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Commodity Market Insights August 10, 2013

The S&P 500 cash index, the standard to which many an investment is measured, has drifted into a low range, low volatility consolidation phase over the past four weeks. Since July 15th, the index has vacillated in a 38 point range and settled out the week at its mean of 1691. In my opinion, the recent period of sideways price action is due to the unclear picture being painted by the Fed's impending tapering schedule and the voices in our head trying to convince us that the economy is gaining enough momentum to continue getting stronger in light of the disappearing stimulus measures. The powerful up trend that began last November may be showing signs of waning momentum as indicators such as the RSI and MACD are starting to turn down from a lower high than that which was set back at the May high. Meanwhile, the index has been setting new highs. The divergences come at a time when the index itself is once again testing the trend line established from the last November's low. It's hard to say whether volatility or daily ranges will surge again next week or even next month. We do know that earnings' season is wrapping up and the next FOMC meeting is still a month away, so there's not a lot in the way of a catalyst, outside of economic data taking a turn for the worse, to inspire a breakout of the consolidative trading pattern of late. As we approach the next Fed decision, I would expect that investors begin to pay closer attention to the various Fed Presidents interim speeches in hopes of clearing up what the Fed is going to do. In the 7/27/13 Wire I penned, "The question remains…What will the markets do once investors are convinced that tapering is upon us? While past performance is not necessarily indicative of future results, the reaction from the Chairman's comments in May might serve as a fair example. The S&P 500 proceeded to give up more than 100 points over the next 30 days, only to march back to new highs again after the tapering talk was toned down a bit." As we get closer to September 15th, this will be something to consider. Stay tuned…

Option Volatilities: Cotton surged higher last Wednesday as it broke out of a corrective wedge pattern that had held prices of the fiber in check for the past two months. Open Interest spiked after the breakout, leading me to believe that the move was not influenced as much by short covering as it was new buying by speculators and trend followers. Open Interest in the 90 strike now exceeds 14 thousand contracts as option traders are watching this level closely due to the December contracts inability to penetrate this ceiling on two previous attempts. Analyzing the at-the-money straddle and the next strike strangle on December options, it appears that the market is pricing in the potential for as much as an eight cent move before the expiration. Implied Volatility is at a lofty 28.4%, which is in the 96th percentile of the range of the past year. On Monday, the USDA will report its Supply and Demand report for cotton with the outlook expected to be on the bearish side. Weather has been good and global supplies are being forecast to increase. Wednesday's breakout however, had a fair amount to do with reports that extreme heat was being expected in Chinese growing regions. Analysts expect the USDA to increase their forecast for U.S. output to 13.75 million bales from 13.5 million in their July review. A stronger number may cause a lot of these new speculative longs to "bale" on their contracts, whereas a weaker number may allow prices to "boll" through the elusive 90 cent level.

Technical Analysis: Gold may be on the verge of testing the $1,500 level. With futures settling on Friday at $1,271.80, the statement seems a little absurd. Looking back to previous Wires, many times I mentioned the multi-year support shelf near the $1,525 level that futures had tested on three separate occasions and was on target to test again. For example, in the 02/16/2013 Wire I penned, "…otherwise the next major downside target should be the support shelf that held up in late 2011 and early 2012 near $1525." Futures tested and blasted through that level this past April and proceeded to decline nearly $400 through late-June. It did, however, take a short pause after the initial two-day breakout that leads me to this potentially absurd forecast. In the 04/20/2013 I reviewed the impending pause, "Looking at the shorter term picture, the move lower as measured from the 04/09/13 high of $1590.1 to Tuesday's low of $1321.5 seems to be a bit oversold on the daily continuous chart even though futures have already retraced as much as 38.2% of the drop. This tells me that the potential correction that may be trying to unfold could zigzag for several days or weeks and possibly extend closer to the 50% retracement level at $1455.8. Once this break in the action has completed, look for another forceful move that could take out the $1300 level and work its way down toward $1150." What interests me most, is that the breakout below the $1,525 support shelf has yet to be tested. It has been my experience that important technical events such as this are commonly revisited to see if the "bull camp", in this case, has the wherewithal to regain their momentum. I think that a retest of this level remains a strong possibility. After taking the brief pause, the secondary move lower reversed at $1,179.4. The more interesting information lies in the divergence of the price decline with momentum indicators like the RSI and MACD which did not confirm the new lows, meaning that they did not post readings of new lows too. The reversal higher from $1,179.4 developed into five waves and a three wave correction seems to have been completed with Thursday's $25 gain. While I am still of the opinion that the bigger trend remains to the downside in Gold, there may be an opportunity to exploit some short term upside potential.

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