Commodities: The Road Less Traveled is the Way to Opportunity

Take: Lean hogs

by Nico Isaac
Updated: September 06, 2017

"Two roads diverged in a wood, and I -
I took the one less traveled by,
And that has made all the difference."
-- Robert Frost

When it comes to navigating trend changes in financial markets, there's one road on which the mainstream majority travels: namely, "Fundamental Street." There, news events are the key driver of a market's price trends.

This is a one-lane, one-way path that, once you get on, there's no turning around.

Take, for instance, the historic top that occurred in lean hogs back in 2014. At the time, the U.S. hog industry was one year into a devastating PEDV epidemic, a deadly swine flu that had affected 4500 farms in 27 U.S. states and decimated an estimated 6-8% of the hog population. In the words of one agricultural economist quoted in a March 3, 2014 MarketWatch article:

"I've never seen anything quite like this in 33 years of following the livestock market."

Hog prices were orbiting all-time record highs, and many industry analysts saw no end in sight to the PEDV crisis. In the school of fundamental market analysis, that equated to one outcome: A massively bullish supply squeeze. Here, these news items from January-March 2014 capture the hog-wild sentiment surrounding lean hogs:

• "Disease Driving Red Hot Hog Market" (March 26 The Gazette)
• "Pig Virus Threatens to Bump Pork Cost" (Jan. 10 Wall Street Journal)
• "Even at these record price levels, the psychology of the market remains extremely bullish. Funds in the game were eyeing a heck of an opportunity." (March 17 CNBC)

So, what happened?

Well, investors walking down the one-way bullish path found themselves at a dramatic dead end. Those great expectations of further virus-related-supply-cuts never transpired. And those holding bullish bets on hog futures got butchered. From their March 2014 peak, lean hog prices turned down a wrenching, 70%-plus deep, two-plus year-long sell-off to 14-year lows.

On the road less traveled by, however, the outcome was quite different. There, in our February 2014 Monthly Commodity Junctures, our senior commodities analyst Jeffrey Kennedy used objective Elliott wave analysis to define the long-term outlook of lean hogs; namely: Hog prices would continue to soar into the early part of 2014 -- after which point, they would get slayed:

"If you look at the monthly price chart, you can see that for some time now, we've been looking for prices to exceed 104.17... Well, we can actually look a bit higher for prices to actually penetrate the 1-3 trendline, that would result in a throw over, something that we like to see whenever we're working with the final move of an ending diagonal."

From there, hog prices continued to soar, peaking in early March above our cited target range, and hovered near record highs until officially committing to the downside in May. Here, in our May 14, 2014 Daily Commodity Junctures, Jeffrey Kennedy set the stage for an enduring downtrend, the next leg of which would be third-wave decline of a larger five-wave fall.

"Lean Hogs are at a critical juncture. For some time now, we have identified the March high as a significant long-term top and subsequent selling as a series of ones and twos.

"As the market begins to show its true hand, critical support will reside at 118.12--115.92. We can take a confident stance when we see a sound and sustained move... below these areas. Once this occurs, the resultant move should stay in force into year's end."

From there, hogs lost any last grip they had on the upside, plummeting from over $1.30 per pound to 40 cents per pound in late 2016 (a level not seen since 2002).

Remember how in 2014, the fundamental experts set their sights on a bullish, disease-driven supply shortfall? Well, this time, in 2016, after hog prices were slashed by 70% to become the single-worst performing commodity in the Bloomberg Commodity Index -- some of the mainstream experts saw the opposite scenario keeping hog prices down. That being, an "obscene supply glut."

Turns out, thanks to all the PEDV-hoarding, the U.S. hog herd in September 2016 was the largest capacity in all the data going back to 1866. Wrote an October 2, 2016 Bloomberg:

 "Ham, bacon, ribs, pork loins -- if it has to do with pigs, prices are in the doldrums. That's because there are simply too many pigs... We have a black cloud over the market as a whole. The slaughter numbers have scared people from going long."

Any guess as to what happened next? Not what the majority expected; meaning, hog prices turned up despite the biggest supply surplus since Andrew Johnson was U.S. President -- and started to soar.

As for the Elliott wave road less traveled, again -- in our December 2016 Monthly Commodity Junctures, Jeffrey Kennedy cleared the set for higher hog prices and wrote:

"We're initially working a five-wave move to the upside and I suspect this advance will continue a bit higher. Once we finish the initial five-wave move up... we can then anticipate a decline."

The next chart captures the two, dramatic turning points in the last three years in hog prices, alongside our Monthly Commodity Junctures' analysis:

So, what about now? Well, on September 5, much of the U.S. hog industry celebrated an "unprecedented, red-letter day" when two new processing plants opened for business, enabling slaughter capacity to grow more in one single day than in any single year "within the memory of anyone alive today -- and perhaps ever." (National Hog Farmer)

On "Fundamental Street," the event was hailed a bullish coup.

On the road of Elliott wave analysis, we believe that, while supply/demand fundamentals may play a supporting role at best in market trends, the main star is investor psychology, which unfolds as Elliott wave patterns on price charts.

Today, you can choose which "road" of analysis to walk down. And that will make all the difference in your chances of identifying high-confidence turns in the commodity markets you follow.

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