EconMatters

The Macro Story as Told by Gold, Copper and Oil

2013-05-22T06:10:00.000-05:00

Gold’s been on a wild ride. After reaching a peak of $1,920 an ounce in September 2011, gold has tumbled 28% to the current ~$1,380 level forcing John Paulson to take a 47% loss in his gold fund during the first four months of this year, according to Bloomberg.

Unlike Paulson who maintained his positions in gold, other big players like George Soros and BlackRock cut their gold ETF holdings, while Goldman Sachs issued a sell recommendation on gold right before the yellow metal plunged 13% through April 15, the biggest drop in three decades. And by looking at the futures curve (chart below), market does not seem to expect gold to come back roaring any time soon.

Chart Source: S&P Capital IQ

QEs Not Hitting the Real Economy

Historically, gold is regarded as a good inflation hedge and store of value, typically thriving in an environment of high inflation, and/or weak U.S. dollar (currency debasement). With U.S. Federal Reserve’s three rounds of QE, the never-ending debt crisis in the Eurozone, hyperinflation and dollar debasement seem inevitable and supportive of gold for the long run, right?

Theoretically, Fed’s QE and near zero fed funds rate is supposed to encourage borrowing and spending from the private sector thus injecting money into the real economy. However, theory and reality don’t always see eye to eye.

Since the 2008 financial crisis, banks have significantly tightened the credit standard and are reluctant to lend. On the other hand, corporations are making money mostly from “streamlined” headcount and structure, but instead of the intended wealth distribution effect expected by the Fed such as investing back to the economy, or increase employee pay which would in turn increase consumer spending, most corporations are hoarding cash or use profits for dividend, share buybacks, or mergers & acquisitions with limited impact on the real economy.

Copper & Oil Indicating Weak Demand

The weak demand is also reflected in part of the commodity market fundamental. WTI crude oil inventory climbed to 82-year high and copper inventory at LME hit a 10-year high in April, while Goldman Sachs cut its “near-term” outlook for commodities.

Although some have argued oil and copper have lost their significance primarily due to increasing domestic oil production, and “temporary” excess copper supply. While the abundance of domestic shale oil production may have distorted the historical supply and demand relationship, but with the U.S. becoming the world’s largest fuel exporter, the fast and furious oil inventory build is nevertheless still an indication of a weak world economy. And I can’t imagine how the “temporary” buildup of copper inventory is not a sign of weak global economic condition?

Further Reading - Oil Market Manipulation Reaches Absurd Levels

Massive QEs, Limited Inflation?

On top of the overall weak spending and demand in the private sector, most of the developed countries are undergoing some shape or form of austerity with reduced government spending. China, the growth engine of the world, is having some problems of its own. The old-fashioned massive infrastructure building QE program got China through the 2008 financial crisis, and was the main driver behind commodity prices. But Beijing can’t afford another QE due to inflation concern (plus China has probably run out of things to build). Low wage levels means China consumers can’t really pick up the spending slack, coupled with bad credit problem (i.e., NPL: Non-Performing Loans), and recent capital flight, had many analysts worried enough to downgrade China’s growth prospect.

The simultaneous pullback from both the private and government sectors in U.S. Europe, and China is a major factor why Fed's massive QEs have resulted in only limited inflationary pressure and increasing signs of deflation.

Dollar and Carry Trade Kills Gold

Nonetheless, when compared with Europe, China or any other regions in the world, the U.S. seems relatively more stable, and has been able to retain the “safe haven” status despite its own debt problem. With investors pouring money into U.S. equity and bond propping up the dollar, and weak demand suppressing inflation, two of the main conditions for a strong gold price -- high inflation and a weak US dollar -- are basically non-existent in the current macro environment.

Furthermore, there was already a bit of disconnect between gold and the other commodity prices such as copper, and oil. So eventually, gold had to come to grip with the macro reality.

Chart Source: Stockcharts.com

Another major factor against gold right now is that gold has no yield and is out of favor with the huge yield-seeking yen carry trade crowd (borrowing yen to invest in higher yield options) since bond and equity now are offering much better returns. Unless there's a shock to the system such as a war breaking out in the Middle East, or an eventual debt crisis in Japan when people start seeking safety, there's not much upside momentum for gold.

Gold's Volatility Game

For now, the prevalent view is that the Fed will slow or exit QE3, and gold is out of favor under the the current macro trend. For example, Lim Chow Kiat, the chief investment officer of the Government of Singapore Investment Corp (GIC), thinks gold still looks overpriced as the usage of gold for industrial or consumer products doesn't quite justify the prices. GIC is one of the world's largest sovereign wealth funds.

As long as dollar maintain its strength and inflation remains tame, gold prices most likely will see considerable volatility swinging between rumors and speculation (e.g., some central banks may need to unload some of their holdings due to debt crisis), and Asia retail buying on the dip (South China Morning Post reported that many shops in Hong Kong were running out of the precious metal for the first time in decades.)

Technically speaking, gold's next support level should be $1,330 range with $1,320 as the major support when most physical retail buyers would rush in. If gold breaks below $1,300 hard, expect a major liquidation when even Paulson could be forced to sell and everybody piles in.

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Oil Market Manipulation Reaches Absurd Levels

2013-05-21T00:39:00.000-05:00

By EconMatters

Markets & Manipulation: A long History

Most markets these days are manipulated to some extent, and this is nothing new if we look back through the history of financial markets. But there are some strange things happening right now in the oil market worth mentioning.

Brent-WTI Spread/Scam

Another scam in the Oil market is the Brent-WTI spread this has been one of the biggest scams over the years in the Oil market. Just to provide some data to the absurdity which is this much hyped about nonsensical spread Cushing Oklahoma has 49.7 million barrels in storage, it had 45.1 million barrels in storage a year ago. Cushing had 50 million barrels in storage at the start of the year. Moreover, in June Cushing will be adding additional supplies to storage due to current pipeline capacity going offline. So for all this talk about pipelines finally unlocking all the glut of oil supplies from the Cushing hub, and this being the reason for the impressive reduction in the Brent-WTI spread it is just a bunch of nonsense.

Cushing Oklahoma Supply Glut

So there is basically more oil trapped in Cushing Oklahoma then there has ever been when the spread was 25! So regardless if the spread is 25 or 8 it has very little to do with supplies residing in Cushing Oklahoma that is quite evident. Now there are a bunch of factors contributing to the nuances of the spread which I will not go into detail here but the takeaway is just to point out the absurdity which is the false and misleading rhetoric that encompasses this spread and Cushing Inventory levels.

400 Million Barrels & Climbing

While we are talking about inventory levels it is funny that WTI sits at $97 a barrel when the entire year we have had basically 3 minuscule draws in inventory supplies which stand at a record breaking 395 Million Barrels in storage. So the Dow keeps hitting new highs every week, and the US keeps setting new modern records for Oil in storage each week.

Weak Demand in an Artificial Economy

But it is not just the supply issues in an obviously oversupplied oil market with the US domestic production being the biggest culprit. The demand side of the equation has been equally bearish for the fundamentals with China`s actual economy slowing over the past 2 years, Europe being stuck in a perpetual recession, and the US being a mature market with higher fuel standards and a stagnant economy that requires $85 Billion of stimulus each month to keep from cratering. The demand side had been very underwhelming from the products side of the equation. For example, Gasoline supplies in the northeast are 10% higher than normal for this time of year.

Strong Dollar Bearish for Dollar Denominated Commodities

Finally the strong dollar is supposed to be bearish for commodities and oil, and with the US Dollar Index hovering around 84 and threatening to strengthen from these levels it is a wonder that the Oil market has barely noticed this strange occurrence in Dollar strength, unlike the Gold and Silver Markets.

Fundamentals: Are we talking about the Fundamentals Again?

The takeaway is that none of the actual fundamentals ever matter in the Oil markets. When you have a house style advantage that would make any Las Vegas Casino envious the fundamentals play little part in a manipulated Oil market. It is all about protecting the huge supply chain that is the oil market and everybody`s livelihood. When in doubt follow the money trail, and money is the biggest reason oil prices are where they are currently despite the bearish fundamentals of the commodity. Oil prices wouldn`t be at these levels if the powerful manipulators of the commodity were not making a whole lot of money as a result.

Oil Analysts Clueless

So the next time some Oil analyst tells you some hard studied reason why Oil prices are up it is all nonsense. Oil prices are up or down depending upon what the powerful players want oil to do, one week it can be at $86, the next $97, or $77, it is all about the money to these players, and they will do whatever it takes to make the money. And if it means being very creative with their methods then so be it, it is not like this is a regulated market!

Technical Analysis of the Silver Market

2013-02-24T00:00:00.000-06:00

By EconMatters

Portfolio Rebalancing for start of 2013

Silver closed Friday`s trading session at $28.46 an ounce, capping off what has been an auspicious start to 2013. On January 23^rdSilver was trading at $32 and has been in a downtrend ever since trying to find a support level that will hold.

There is some real minor support at the $28 level, but nothing to hang your hat upon. The real 2-year support is the $26 level, where it has bounced four times from the level in the last three years.

If it breaks the $26 level, then there is pure air all the way down to $20 an ounce, which we last saw in August of 2010. The next level of support would be the $17.50 - $15.00 area which used to be upward resistance prior to 2008.

Technical Uptrend Levels

If $28 or $26 holds and silver bounces off these levels a break above $30 would be a start, but an uptrend to be confirmed needs to close above the downtrend upper channel line around $32 with conviction, which will attract new buyers in the metal.

If Silver can close above $32, then $34-$35 is in the cards. The $35 level of resistance has been tested four times during the last two years, and silver has been unable to break out above this area.

$35 Resistance Level

However, a close above the $35 level brings the $40 resistance level into play. The next upward resistance level is around the $45 an ounce area, and expect a downward rejection of this level for the first test - if historic patterns are our guide.

The final level of resistance is the $50 an ounce level which has never really been tested since the April 2011 period, needless to say, this level should also provide substantial selling pressure the first attempt at breaking through the barrier, depending upon the reasons silver is up there in the first place.

Unchartered Territory

If Silver breaks out above the $50 an ounce level, then the market is in new territory, and you want to be long until some resistance level is rejected. Whenever a market gets into unchartered territory, the rules are being made up on the fly so to speak from a technical standpoint. This is an area that shorts can really get hurt because moves can explode around these types of historical technical breakouts.

Value Trading vs. Major Trending Market

I anticipate the Silver market being used more as a value trading market like it has been basically for the last two years with buyers coming in looking to buy low and sell for a trade, and at the high end of the range, sellers coming in for a range trade, anticipating selling at the high end of the two year range, and closing out their positions at the bottom end of the trading range.

The Silver market has been unable to go on a sustained trend in either direction during the better part of two years after what I refer to as the liquidation drop in September of 2011. Ergo, it will be interesting to watch when the next definable trend will take hold in the Silver market, and the related market events that play out as the catalysts for such a move.

Technical Analysis of the Natural Gas Market

2013-02-23T15:24:00.000-06:00

By EconMatters

Near-term Double Top

Natural Gas closed Friday at $3.35 per mmBtu and has been on a three month downtrend from the $4 level where it put in a near-term double top in October and November of 2012.

This was your classic short setup, as NG bottomed in March of 2012 from the prolonged downtrend to test just how low prices could go, it then had to test the upside, where the top of the near-term range would be. This turned out to be an eight month process with a definable trend upward until the nice large number that $4 represents for resistance.

It couldn`t bust through this level, pulled back to previous resistance around $3.60, and made another run at breaking the $4 barrier, it failed putting in the classic double top, profits were taken and the shorts piled into the market, leading NG to break the $3.60 level and confirm the break of the uptrend channel.

Downtrend or Parallel Channel

Natural gas is technically still in a down trending channel if you draw a line from the top at $4 to the higher lows established at $3.67, and so on based upon the three month time frame.

However, if we look at the eleven month time frame Natural Gas has mainly been in a tight parallel trading range between $3.20 on the downside support and $3.60 upside resistance for the most part - with the exception of the three month dual try to continue the trend higher ( $3.60-$4.00).

So depending upon the time frame natural gas is either in a distinct downtrend channel or a parallel trading range.

Key Technical Support Levels

There is strong support at $3.20 as we basically have found it hard to close below this technical level for ten months. Therefore, any close below $3.20 would be significant and the shorts would take notice of this technical break. The next level of Support would be the round fat target of $3.00, and if this fails to hold then the momentum will gain, and $2.50 is possible.

This level of support should provide substantial incentive for buyers to step in on rigs shutting down production talk, but as we have seen before because some of the derivative products from the natural gas extraction process are highly profitable, production often continues at natural gas prices lower than otherwise profitable.

So the caveat here is that $1.90 is the last level of support that held after considerable effort to find that bottom. Ergo, it is conceivable that $2.50 could break, and the $2.00 level is in play all over again. I think it is a low percentage probability that we ever experience prices that low again as there was a lot of momentum on that move down to find the bottom.

However, one of the consequences of increased US oil production is that Natural Gas gets derivatively produced, and Oil prices are high; this results in more natural gas despite lower prices and the potential for Natural Gas only production rigs being shut-in.

Is the Natural Gas Market becoming “Intel Boring”?

The Natural Gas market loves to trend in channels that go on for months despite the fundamentals of the supply and demand equation. The market will be looking for a channel to cling to for a sustained run of 5, 7 and 11 months if possible. This is just how the commodity trades if at all possible.

But right now the economy is performing slightly better, there is increased manufacturing looking to take advantage of cheap Natural Gas, so I think the downside moves are limited. And regarding the upside, there is an over-abundance of supply, so until a robust export market comes into existence, prices to the upside seem capped as well.

As a result, the most likely outcome for Natural Gas is to stay in a relatively tight trading range between $3.00 and $4.00 for the bulk of the price discovery process.

Dow 20,000 Only a Matter of Time

2013-02-22T19:23:00.000-06:00

By EconMatters

Dow Record in sight

We are 200 points from breaking a new high in the Dow Industrials which got me looking back at assets over the last 25 years in relation to the value of the US Dollar Index and the overall money supply.

25 years in Markets

Some of the best performing assets are the stock market and gasoline with bonds and housing putting in steady gains. Of course with all assets you get a whole lot more bang for your buck if you happen to time the market correctly. And assets like Stocks, Housing and Gasoline all have crash periods where Dow components go bankrupt and are replaced, homeowners lose their homes, and in the financial crash any Gasoline investor would have been forced out of the market.

Need to be Invested

But make no mistake the long-term trend is that you want to be invested in something that appreciates in value, you can get out of it if you need to as in liquid, and is going to be attractive to other investors over the long haul. But you have to be invested to take advantage of the trend of the growing money supply, currency in circulation, printing press phenomenon that ultimately underlies all asset values.

Your Grandpa was on to something

Whether it is the price of a car, a new house, the price of gasoline, a movie ticket, or a good stock there is going to be more money created each year chasing these assets in the system. This represents the phenomenon of “when I was a kid a coke cost a nickel” or you could buy a home or a vehicle in the 1950`s for prices that are unrecognizable today.

Dow 20,000 only a matter of time

In looking back at history of markets, if we take the Dow Industrials, there is no doubt we are going to blow past Dow 15,000, 16,000, 17,000 and so on based upon currency creation effects alone. The fact that markets are liquid, capital will flow in and out, there will be major pullbacks, those who fail to market time will get crushed at times, but make no mistake Dow 20,000 is a foregone conclusion.

If we filter out the noise, and it is considerable at times, the unmistakable point is that most assets appreciate over time. The last 25 years show quite clearly in Gold, Lean Hogs, Real Estate, Stocks and Energy the benefit of being invested, especially in relation to the ever-present growing money supply in the economy.

I would say that if the economy cooperates even modestly over the next three years that the Dow 20,000 milestone will be reached. For how soon we get there will depend upon other variables for sure, but watch how the market performs once we break through the 14,200 level, and start putting in new highs in the other indexes. The pace can really take off once markets are in unchartered territory, and we can start taking 1000 point monthly clips that will leave you speechless.

And of course Dow 20,000 isn`t going to happen without some pain along the way, but make no mistake it will happen, and it is closer than you think! We are on the verge of taking that next leg up in the Dow, in fact, we should set a new high pretty soon; enjoy the ride as this breakout has been a long time coming.

The Pullback Memo

2013-02-22T00:00:00.000-06:00

By EconMatters

Pullbacks…pullbacks….are we talking about Pullbacks?

That`s all I heard for two straight months, “Gee everyone is waiting for a pullback to get in on the rally”. Well you asked for it, now you got it! But you better not be too picky about waiting for some exact perfect 7% correction because that probably ain`t happening.

We are in the midst of the strongest four months of the investing cycle for each of the last four years. Basically, everyone and their uncle go long assets until late April before the annual summer selloff. Don`t expect this year to be any different.

March 1^st New Capital & Front Running

The way I look at it new money comes into the market March 1^stwhich is next Friday, so any window for a pullback has 5 days to occur, and less than that because everybody front runs the monthly 401k money that comes into the market the first of every month, and is usually good for a major Risk On day.

So investors have 4 days for a pullback, you get the idea, Thursday`s mid-day selloff was the pullback. There isn`t going to be any ideal 7% pullback so all those who missed the rally can conveniently get right in with the rally that they missed for the first two months of the year.

You think this stuff just happens randomly?

There are no do-overs in markets! What were you thinking, haven`t you been paying attention the last four years? You start going long in November of the previous year and you stay long until option`s expiration in April, then you sell, wait for the summer sell-off when some crisis in Europe or Downgrade is the end of the world, and after the sell-off, then everybody buys back for the “Money Manager Make Their Numbers Yearly Close”!

We are working here!

Now get with the program, this isn`t the airport where we wait for passengers to board! This is the first four months of the year, and damnit we are making our numbers regardless. We don`t care how steep the freaking charts look, we are going to make them look even steeper.

Nothing stops the rally, we don`t go backward, we just keep going higher till mid-April, Got it? Good, now quit your hoping, praying for the 7% pullback, we don`t have time for this crap!

We don`t have time for no stinkin 7% pullbacks!

There are no 7% pullbacks in the first four months of the year when we are making are damn numbers. That would be stupid, we would have to start all over again, we don`t have time for that crap, we are working here!

Have we set new highs yet? I didn`t think so…

We will give you your damn pullback at the end of April after we have set new highs in all the market indexes. So don`t ask “Are we going to pullback yet”? No we are not going to pullback, you will know when it is time for the pullback by checking the damn calendar!

Here is the damn memo…..

Just so you know since nobody seems to pass around the memo anymore we run up everything for the first four months as high as we can, hopefully around 11%, then we short the market, and if we are lucky the damn thing goes negative for the year and we make another 11%, then we ramp it up at the end of the year back to the same 11% we know we can hit, and a little more if we are really good.

So the market benchmark the S&P 500 is up 12% for the year, and of course we beat the benchmark dumbass we are professionals, just add the 11%+11%+12%=34% we blow away the damn benchmark and everybody wants to invest with us and we make more damn money cause now we got more AUM!

So now you have the damn memo, study it, memorize it, live it and for God`s Sake quit askin about the damn pullback!

Gold Sitting at Ledge of 2-Year Support Cliff

2013-02-21T00:00:00.000-06:00

By EconMatters

A Rough Start for 2013

Well Gold hasn`t had a particularly good start to the year, in fact, a good pairs trade would be going long the S&P 500 and short the Gold market for a nice 12% return in two months. But many Gold Investors are not yet ready to throw in the towel for 2013, and some even have targets in the 2000 an ounce area, and think this pullback, although significant, represents an excellent buying opportunity.

A Buying Opportunity?

Well, all those waiting for a pullback to get long on this Gold trade now have their opportunity. The real question is whether this is a good place to buy, or the proverbial “Catching a Falling Knife”? I put some charts together, and I will let you decide that one for yourself. Just watch for key technical levels that break, and protect yourselves with stops, and you will survive with little more than some flesh wounds if you are wrong.

Charts Galore

The Stock Market is a Giant Ponzi Scheme

2013-02-20T07:23:00.000-06:00

By EconMatters

An Auction with Fake Buyers, that will end well!

The reason why is when you have the Federal government in the form of the Federal Reserve injecting 85 Billion worth of artificial capital, i.e., capital that wasn`t earned, or created through increased sales, revenues or increased productivity gains.

The problem is that this ‘artificial capital’ is not real, it is temporary and the Fed will discontinue the artificial capital injections, and even remove the liquidity out of the system when they begin tightening.

You call it Asset Purchases, I call it a Ponzi Scheme

So a Ponzi scheme pays out old investors with the proceeds of the new investors. Well, current retirees right now are benefitting from these ‘artificial injections’ into the stock market at the expense of future retirees who will be left holding the bag on depreciating assets once the fed stops the artificial injections, and asset prices go down. Moreover, when they take the additional step of removing the liquidity from the system, i.e., tightening mode, asset prices will go down even further.

Consequently, anybody who takes money out of the stock market while the fed is artificially raising asset prices is benefitting at the expense of all 401k money that is buying assets now at artificially raised prices.

In short new investors are buying assets at prices higher than they would otherwise without the Fed`s involvement in the markets.

These are ‘Temporary Purchases’ right?

Hence the cost basis of their investments is much higher with each artificial liquidity injection. This is great for current retirees, but at the expense of future retirees who now have inflated assets that will deflate once the Fed takes away the proverbial punch bowl.

Read more: http://www.econmatters.com/2013/02/so-david-einhorn-is-dumb-money-on-apple.html

Throw in the fact that baby boomers will start withdrawing their retirement capital to live on and those are two deflationary variables that future 401k retirees must overcome.

Nobody likes the Re-Pricing Mechanism

By artificially raising prices in a temporary fashion the Fed is guaranteeing losses for the future for anybody who bought the assets under these ‘artificial circumstances’ and these policies are withdrawn and the very same assets re-price to non-artificially inflated levels.

3 Alternative Outcomes

The only way the Fed can avoid this guaranteed negative outcome for these investors is to hope real productive growth and private capital can substitute for the greatest artificially created liquidity market capitalization in history.

Read more: http://www.econmatters.com/2013/01/apple-price-target-50-stock-by-2016.html

Or alternatively, the Fed can never stop artificially raising asset prices with the same magnitude and level of involvement. So they have put themselves in a box, effectively committing them to QE eternity.

The other possibility is they lessen the liquidity as much as private capital can make up the difference, i.e. a QE lite.

Should Retirees Gamble with the Fed?

But for future retirees this is entirely too risky territory to be caught up in a scenario which the Fed seems to have no solid exit plan. And I know that employees just sort of allocate money into the company sponsored plan with a given level of investment choices each month without really thinking about these deeper issues.

Read more: http://www.econmatters.com/2013/01/when-gold-bugs-start-selling-look-out.html

But every asset that employees have bought over the last four plus years and put in the retirement account has been artificially raised through Fed involvement. When the Fed stops being involved investors should seriously move out of these investments and into money market funds to protect the gains made in the artificial liquidity driven period.

Don`t be left looking for a chair, when the music stops

Otherwise, these investors are going to be paying the price, just like in a Ponzi scheme when the liquidity tide recedes back into the ocean of actual asset values. Make no mistake current asset holders are reaping the benefits, at the expense of current investors, and future asset holders who will be left holding the bag of artificially inflated “Non- Stores” of Value! The Federal Reserve is guaranteeing that these assets will lose value in the future.

Lumber Prices near the Top of their Historical Range

2013-02-19T07:12:00.000-06:00

By EconMatters

You have come a long way baby

The lumber market has really come off the 2009 bottom of $140 per mbf and closed Friday at $399.80 per mbf on the back of good news out of the housing sector of the economy.

The housing sector of the economy led the way in 2012 with record low interest rates, and investors and banks working through the foreclosed inventory, leading to a trending and steady rise in both average home prices and new constructions.

Read More - Technical Analysis of Cotton Market

Everything related to the housing sector performed well in 2012 from materials to the home improvement and remodeling big box retailers in Home Depot and Lowe`s Companies Incorporated.

Lumber prices getting slightly ahead of themselves?

But if we examine the history of lumber prices relative to the strength of the housing sector, lumber prices may be getting slightly ahead of themselves from a valuation standpoint.

Lumber prices will probably break through the $400 level on trading momentum alone, but if we look at the charts most of the time lumber prices are south of the $400 level.

The all-time high for lumber prices established in 1993 was just shy of $500 on a spike, with additional spikes of $440 in 1997, and $420 in 2005. So we are now basically sitting at $400 and in spike territory based upon the charts.

I will be watching lumber for some additional upside momentum, and looking for a good entry on a longer term reversion to the mean short in the commodity as I think the risk and reward dynamics are setting up nicely in lumber for an eventual short once the momentum is exhausted.

Further Reading - Technical Analysis of the Wheat Market

Cheap capital chasing returns fueling the upside momentum

The US economy is looking for all the good news it can get, and housing has definitely improved but lumber prices are pricing towards the best ever levels in the housing market from a comparison standpoint.

I know that a lot of investment capital has moved into anything housing related seeking a return with a bunch of easy access to cheap capital.

As a result prices can move well beyond historical valuation models, and I think they will definitely test the $420 and $440 levels as a direct result of liquidity flows.

But from a historical valuation standpoint prices just do not stay for long at these elevated levels, and once the housing euphoria trade loses momentum, prices should fall more in line with historical norms around the $320 per mbf level.

Therefore, the higher prices get pushed up on the crowded investment spike this year, the better risk reward trading setup for shorting the lumber market in the future looking for a high probability reversion to the mean trade.

Technical Analysis of the Cotton Market

2013-02-18T09:38:00.000-06:00

By EconMatters

The Cotton Market & Historical Slumber

The Cotton market was a pretty calm market until the last four months of 2010 through the first four months of 2011 when it awoke from its giant slumber to more than double its historical trading range. Cotton #2 for May 2013 which trades through the CME Globex & ClearPort venues has recently shown signs of life after the big spike and full retracement move of the last 2 plus years of trading activity.

Future Spikes or Trading Range Market?

So where is the Cotton market going next? Was the major move just a historical blip on the trading radar, or has something fundamentally changed in the Cotton market that makes for more aggressive price swings? The rationale for technical analysis and price action analysis is that fundamentally there is just too much information for anyone, group, or organization to factor in to an effective understanding of market dynamics.

TA helps clarify the “unknowable”

In short, there are just too many variables, too much information, and even unknown variables that play into market dynamics. But the thought is that eventually all the factors reveal themselves in the charts, the deciding factors affecting price movements, this knowledge is in the charts. Even inside information is reflected in the charts, so an understanding of price action and technical analysis tells the trader all they need to know about the commodity.

What is “priced in” regarding crop rotations, results, weather, etc. and what is not priced in by how the price reacts to fundamental news in the market. The idea is that eventually every factor that is knowable, and then needs to be prioritized by the market, is in the price movements on the chart.

So study the price action, and the trader knows what is going on in the commodity. This is the argument for technical analysis in general, and price action analysis specifically. Price action analysis avoids all the fancy indicators for the most part and just focuses on how price is moving in a given time frame.

Now that was a decent Spike story

So the major move in the Cotton market was going from $90 a pound on September 20 2010 to $220 a pound by March 7 2011, and then bottoming at $68 a pound on June 4 2012, quite a move there! Since bottoming last June, a major retest was established on November 9 2012 in the $71 a pound area, and since then the market has been putting in higher highs and now stands at $83.19 a pound as of the Friday close in markets.

How does Cotton react to first major correction in 2013?

Cotton is trying to breakout above the $84 area of resistance and has been rebuffed four times in the month of February. It seems that some of this recent move is basically mirroring the move in the S&P 500 and markets in general.

We haven`t had an outright rejection of price moving higher as the $81 level of support has held for the last 3 weeks with little effort.

Now mind you market optimism is very bullish, and not many markets have experienced any heat yet in 2013, so I want to see how Cotton reacts to the first 100 point negative close in the Dow Industrials before I get too excited about the recent move off the bottom.

We could just be in a trading range which has resembled the majority of historical trading in this market, it hasn`t historically been a very exciting market to trade. This isn`t exactly the coffee market by historical standards!

Resistance Levels

If we break through the $84 level of resistance with any conviction then a likely test of the $90 level seems like a surety. The next much stronger resistance level would be the nice round number of $100 a pound. The final level would be $110 a pound, and if we break this level something is going on in the Cotton market beyond a little market optimism.

Each level that breaks convincingly should provide strong support for backing and filling purposes. This provides many different ways to play the breakout via outright buy stops to buying the retest on support holds, there are pros and cons of each trading setup strategy around these key levels both on the upside as well as the downside.

Support Levels

Speaking of the downside, if Cotton breaks the $81 area of support, expect price to move down towards the $77-78 area of support, watch how it reacts to these levels. The next level of support would be the $71-72 area, which should provide for a solid entry point for a long to play a trading range setup with a relatively tight stop.

But even if the $68 a pound level of support breaks, there is really strong support at $60 a pound. As the trips down to the $40 a pound levels have been recession level/market crash induced, and of course, one doesn`t want to be long a commodity when all assets are being pulled from markets on a “just protect my principal” trading event.

The Fundamentals Matter

As always pay attention to the fundamental news regarding the commodity you choose to trade, as many strictly TA focused participants fail to gain the advantage that has yet to be priced into markets. Let`s face it the fundamentals matter in the equation, and sometimes the fundamentals are obvious, but other times require interpretation which is open for debate, and takes months and sometimes years to be fully priced into markets during dramatic paradigm shifts.

This is why reading everything you can, and knowing and thinking about the drivers of a given commodity can pay dividends if you anticipate and are right about fundamental shifts in a given market. Of course, just because you are right if too early doesn`t make for a profitable trade. You have to allow for the herd to catch up with your genius.