Commodity Trading: 1998 versus 2008

In his book, Hot Commodities, author Jim Rogers talks about the bear market in commodities ending in 1998 and a bull market starting that will last at least until the year 2014. And, so far, Jim Rogers seems to be quite accurate. We’ve undoubtedly seen a massive bull market in the commodity energy sector, such as crude oil, and gasoline and in the grain sector with corn and soybeans. If Jim Rogers’ time frame is accurate, even though we’ve seen some pullback in crude oil and the grains, prices will rebound and continue to rise for some time to come.

In view of the fact that the commodity markets were in a bear market in 1998, it’s very interesting to look at old commodity charts from 1998 and see where the markets were then and what the margins were then.

For example, in April 1998, Oats was trading around 125 cents per bushel compared with around 400 cents per bushel now. Margin on an Oats contract was $405 compared with $1,350 now. Gold was trading at $300 per ounce in 1998 compared to trading around $929 per ounce now. Margin on a futures gold contract in 1998 was a mere $1,350 compared with margin of $5,063 today.

Of course, Crude Oil is one commodity that has the biggest differences in prices and margin. In 1998, Crude Oil was a mere $12 per barrel. That’s incredible considering that crude as recently as July 11, 2008 was at $147.90 per barrel. In 1998 margin on a crude oil futures contract was a mere $2,025 compared with $12,488 now.

So, what’s the point of this exercise? There are two benefits, actually.

The first benefit is perspective. Knowing where the markets have been, where they are now, and where they have the potential to go always helps one’s trading as we can see a clearer picture of potentially how far a market may move up or move back down. Going back to Crude Oil as an example, we can see that considering the considerable rise in crude, that crude going to $200 per barrel would not be out of the question. On the other hand, if Crude Oil were to have a major correction, it could have a long way to fall.

The second benefit of this exercise is realizing that the markets are going to be “different” in a bull market than in a bear market. What is this difference? Simply put, volatility. The very high margins on a futures contract reflect this volatility. And, we should know that trading will be much more challenging in a volatile market. Volatility means that our stops that we use to limit risk may be much more likely to be hit, therefore stopping us out of a trade. On the other hand, profit target may be reached more quickly, but a trader has to be ready to take his or her profits lest he will see the profits evaporate as a market moves back quickly against him.

In options trading volatility can also make a big difference. The high volatility in many of the markets means that options prices will tend to be higher than in markets that have relatively low volatility. I remember Corn options in 1998 that had 60 to 90days until expiration and were within three strikes of the current market price could often be had in the $300 to $350 range. Now, a similar option would probably be around $1,500.

In summary, there are advantages and disadvantages in both bull and bear commodity markets. But, as traders, we have to trade the markets as they are, but it helps to know the characteristics of the markets we’re trading.