COMMODITY FUTURES FORECAST WEEKLY REPORT
Philip Gotthelf
Crash Testing
Those who anticipated a major October correction have essentially run out of time.
Although equity markets had a slight hiccup this past week, there were not technical meltdown and the Fed encouraged everyone with a pledge to keep the 1% fed funds rate. This brings up a new adage, "The same news is good news."
We have all experienced the wrath of over reactive markets. Today, a penny makes the difference between a rally and a crash. The absence of government influence has left the "markets" on their own. This covers all major indices. The hint of a recovery in technology and communications has sustained enthusiasm regardless of some warnings that consumer debt is "tapped out" just before the holiday shopping season. Thus, anticipatory trading has been held at bay...for now.
The recovery couldn't look more beautiful. The powerful and steady slope has only been briefly interrupted by blips that have quickly faded into insignificance. The impetus for the recovery cannot be associated with
economic performance. Unemployment remains problematic as does the war on terror, mounting deficits, and the enormous domestic debt burden. What is the catalyst?
Essentially, short-term interest rates are "flat-lined" above 9865 support in the December Eurodollar. The servicing burden on mortgages, consumer debt, and business debt has been reduced sufficiently to carry the economy forward.
However, unless the economy supplies more income, this fix may be temporary. There are increasing signs that the decline in interest rates is being offset by an increase in debt. This is not just true of credit cards and
mortgages. Examine mergers and acquisitions. Look at the corporate debt market. See how Ford Motor Company just recalled issues that still yielded 7-1/2%.
With the Dow approximately 200 points shy of 10,000, most traders have been lulled back into a sense of security about their favorite paper assets. Even though the charts are undeniable, I have a sense of discomfort about the fundamental ability to sustain rising stock values.
Corporate income has picked up in a widely general sense. But, the P/E ratios reflect significant increasing risk. By historical standards, stock markets are overextended...unless you believe the rules have changed.
If everything is hunky-dory, explain the following gold chart.
The interim secular trend is almost as impressive as the cash Dow Industrials Index. The slope is more erratic for understandable reasons. This is a single commodity that reacts to immediate supply and demand. Stock indices are composites that enjoy diversification.
Gold is rising. This bodes of change. We face either an evolution whereby the rules and relationships do change, or a revolution whereby the rules and relationships revert or revolve back to traditional logic. This would put the
Dow Industrial average down below 6500!
The Commodity Research Bureau Index reflects the same pattern as the Dow and interest rates. This brings inflation to the forefront. Yes, dollar parity is deteriorating against the Euro and yen. But, the inflation of food and energy is more than the decrease in U.S. Dollar parity.
Twice within the last two months, a decline in crude and related energy balanced rising agriculture, rising metals, and other inflating components. This is why stocks have remained unshaken by the CRB Index.
So, have we avoided a crash? We should not forget that the Crash of '87 was followed by the mini-crash of 1990. That recession was generated by evaporated wealth and lasted until the real estate correction through 1993. The current "economic slowdown" came with March 2000. If we are, indeed, recovering, it will be a very short recession regardless of the severe impact upon stock market wealth.
Over the next month, the U.S. economy will face it biggest known challenge...the 2003 Christmas season. If consumer debt becomes a bottleneck, investors will not treat equities kindly. Several industries must have a good season. These include home entertainment, computers, electronics, and apparel. Any wavering can generate a new round of skepticism and destroy the dream of a near-term recovery.
Any Keys?
While writing this Report, December cotton made a new life-of-contract high at 8450, the price plunged to 7973 to define a "key reversal." Many traders are extremely cautious about taking a key reversal signal because
of the implied volatility. In other words, key reversals are only reliable after you know the reversal has some legs. There are dozens of after-the-fact excuses for a botched key reversal trade. Most commonly, it is blamed on a lack of volume.
Although not a "key," crude oil violated the 30-day and 40-day moving averages today. This constitutes a technical breakdown and sell signal with a 2800 downside objective. Energy inventories are building into this winter season. We cannot know if cold will be severe, but we do see a willingness to allow crude to drift lower within OPEC's arbitrary target range.
OPEC members are keenly aware that their financial futures rely upon more than just oil. The second tier diversification is paper. The bulk of the paper comes from U.S. companies and the Treasury. If OPEC fails to assist the U.S. in maintaining the recovery, oil reserves will be meaningless compared with the losses in financial markets.
Yes, selling such weakness just doesn't "feel right." This is why discipline is so important. We must remember the adage, "Sell weakness and buy strength." The crude oil chart does not look encouraging. We missed the larger opportunity to track crude from more than $32 down to $28. It was a $4,000 move that took place in less than two weeks.
I was aware of the downside potential with our short recommendation in December crude oil. The natural gas was too volatile for our stop placement, but we were fortunate to see resistance hold in the crude.
I am inclined to follow this with a wide stop because intermittent announcements can bounce prices around like an intra-day ping-pong match. Do not be surprised to see a rapid retreat below September's 2660 support. Keep in mind that OPEC has expressed contentment with prices between 2200 and 2800.
Interest Rates
As mentioned, the Fed calmed apprehension over a short-term rate hike. While I can't claim I knew this was coming, I continue anticipating December bond support at 10500 and resistance at 11000. Some subscribers were tentative about taking the short 110/105 strangle for only 1 31/64ths, But that gives a safety range from almost 102 all the way to just under 112.
If we can be confident short-term rates will remain stable through the quarter, it is unlikely December bonds will experience a significant breakout above 112 nor should we see a dip below 102.
Looking at the 4-month range, it would take a major incident to bring the market above or below our band before the December options expire. Was I concerned when blasted up more than a point right after I placed the trade? A bit. In fact, I did not expect prices to back off as far and as fast as they have just this week.
The nice thing about the bonds is the premium. Given the time we have left and the chart pattern, we should be safe!
October 31, 2003
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235
www.commodex.com
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