report, summed it up best as saying ... 

"Under these circumstances, we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his 'best' cell, he knew, would allow him to bat .400; reaching for balls in his 'worst' spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors."

For the futures trader, the best cells are represented by the times of the year when a particular market has had a strong historical tendency for a directional move. Waiting patiently for only these situations may make the difference between profits and losses in the game known as speculation.

Of course, just because a market has reacted a particular way in the past does not mean it has to repeat this year- read those disclaimers; they are there for a reason!  However, having an understanding of the past, and strong tendencies of the market to move in a particular direction can be used in conjunction with other methods to make an informed decision regarding your positions.