Commodity Markets Start to Gyrate at Higher Price Levels

Many recently overheated commodity futures markets have taken a steep tumble recently, with gold and crude oil leading the slide. Crude oil futures at the New York Mercantile Exchange have dipped back below $100.00 a barrel in recent days, while gold dropped by over $100.00 an ounce from its recent highs.

There are two catalysts that ignited the sharp downturn in commodity futures prices the past couple weeks: The short-term credit market crisis that prompted the U.S. Federal Reserve add liquidity to the financial system and reduce U.S. interest rates, and the rebound in the value of the U.S. dollar versus the other major currencies, which can be tracked at Trading Education.

Commodity market speculators, including the large commodity "funds" have been seriously rattled and many are now moving to become de-leveraged in the highly leveraged commodity futures markets. Much of the recent selling pressure this week was profit-taking from previously established long positions in the commodity markets and also long liquidation from the weak-handed futures traders.

There is also the old trading adage that says, "When in doubt, get out." There is, at present, certainly enough doubt among financial, currency, stock and commodity traders after the sudden demise of the investment banking firm Bear Stearns.

An examination of charts for the Continuous Commodity Index (CCI) show just how severe the decline in commodity futures market prices has been this week. In the past few weeks, markets like gold, crude oil, corn, soybeans and wheat had set all-time record highs. Many other commodity futures markets hit multi-year highs, like those predicted by VantagePoint Trading Software ( www.TraderTech.com ).

A major fear for all commodity market bulls in the present economic environment is deflationary pressure. Weakening world economies and shaky world financial markets argue for lessening demand for raw commodities. If deflation does grip world economies, that would be a sure bet that major market price tops are near, or already in place, in those recently high-flying commodity futures markets.

There is also a camp of analysts and traders that argue the present setback in the commodity markets is just a needed downside price "correction" after big price advances that were scored in recent weeks. They are proclaiming the present declines in commodity futures prices are, or will be soon, bargain-hunting buying opportunities in markets that are destined for still-higher prices in the coming months.

Where to in the markets from here?

I've said before that bold, specific predictions of market tops (or bottoms) before they actually occur are foolish endeavors that most respected analysts and veteran traders avoid. What is apparent, at present, is that the strong price up trends in the grains, precious metals, liquid energies and other markets are in jeopardy. What we have in many commodity futures markets are mature bull runs--and arguably very mature. These mature bull markets are fraught with high volatility and the risk at any time of steep
downside price corrections in the major up trends. When near-term price up trends on the daily charts are soundly negated, near-term chart damage starts to be inflicted. Even stronger technical clues that market tops would be in place would be downtrends developing on the weekly charts.

Importantly, it has become apparent to me that one key market in trying to determine where most of the other markets are heading is the Euro currency. As the Euro hit a new all-time high against the U.S. dollar recently, the bullish commodity markets followed with strong price surges, themselves. As long as the Euro currency continues to trend higher (and the U.S. dollar careens lower) the bullish commodity markets are likely to do the same. Keep in mind that the Euro currency is in a mature bull market move.

Note that traders could also argue the U.S. dollar is most important currency watch, via the U.S. dollar index futures. However, the reason I choose the Euro is that it's more liquid in currency futures trading than is the U.S. dollar index futures. And in the cash FOREX trading market, the Euro currency-U.S. dollar is a major currency pair traded by FOREX traders.

When markets are making parabolic price moves, like so many are doing at present, it's also prudent to examine longer-term historical charts to seek out classical technical patterns, major highs and lows, and to seek out any correlations that might occur with a technical study overlaid on the longer-term charts.

Watch for Government "Jawboning" as a Precursor to Central Bank Intervention

I want to also touch on a matter that could seriously impact the Euro currency and the value of the U.S. dollar.  It's coordinated central bank foreign exchange market intervention. This phenomenon has not occurred in any significant fashion since the mid-1990s. Central bank intervention in currency markets occurs when central bankers from the major industrial countries act in unison to try to influence the value of one currency against other currencies--usually the U.S. dollar.

It has been and still is the official policy of the government of the United States of America to have a "strong dollar." U.S. Treasury Secretary Henry Paulson reiterated such just Thursday. Most economists and analysts would agree that at present the value of the U.S. dollar versus the other major currencies could not be considered "strong."

If the U.S. dollar continues to slump (and the Euro to rise), then what is likely to occur sooner rather than later is more U.S. government officials "jawboning" and trying to talk up the value of the greenback. That tactic is not likely to work. What comes next would likely be coordinated central bank intervention in the world currency markets--done by buying or selling huge sums of currencies on the world market. In this case the central banks would likely dump other major currencies on the world market and buy up U.S. dollars.

The results of central bank intervention in the currency markets are debatable. What has occurred in the past is that shortly after the intervention is announced, the currency markets do react in the fashion the central bankers hoped they would--usually a rise in the value of the U.S. dollar versus the other major currencies. However, then what has happened is the currency speculators become emboldened by the central bank intervention, as they sense the move by the governments is a "last ditch" effort to support a weakened U.S. currency. That has caused the greenback to make one last stab to the downside, but then it does begin a sustained recovery. Importantly, the history of coordinated central bank intervention that occurred in the early-to-mid-1990s does suggest it's a last major step that occurs just before the U.S. dollar does put in a major low and embark upon an uptrend in value.

Bottom line: In the coming days or weeks, if you see more pronounced jawboning by U.S. government officials trying to talk up the U.S. dollar's value--with little results, then you can look for the next step to be coordinated central bank intervention. To likely follow that would be a last and quick jab down in the dollar's value (up in the Euro), and then the beginning of a major and longer-term recovery process in the dollar's value. To extrapolate further, at such time when the U.S. dollar does start to trend solidly higher (Euro lower) on the daily chart, then it would likely mean the end of the major bull market runs seen in many commodity futures markets. My job will continue to be to point out to you, my valued reader, any early clues that price trend changes are occurring.