January 12, 2006

Name: Phil Flynn
Company: Alaron Trading
Years Trading: 19
Favorite Movie: Patton

The Year of Commodities

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The Year of Commodities

Have you kept your New Years resolutions? Well if your resolution was to get long the commodities markets in 2006 then your resolution may already be paying off. What a way to ring in the New Year! It appears the commodity markets are living up to their New Year's resolution to be bullish and to live up to those rallying expectations. If the first couple of weeks of trading are any indication, 2006 may be one of the most bullish years for commodities ever.

Last year I wrote many articles talking about the bullish fundamentals for commodities. I spoke about the reasons why the commodity markets were in the midst of a historical bull that could actually continue on for decades. Commodities trade in long term cycles. They go from boom to bust and to boom again. They swing from one extreme to the other. Commodities have gone through several decades where they languished in a bear market but are now back on track to change the way we think of prices for many hard material markets.

In these past decades, the world grew accustomed to cheap raw material prices. Now with growth of demand from China and other places around the world, we can no longer count on cheap prices to bring about great economic expansion.

Incredible growth around the world has brought about a tight supply situation in many markets. And as good as 2005 was for hard commodities, if the early returns on 2006 hold up this year could prove to be extra special. And in 2006 it didn't take long to see that commodities are one of the hottest sectors on the planet. And in the new era of commodities it may be clear that 2006 might be the most explosive year in this historic bull run.
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Just take a look at some of the moves we have seen already in the first 8 trading sessions of the year. Gold surged to a 25 year high and has many analysts calling for a run to $800.00 an ounce. Zinc rose over 52 percent in 2005 and hit a three month high. Sugar is being driven by ethanol demand in Brazil and has hit its highest level since the mid 1990s. Silver is at its highest level since the 1980s. Platinum and palladium has also been on the move. Even lumber has been on a bull run. This solid performance of commodities is calling investors from far and wide and they are responding with gusto!

And where the action is you can always count on the big money to follow. In 2006 the funds have come a running. Commodity funds and hedge funds have embraced the commodity markets almost like never before. The early price spike in 2006 has traders wondering whether the funds have been the only driver of prices. Well the truth is that the funds have been driven to the complex by extremely strong market fundamentals.

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Let us look at oil for instance. What a first week! Whether it's short covering or just getting long this explosive market, the funds are being blamed for the move higher in oil. Of course there is absolutely no doubt that the funds have been active in oil but are they the only reason oil is moving or is it because the fundamentals for oil are just downright bullish. In other words, what came first the funds or the bullish fundamentals?

Bearish traders of course argue that the fundamentals for oil are not bullish. They say that crude oil supplies are more than ample, if not glut-ish. They point to the fact that crude oil supply in the US is 12.5% above a year ago. (Of course they forget to mention that in 2005 crude oil went on to have one of the most bullish years in history).

Bearish traders also point to the unseasonably warm temperatures. They say that heating supplies for oil are more than adequate with distillate supply up 2.2% over a year ago.

Surely they say the rally in oil is a figment of the greedy commodity funds imagination and their lust for oil profits.

Yet to have too tight a focus on what constitutes oil price fundamentals is where many of the bears have gone wrong in 2005 as well as early 2006. Yes, we seemingly have lots of crude and we do have down right balmy temperatures. Yet the rally fundamentals run much deeper than that. Oil has been plagued by storms, strong demand and geopolitical events that have gripped trader's imaginations. But oil and other markets seem to be moving on something much larger than short term fundamentals. Something much more significant and longer term.

The first week of 2006 was a downright bullish cornucopia. You name it: gold, silver, copper, lumber, cocoa, sugar across the board. Commodities are definitely king in 2006 and crude is no exception. The main reason for the commodity blast was the drop in the value of the dollar. Most commodities are priced in dollars and the dollar as of late has been taking it on the chin. The dollar fell 2.5% against the euro last week.

The dollar and oil are very closely linked these days. And it's not the only factor influencing oil but so far in 2006 it has been a factor. Fund traders have an international view when they look to investing. The US Budget deficit and signals from the Fed that interest rate increases may be coming to a halt helped put downward pressure on the dollar.

Last week China hinted they want to diversify its currency holdings and their paper away from just US interests. They released a statement that said China wants to "optimize the currency and asset of the counties foreign reserve". This seems to suggest that China may start buying assets from outside the US. This brings out fear that the dollar might be weak and China, with extra money to play with, could end up buying more gold, silver and of course euros. Not to mention that a weak US dollar could make oil and other commodities like gold and silver awfully attractive to the Chinese.

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Now why is China making this move? Is it because they are tired of being pressured by the US to float their currency and remove its peg to the dollar. The moves that they have made in that direction have not satisfied many critics of China's foreign exchange policy. Or could it be a bit of payback because of the congressional opposition to China's takeover of UNOCAL. Or maybe its just good business sense by the Chinese who don't want all their eggs in one basket. But what ever the reason it's clear the commodity funds interpret this as bullish for oil and other commodities as well.

China has also made a 2 billion dollar bid to secure a Nigerian oilfield. This is another clear sign that China will continue to aggressively secure oil fields for future growth. China has also said in the past that they will maybe spend cash to build up their strategic petroleum reserve, another issue that will add long term upward pressure on oil.

Of course diversification comes in many forms. The oil is and always has been a geopolitical animal. Last week's gas showdown between Russia and the Ukraine made Europe realize how vulnerable they are to an oil or gas embargos from Russia. For commodity fund traders this event has made it obvious that many European countries will start to look else where to secure some oil supply. This of course means less oil for the rest of the world and the potential for higher prices.

The issue that the funds are pricing in is the unreliability of Russian oil. Not just in the short term but in the long term as well. Russian oil production growth has been more than disappointing to say the least. And of course the world had been assuming that Russia of course would provide the answer to the worlds growing energy needs. Yet with the Russian stealing of YUKO's and its recent gas spat. It's clear that the prospects of 2006 oil output growth in. Russia will disappoint again.

And Iran, by restarting its nuclear program, has raised tensions that could cause oil prices to keep on its bullish edge.

Yet the US economy doesn't seem to care. Not only that the US stock market start to break out of its doldrums by barreling in on and closing above the 11000 mark. The economies in Japan in Europe seem to be expanding as well. This of course in the eyes of funds adds to the bullish aura of oil. And not just oil but other hard commodities as well.

Commodities have always been a high risk high profit of potential investment. But those who can afford the risk the opportunities seem to be exceptional. Yet even in bull markets there can be wicked corrections. But even to the casual observer there's a lot of evidence that tells us the year ahead in commodities is shaping up to be something special.

Complimentary Daily Research Newsletter from Phil Flynn

Phil Flynn's market commentary, fundamental and technical analysis, and long-term forecasts are in demand by industry executives, investors and media worldwide.Take advantage of this special offer and get this highly sought after analysis with your complimentary daily research newsletter from Phil Flynn.

About Today's Author

Phil Flynn is Vice President, Energy Analyst and General Market Analyst with Alaron Trading Corporation. Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide.

Most recently, Phil and his energy team were one of the first to predict that global crude oil prices would exceed $30/barrel in the year 2000, a correctly-predicted market milestone which has highlighted the economic scene in the new millennium. Through hundreds of media interviews, Phil Flynn and Alaron Trading have become familiar names in living rooms and boardrooms worldwide. The world's print, broadcast and online media have come to rely on Phil's accurate and animated forecasts and analysis.

Media highlights include: The President of the United States, Bloomberg, ABC, CBS, NBC's "Today Show" and "Nightly News with Tom Brokaw", CNBC, CNN/ CNNfn, FOX's "O'Reilly Factor", PBS's "The Newshour with Jim Lehrer" and "Nightly Business Report", MSNBC's "The News with Brian Williams", Wall Street Journal Report, The Wall Street Journal, Business Week, Investor's Business Daily, The New York Times, The Los Angeles Times, Chicago Tribune, Associated Press, The Toronto Globe & Mail, Houston Chronicle, Futures Magazine and National Public Radio.

Phil's daily market analysis can be viewed at Alaron's website, the world's leading futures Web site. He has been featured on MarketWatch.com and FutureSource.com.

Phil's commitment to and experience in futures trading is documented in two books, The Mind of a Trader (Financial Times/Pitman,1997), and Trading Online (publisher, date), both by Alpesh B. Patel. Phil is a lifelong resident of Illinois. He attended Daley College in Chicago before beginning his career on the trading floor of the Chicago Mercantile Exchange.

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