James Mound’s Mid-Year Commodities Review and Forecast


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The Mid-Year Commodities Review is intended to be a reflection point in the macro outlook on commodities. It is vital to have a micro view of market conditions balanced against a macro understanding of fundamental and technical issues impacting price. When combined, these two assessments allow for a comprehensive grasp of what the next 3-6 months will bring to commodity prices. This report will explore that time horizon.

Congestion Period
The general outlook on commodities continues a pattern that began in late 2008/early 2009. The markets have set critical long term highs and long term support. The highs are clearly in for markets like oil, corn and stock indices – likely for many years. The lows, on the other hand, are defined but not without the potential for retesting and/or penetration. Overall the general theme in commodity markets for the next 2-5 years will be congestion.

This congestion is not a new concept for my readers. In fact I discussed this in detail in my 2nd quarter forecast report and it is worth reiterating here. Rubber Band elasticity offers an analogy for the current condition in commodities. Throughout the price history of commodities there have been numerous examples of price expansion and contraction often times exhibiting a pattern where the more extreme the price rally the more devastating the collapse. However most stories end there instead of exploring what happens after historic highs and lows are set. This is where I believe things are sitting today, so let’s talk about what to expect and how to take advantage of it.

What I believe the markets are experiencing is something that I refer to as the Rubber Band Effect (aka Bungee Jump Theory). I like to view markets as going through cycles of tension. This tension occurs when the bull or bear takes control and ferociously moves price to one extreme. Flashback to 2008 with crude oil approaching $150 a barrel and a global grain/rice crisis - prices were seriously stretched at that time. This extreme pulled that Rubber Band price threshold about as tight as anyone has ever experienced. Then instead of snapping (market rubber bands rarely snap), the markets recoiled, often plunging price at a more rapid pace than when prices were being stretched. What happens after a rubber band stretches and then recoils? It reforms its shape. Within the scope of this reformation is an inner band, a price stretch that retests the outer price points previously reached on both extremes. Typically these tests form lower highs and higher lows. Ultimately this causes a massive pennant price chart formation on a long term basis, and price consolidations like this can often mean trouble for trend traders. Trends would, in theory, have a shorter life span than the most recent price move and limit breakout trades to smaller moves. However, being ahead of this type of action can offer significant opportunity should the forecast be correct.

Turning points in markets during congestion periods tend to fall on or short of Fibonacci retracement points. In this case the 61.8% retracement level is critical in most markets however all critical Fibonacci levels should be acknowledged. For those unfamiliar, Fibonacci retracement relates to ratios, or relationships, between numbers in a sequence. Based on the work of a thirteenth-century mathematician, technical analysts use the ratios to try to identify possible support and resistance levels.

During periods of price congestion I expect to see the following:

1) Stabilizing supply – With input costs in a more controlled, less volatile environment the supply chain stabilizes.

2) Declining demand – Global economic weakness following price expansion means declining demand.

3) Failed price breakouts – Short term issues can cause price breakouts, but in a congestive environment these breakouts tend to fail more often than not.

4) Failed trend line support and resistance – The market has a tendency to break trend due to market boredom (yes, I said market boredom – it’s a real occurrence).

5) Frequency of option premium expansion without follow through – short-term price spikes expand implied volatility and that means congested markets are a premium collectors main playground.

6) Currency-influenced market price action – Inter-market correlations tend to be heightened during these periods with a focus on currency action to determine shifts in demand.

7) Long term pennants and channels - Lower highs and higher lows – the basic concept behind pennants and channels is the maintaining of prior highs and lows suggesting the market has not established cause for new price points. The markets will constantly test these levels but fail.

Long term congestion is a fairly difficult market action for most traders to find success trading. Trends like the one experienced in crude oil from $11 a barrel to $147 is relatively easy for a trend follower to find opportunity and potential success trading. However, when markets are choppy and offer congestion then these trends tend not to last as long and volatility spikes become more random and unpredictable. Its makes trend trading quite difficult, but opens the door to a different style of trading.

Due to the volatility and price expansion that caused the collapse in 2008, the choppy trade that has ensued, and is expected to continue, falls within a very wide price range. This type of setup does not come along very often. It allows for swift trend changes while still providing substantial price moves and volatility – an option strategist’s ideal trading environment.

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James Mound
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