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The past few months the commodity futures have been marked by an overall bias that if prices drop, then it would be an opportunity to add-to existing longs: a "buy the dip" psychology is what has allowed the grains and oilseeds to work themselves to the levels we’ve seen heading into the end of November. Even wheat has been able to retrace thanks in part to renewed concerns about new-crop supplies in the southern hemisphere, but also in part due to the underlying strength in the beans and corn (Even the S&P 500, Gold, and Crude were able to retrace nicely after their early November breaks). But now, some of the key cornerstones of our analysis -- those that helped ignite the commodity rally back in 2001 -- have begun to show vulnerability. We suspect that this is primarily a result of less confidence by the overall market that global demand will continue to outpace global supply; and with lead-month composite wheat futures up 73% YTD, beans up 61%, Bean Oil up 58%, and corn up 2%, what are the possible implications to grain and oilseeds prices as we close out the year? We wonder if the desire to "buy the dip" going into the end of the year will be limited by these leading indicators warranting a more cautious approach. Most important, we think it puts even more burden upon the Federal Reserve to continue to provide liquidity to the market through Rate Cuts. But will those rate cuts help?

Since the early October, high lead-month composite copper futures prices have lost more than 20%; since mid-October, the Baltic Day Freight Index has shed 10% of its value; and since its mid-October high, the lead-month S&P 500 composite futures has also lost over 10%. Because we incorporate these three into our analysis as Leading Commodity Trend Indicators (L.C.T.I.) when we project our "Overvalue" and "Undervalue" prices to our clients, we started looking at some of the commodity index weekly charts, to see how some technical indicators we track were holding-up. The Morgan Stanley Commodity Index Chart for instance (Figure 1) indeed shows vulnerability in our short-term moving averages, momentum, and stochastics.

If you cannot view Figure 1, go here.

With all of the indicators we’ve looked at so far not looking very optimistic, pressure mounts on our last two LCTI’s: The dollar and the 10-year bonds. Figure 2 shows very clearly how a bear trend starting in the dollar index and a bull-trend starting in the crude oil occurred almost simultaneously -- igniting the general commodity bull trend currently underway. At the time of this writing, lead-month dollar index futures has crossed above it’s 10-day moving average and violated a resistance tread-line; and lead-month Euro currency futures has crossed below it’s 10-day moving average and has also violated a support tread-line. The Yen has also started to show weakness against the Dollar.

A change to a more sideways to upward bias in the dollar makes it imperative that if the commodity bull trend is going to stay in-tact, bond yields need to remain low and the FED needs to keep injecting liquidity into the market by cutting the Fed Fund Rate by at least 25 basis points on December 11th. This rate cut should also help prevent a mass-exodus out of long positions by commodity index funds, in our view. Why? Another injection of liquidity by the FED should help stoke inflation fears by the investment community as we head into 2008. It should also turn the dollar weaker again since yield wouldn’t be worth chasing. Gold should also once again be looked upon by speculative fund managers as a safe-haven, we believe. 

If you cannot view Figure 2, go here.

But before you go out and buy gold and sell dollars, a word of caution: Figure 3 and Figure 4 indicate some technicals we track are pointing to lower not higher bond prices, which would equate to higher, not lower, yields…especially in the 10 year T-Note market (We say "especially" because we expect higher yields would come first in the benchmark since this would be where most of the institutional and hedge-fund money would park their assets if they expected the yield curve to continue to widen). These two charts are essentially mirror images – Figure 3 showing that a 10-year yield below 3.75% has been hard to achieve the past 7-10 years (excluding a spike to almost 3% in 2003). Figure 4 portrays this as stiff resistance in lead-month futures at the 115 level. Note how most important, the oscillators suggest on both charts that, on a weekly basis at least, extremes are currently being hit. Let’s face it, at the time of this writing, treasury futures prices have already factored-in about a 100% likelihood of a 25 basis point cut, and almost a 30% likelihood of a 50 basis point cut; so the potential really exists for a "buy the rumor/sell the fact" type reaction to what the FED does. Last, let’s consider what the possible implications would be to a stronger Dollar/weaker Crude market could be: in the short-term we believe it would likely mean a return by investors to the Equity Markets. Here too, we should see this play-out in the Treasury market as bond yields going up not down. We are assuming that the Dollar and T-Note Yields will continue to move in a similar pattern, as they have since the end of 2004. This being the case, Dollar demand should go up on a stronger performance on Wall Street.

If you cannot view Figure 3, go here.

If you cannot view Figure 4, go here.

Conclusion: Almost all of our leading indicators are giving us a "caution sign"; we’re going to respect these indicators as well as the bond technical’s and not assume Bernanke will dress-up as Santa and bring to the market calm and peace, even with a 25 basis point rate cut. Because of this, we would recommend taking some long grain and oilseed position profits ahead of the end of the year if not before the December 11th FED meeting. Or, if you want to keep your grain longs in place, and are convinced that the grains have more upside in them on a return of a bullish gold outlook, consider buying some Feb. 10-Year Note Puts to protect from higher yields causing speculative grain and oilseeds longs to be trimmed. Let’s see if the bearish Treasury and Commodity Index technicals we’ve laid-out in this piece manifest themselves going into the end of the year. Just don’t get caught on the "Island of Misfit Traders"! Happy Holidays and Merry Christmas to you all.

General Risk Disclosure: There is a substantial risk of loss in trading futures and options; therefore you should carefully consider whether trading is appropriate for you in light of your experience, objectives, financial resources and other relevant circumstances.

Information Disclaimer: The information and data contained herein was obtained from sources deemed reliable. Their accuracy and completeness is not assured. Any decision to purchase of sell based upon such information is the responsibility of the person authorizing the transaction.

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Risk Mgt. Commodities Inc. brings you complimentary market commentary! Now you can get daily and weekly commentary covering Market trends, Momentum indicators, Critical days, and specific recommendations. Sign up for your COMPLIMENTARY Daily Market Trial Subscription!