Commodity Implosion

Clive Maund
Jan 5, 2007

Note: written Thurs. Jan 4, 2007

For commodities the new trading year did not start off with a bang or a whimper, but rather with an implosion. After moving higher in a most deceptive manner in the early trade commodities across the board went into a dramatic retreat, ending the day at or close to their lows. Damage was widespread and severe, and we will now quickly review it on a range of charts. The early rally is thought to have been an orchestrated campaign to shake out shorts ahead of the big drop.

Copper, which had been clinging on to the underside of its large top area by its fingernails, let go and plummeted. Although now oversold it could get more so, and this drop has set up a massive supply overhang that will inhibit any attempt to recover. This commodity is now a bear market and any rallies should be sold.

Gold rose higher in the early trade in a move clearly contrived to take out the stops of those who had gone short, as it briefly looked as if the Head-and-Shoulders top that has formed since early November had aborted. It then turned on its tail to close sharply lower. This was bearish action and the Head-and-Shoulders top therefore remains valid. The real downside action will begin once the key neckline support at $615 is breached. This would project the price back down to the $570 area at the minimum.

Silver moved sharply higher in the early trade to trigger the stops of those short before plummeting back to end the day down about as much as it had been up earlier. On the silver chart we can now see that a Head-and-Shoulders top is forming that parallels the one in gold. This formation projects the price to a minimum downside target at $10.50 - $11, and the price can be expected to drop steeply towards this objective once "neckline" support at $12.40 fails.

Light Crude broke down from its long-term uptrend in force for about 5-years, which triggered heavy selling of oil stocks. A break below the support level at $55 - $57, signaled by a break below $54, will usher in a bear market in oil. As long as this support holds it is still possible that a Right Shoulder will form to complement the Left Shoulder of late 2005, despite the trendline break.

US dollar - A major precipitating factor behind the carnage in commodities yesterday was the action in the US dollar, which rose strongly. The last thing you want to be part of in this business is a very large crowd, and dollar bears are a VERY large crowd. Over the past few months dollar bulls have been almost as hard to find as mahogany trees, while you could probably fill a thousand baseball stadiums with dollar bears, at a conservative estimate. This is a situation that creates the potential for an explosive advance, and it is the dawning perception of this possibility that is believed to be a contributing factor behind the extraordinary action yesterday. A glance at the long-term dollar chart quickly reveals that there is plenty of scope for a substantial advance, even if the fundamentals appear to rule it out, especially as it has recently been flirting with multi-year lows.

So, what does all this mean? There has been a sudden shift in perception and massive change is afoot - what is driving it? A suspected reason for this shift is the dawning realization in the markets that the long-threatened attack on Iran is not going to happen, at least not for the foreseeable future. This would explain the breakdown in oil prices.

The most dangerous mistake made by many dollar bears it to underestimate the Federal Reserve. When it comes to financial wizardry the Federal Reserve has on its payroll some of the sharpest minds on the planet. Stop and think about it; they have succeeded in seducing the rest of the planet into trading in US dollars. This has conferred enormous disproportionate power upon the United States, and made it possible to run trade balances of astronomic proportions as goods imported are paid for with an endlessly expanding supply of electronically created money. The trading partners of the US have been duped, and have been left holding a very big bag. There is an old saying "Never give a sucker an even break" and the Fed certainly don't intend to.

The reasons why the dollar might rally from here are not known, but one plausible explanation might be a progressive 'beggar thy neighbour" policy of competitive devaluations by other countries and trading blocs battling to keep a competitive edge. With other factors weighing in, the dollar could end up being "king of hell" if money supply expansion elsewhere outran the dollar.

In conclusion, commodities gave an across-the-board sell signal yesterday which it would take a move above yesterday's highs to begin to negate. We will be looking at effective ways to protect long positions in the sector and to capitalize on further weakness in the time ahead on www.clivemaund.com.

Jan 4, 2007
Clive Maund
email: support@clivemaund.com
website: www.clivemaund.com

Charts courtesy of StockCharts.com.

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