8-7-2008
The Inflation Bubble “Burst”
Since my last market report, written nearly 2-weeks ago, commodity prices have tumbled hard. In fact, most commodity prices are well under their end of May settlement prices. The Spring Time Premium that built in a few months ago has been completely wiped out by a series of events having to do in part with:
- The rise in the Dollar
- A sense that the Euro has topped out
- Continued talk of changes in the way Index and Hedge Funds can trade futures markets
- A $28 break in the price of Crude Oil and a break in other energy product prices
- A change in weather patterns that have “saved” the grain crop
I must point out that getting prices down to what I still consider to be very high levels is not in my view deflationary, especially when you look at the longer term picture. It is however deflationary when you take a look at just the past 60-days, which seems to the focus of the press and their articles on “demand destruction”. Over the past 60-days we’ve seen Crude Oil at $145, Corn at $8, Wheat at $10, Soybeans at $16, Cocoa at $33 and so on. All are well below those price levels, which leads me to wonder how much downside is left.
My guess is a lot less than most think.
What seems to be lost on many is that Crude Oil is holding the $120 price level, which is nearly 4 times the price at which Crude Oil was trading at in January 2004. I do not see prices going back to those levels. The longer term charts, namely the Quarterly one show $78 as the top of the previous trading range. This was the top before prices began soaring in 2007. I don’t expect prices to get back there without some type of major fundamental change, such as a very serious world-wide recession, which is always a possibility, but not highly probable.
My point is this, when prices rally and especially when they rally to all times highs, sharp corrections from those highs is the norm. Downside corrections typically move faster and prices often overshoot whatever the “downside target” may be because professional type traders know how to press the short side and squeeze out those that are typically long, the public. The typical speculator not only doesn’t know how to go short, but is discouraged from doing so. Need proof of this? Just look at the new changes in Short-Selling Rules that the US has enacted in stocks.
To stop prices from rising, the government is now limiting how Index and Hedge Funds are categorized. This will affect both the amount of contracts a fund can hold and most importantly, how margins may be applied to them going forward.
Most importantly, the current price break fits in well, yes fits in well with what I have been writing about in my previous reports. I say this because when in looking at what Gold’s Seasonal Chart, it’s apparent that the summer does NOT hold upside promise. It’s after August that prices tend to move up strongly, into December.
Gold’s Seasonal Story
Let’s rehash things. Keep in mind that when prices go up, investors think prices will never fall. When prices fall, the same investors lose confidence and think the market will never turn around. Let’s look back at the Seasonal Gold Chart, provided to us by the good folks of Moore Research Center…www.mrci.com
As I see it, August often breaks early in the month, recovers a bit and breaks again into month end. After August there is a strong 15 and 34-year history of upward price momentum. In other words, the weakness seen in “summer months” dissipates and momentum suddenly shifts.
December Gold
Lets now look at a Daily Chart of December Gold Futures
First, the Stochastic Study is embedded. Embedded means that the two lines that make up Stochastics, the “red” K-Line and the “yellow” D-Line remain under a 20 reading in the Stochastic graph. This is exactly what is occurring. As such, the market finds it easy to breakdown since “Bearishness” is embedded in price action. Hence the term “embedded Stochastics”. It is not important to me how low prices go. What is important is getting involved with Calls once the “red” line, the K-Line turns up and closes over a 20-reading. It will do so prior to the K-line doing so since that is how the mathematics of this particular study works.
The second observation is that while the Seasonal Chart often has a lower low in July than June, that event did not occur this time around. Rather, as you can see form the Swingline Study, the bright “yellow lines” on this chart, Gold has broken under July’s low. May and June’s lows are holding so far.
My third observation is that in order for Gold to rally, it has to transition to a more stable Dollar environment. If the Euro is not going to rally, the Dollar will stay relatively strong. Gold can rally in that environment. It simply has to make the transition. Should the Dollar lose its bid to the Euro, Gold will have an easier time rallying.
My preference is to wait and trade the Seasonal Uptrend, the one that often turns up in September. As such I will simply wait for a Stochastic signal to surface. It will surface. The question is when and how long it will last.
Conclusion and Recommendation
I recommended getting into Gold Call Spreads way too soon. Given that amount of time left on them, 105 days and the likelihood of another move up before time runs out, I recommend that you hold onto and possibly add to this or other Gold Calls, once I get a signal to do so.
Those that follow my Twice Daily Updates are long the December Bull Call $1000-$1025 Spread at 6.30.
This spread has until the end of November. If the seasonals in gold and silver take hold and Crude simply holds steady, the gains ahead could be very substantial. If you or I am wrong, your risk is limited to the cost of the spread plus fees. Don’t forget that this strategy is not a do or die situation. You have the flexibility to get out at any time prior to expiration for whatever the spread is worth. Expiration is in late November, so you have a lot of time to see trends develop.
My recommendation at this time is to hold tight.
Silver
Let’s look at the Seasonal Silver Chart to see what it offers.
Historically speaking Silver is following the Seasonal Chart very well. In my last Metal Report I said, “its possible that today may represent the near term high in silver in terms of seasonality as prices had an “Outside Day Down”, a chart pattern often associated with turn in market trend. If this proves to be the case, a move down is likely.” This observation was “right” on the money.
Recommendation
I see no point in writing much about Silver since every point I made in Gold applies to it as well.
Customers are long the 1900-2000 spread at 35-cents. There is lot of time left and seasonality is on your side. Hold.
