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The 2005 Year in Review & 2006 OutlookJames Mound Overview 2005 proved to be one of the most volatile years in the futures markets in recent history and surprised many analysts by showing persistent strength in many expanding commodity markets. Typical of historical bull cycles in commodities, volatility and price action far exceed many traders' expectations. However, unlike previous bull cycles the influx of foreign speculators, hedge funds, managed funds and general speculators drawn in by the growing acceptance and attention of the financial industry and decline in the interest of stock market participation has created massive changes in the price action of many of the major commodities. Moreover, the advent of improving technologies and the stabilization of the integrity of the exchanges and futures markets themselves (mainly due to increasing global market competition and online efficiency) has created an added incentive for outside participation in what has long been an insiders market. This trend is most evident in the expansion of the managed futures market which has had explosive growth in a very short time frame - both from the perspective of dollars invested and quantity of funds available. This is reminiscent of the metamorphic rise of mutual funds in the stock market in the 90s. This expansion will force traders to acknowledge a new aspect of price action in commodities, one not so different from that of electronic buy/sell programs implemented by large funds in the stock market. Earlier in the year there was growing interest in the grain markets as outside institutional investors were developing large diversified positions in what many saw as an undervalued market condition and an opportunity to invest in growing demand from China's explosive economy. The mere rumor of this surged soybean and grain prices during a seasonally strong period and the underlying investment by these in funds paled in comparison to the psychological momentum this created in the market. Of course, no one will forget the surge in energy prices this year, spurred on by a fundamental shortage and hurricanes. However, more in-depth analysis would suggest market pundits like Jim Rogers and 24/7 coverage on CNBC led the sector into hysteria buying. Back in February crude oil was up some 22 out of 26 trading days, and in August it had a similar run - a clear sign of market hysteria and short covering surges that would lead to an inevitable decline. Nevertheless, the market surged further when Katrina offered a fundamental catastrophe and, as often happens in market conditions such as these, gave us the eventual top in the market. You can certainly identify moves like this throughout our history, but an objective evaluation would tell you the bulk of this move occurred on the expanding coverage and PR that the commodities sector is getting in the financial industry. And this is just the beginning Metals 2005 was the year of the worst market call of my career and it found its home in the gold market. While most traders are of the 'what have you done for me lately' mentality, I hope there are readers who remember the nearly 2 years of my analysis being a step ahead of this market in my reports and recommendations. Moreover, the recommendations in the gold market, as I acknowledged I was fighting the trend, was mainly buying cheap OTM puts to play potential spikes in volatility to the downside. This is one of the few ways I would feel comfortable standing in front of a steaming locomotive heading to multi-decade highs. The gold market surged despite a strong US dollar, and the dollar was the basis for anticipating a retracement in gold. This most recent leg up to fresh highs in gold and the continued expectation for strength in the dollar leads me to continue to fight the trend in '06. The correlative principals that connect the dollar to gold are undeniable, but a market can, and historically has, run free of its intermarket or cross-fundamental correlations for a brief period of time. However, when these forces go to such extremes as the gold/dollar relationship, and other correlative inflation indicating markets like oil and bonds do not explain the movement, then the relationship will almost inevitably come back into alignment over time. A gold retracement from these price levels could be historic in its magnitude and ferocity.  Silver ratio credit call spreads remain solid premium collection plays as underlying volatility in silver remain at significant highs on 15 cent more rally days. Silver as a whole lacks the short covering momentum and the disappearance of sellers we saw that brought the market to these levels in the first place. Buying puts here is also recommended as an aggressive complement to a ratio credit call spread strategy. Copper remains at extreme levels as foreign demand and an expanded use market has propelled copper to nearly quadruple its levels of 2002. Technically there is little to be bearish about, and the risk exposure of any short futures play is likely not worth the risk. Fundamentally the market is due to see some relief in the supply/demand equation, but to what degree has the market priced this in? Given the potential for major volatility spikes to the downside I recommend being a buyer of straight deep OTM puts and selling deep OTM call premium should the opportunity present itself. Palladium spiked off of significant value lows and has reemerged as a strengthening market. However, as the metals complex climate gets more volatile I am inclined to stand aside despite my bullish views here. Platinum remains overbought and due for a significant correction in 2006. -James Mound Open a commodity trading account with JMTG Brokerage, the firm that brings you the MoundReport. Contact a customer service representative at 888-744-8866 or by email at info@Moundreport.com for more information. Charts Courtesy of Gecko Software's TracknTrade Disclaimer: There is risk of loss in all commodities trading. Please consult a James Mound Trading Group Broker before you trade for the first time. Losses can exceed your account size and/or margin requirements. Commodities trading can be extremely risky and is not for everyone. Some option strategies have unlimited risk. Educate yourself on the risks and rewards of such investing prior to trading. James Mound Trading Group, or anyone associated with JMTG or moundreport.com, do not guarantee profits or pre-determined loss points, and are not held monetarily responsible for the trading losses of others (clients or otherwise). Past results are by no means indicative of potential future returns. Information provided are compiled by sources believed to be reliable. JMTG or its principals assume no responsibility for any errors or omissions as the information may not be complete or events may have been cancelled or rescheduled. Any copy, reprint, broadcast or distribution of this report of any kind is prohibited without the express written consent of James Mound Trading Group LLC.
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