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[FREE] fx:macro Lite / 17.09.23
FOMC Meeting Prep and a primer on the term structure
Hi there! It's already Sunday, so welcome to the first edition of fx:macro Lite! I hope you like the new format.
If you missed the usual deep-dive yesterday, you can still sign up for that here and get access to the premium content:
💎 FOMC Meeting Prep for next week
We have four central bank meetings next week: the Fed, Bank of England, the SNB and the BOJ. Here's a meeting prep for the Fed on Wednesday. It includes a summary of their last statements, economic data and a summary of Fedspeak since the last meeting. It's a great resource if you want to have an informed view beforehand or if you want to trade the event. Here's what it looks like, and the link to the PDF below.
fx:macro Premium includes preps for the other three central bank events as well, among other things. You can find out more about it here:
📌 Here's something useful
Just a quick reminder that you can actually export data from TradingView:
Click on the icon in the top right of the window (yellow arrow)
Search for “Export chart data” in the search box that shows up
💡 A Primer on the Term Structure
The term structure is one of the most useful things to look at if you're trading commodities, so it pays to have a good understanding of what's going on there. This will be the first of a few short bites on the term structure with actionable advice on how to find trades or filter signals.
You might be asking: what do FX and macro have to do with commodities? The price of crude oil is basically inflation, copper is called Dr. Copper because it's a proxy for global growth, there are correlations between commodities and currencies, and so on.
If you have no idea what the term structure is and you ask Midjourney to draw you one, you get this eerily beautiful thing:
🤔 What is the Term Structure?
Futures are trading with an expiration date. You can buy and pay for oil, wheat, coffee or other commodities today but have them delivered months or years from now. That means that on any given day, a number of futures for the same commodity are trading. Here's an example for crude oil. The x-axis represents the different expirations, and the blue line shows the price at which they were trading on August 8th, 2022 (left-hand scale). You can see that, on that day, further-dated expirations were cheaper than nearer-dated ones.
On November 12th, 2020, the whole situation looked completely different for crude oil: expirations further out traded at a premium:
There are different reasons why that is the case. Futures are forward contracts, i.e. you pay now and receive your purchase later. We could call it PNRL instead of the more common BNPL when you go shopping and buy stuff you don't need.
Since commodities have to be stored, transported, fed and taken care of, this will be factored into the price: if you buy oil now but don't want to get it delivered for another year, the person you're buying it from will most likely charge a higher price than if you want to get it next month.
It's similar for financial futures where the price of “storing” whatever the future's underlying is, is negligible… except for the price of money, i.e. interest rates. A good primer on forward pricing in general can be found in Sheldon Natenberg's book Option Volatility & Pricing.
Sidenote 1: Since most futures don't go into delivery, commodities could also be considered stuff you don't need. At least if you're a trader.
Sidenote 2: People often claim that the price of a future with a certain expiration date reflects the market's expectation of where that commodity will trade at that date. That's complete nonsense.
👅 Basic Term Structure Lingo
You need to be familiar with two terms:
Contango refers to a term structure that is sloping upwards like the one in the second chart above: prices further out are getting more expensive. Backwardation is the opposite: the curve is sloping downward, i.e. you pay more now than in the future.
Generally, contango is considered “normal”, while backwardation is the exception. Also, backwardation is generally bullish for a commodity. We're not going to concern ourselves with why that's the case but there are good reasons.
The important thing is that it's not just contango and backwardation that matter but also changes in the slope of the curve: as it gets flatter and more into backwardation, price tends to go up, and as it gets steeper and more into contango, price tends to go down.
That's some pretty valuable information when we apply it to a filter for entering trades, for example.
🌊 Weird Term Structure Shapes
Okay, so we know contango and backwardation, and that changes in the curve relate to price. But what about something like this:
The chart shows NG, natural gas. That's a highly seasonal commodity with a seasonal term structure, so different expiration months cost more or less than others depending not only on how far out they are in time but also what month they expire.
There's no name for the shape, thankfully.
⏭️ Now What?
I promised you something actionable but that will have to wait for next week. Blame the fact that the average human reading speed is slow enough that it took you five minutes to get to this point. And the fact that I wanted a cliffhanger. But: next week I'll show you how we can put this knowledge into an indicator in TradingView and use it to find trades!
Oh, and I'll answer the question that has to be burning on your mind: quite a lot of futures in the charts above show zero volume traded. How have they been priced then?
Feel free to leave a comment and let me know what you think!