Is the 2006 Commodity Bull Run over?
Richard Ilczyszyn & Phil Streible
Is the 2006 Commodity Bull Run over?
Big rallies in many commodities earlier this year, from corn to gold to crude, were deflated by summertime. Now as we head toward year end, you might be wondering: is the commodity bull run of 2006 over? This is the “golden” question. To understand how commodities trade, let’s take a look at the last five years in gold. In 2001, gold futures were trading at about $270 per ounce. A lot of analysts believe this was the beginning of a large commodity bull run or “mega cycle.” Within those five years, gold futures have rallied to $732, peaking in May 2006. That represents a gain of more than 100 percent, certainly a more shrewd investment than the stock market over this time frame. Even with the correction off its peak, the gold market has provided impressive returns. Similarly, remember in 2001, crude oil was trading under $25 per barrel, and peaked above $78 in July 2006. Crude has likewise backed off a bit, trading around the $60 range today. We can see similar trends in other commodities as well.
If we are in the midst of mega bullish cycle, we can expect another 10 to 15 years of higher prices for commodities. Of course, what goes up does come down at some point. Markets are always two-sided, and there will be pullbacks and retracements along the way. Currently, gold is trading about $600, and I see the pullback from the May peak as a buying opportunity. Chart 1 below illustrates the low in 2001 gold futures at $270, the beginning of the bull cycle. Chart 2 below shows the peak at $732 on May 12.
What defines a mega or large bull cycle? Some of the tip offs i
nclude geo-political events (such as “9/11”), sustained higher prices, inflation (or perceived threat of inflation), war or threats of war, and a sustained change in consumption (demand) patterns. I see all these factors still playing out next year, and believe commodities are a still a good bet for bullish investors. If this is a mega cycle for commodities, we can assume recent pullbacks represent buying opportunities.
When a market rallies as hard as gold has, we can expect bouts of profit-taking and some sharp declines. With any investment, market timing, solid money management techniques, and a favorable risk-reward strategy are critical for long-term success. These tenets can help you weather the market’s ups and downs within the overall trend.
From a technical perspective, there are indications of a short-term turn higher in the December gold futures contract. It’s represented by a crossover on a trend indicator, the Moving Average Convergence/Divergence (MACD), on September 25, 2006.
Investors who are long can use June’s low at $559.30 as a price level on the December futures to buy against. A trade and close above $628 would signal higher prices likely ahead. A trade below $550 would signal lower prices likely ahead. Chart 3 shows the crossover on September 25, 2006, while Chart 4 indicates a close above $627 would buck the short-term downtrend.
You might ask how to capitalize on the late summer pullback. With diversification in mind, I would suggest taking a percentage of your risk capital and buy a gold option as one possible long-term strategy. When buying a gold option, you have defined risk. For example, you could buy a February 2007 gold 630 call at 22, with the underlying futures priced about $607.50 as of this writing. The total risk would be $2,200, excluding your commission costs. This strategy offers unlimited profit potential, and with this trade, you are now playing the long side of gold. I can see a move up to $680 in gold possible by early next year. The options expire January 26 2007.
However, if you think the bears have taken control and the market will trade below $550, you can buy puts. Remember, the market is fluid, and conditions can change quickly, so you must adjust your strategy accordingly. With that in mind, you can buy December 540 puts for $400, plus commission costs, which defines your risk. You likewise have virtually unlimited profit potential with this strategy.
In conclusion, we believe commodities are still a good bet, and many investors are waiting on the sidelines to jump back in. For a balanced portfolio, we feel a portion of your risk capital should be in commodities, which academic studies show can reduce your overall risk. Please feel free to contact us with any questions you may have on this topic, or other strategies to suit your particular needs.
You can reach Richard at 800-605-0095 or via email at firstname.lastname@example.org. You can reach Phil at 800-803-8037 or via email at email@example.com.
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About Today's Authors:
Years Trading: 10
Favorite Movie: WallStreet
Richard Ilczyszyn is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker-assisted division. From 2002 to 2004, he was a Chicago Board of Trade member, a licensed floor broker and a proprietary trader on a house account in the DJIA futures pit. He also spent five years as an institutional Treasury Bond Arb desk supervisor at the CBOT. His off-the-floor screen experience includes the DAX, Euro stocks, E-mini S&Ps and 10-Year Treasury notes.
With Lind Plus, Richard integrates technical and fundamental analysis, and his goal is to create a solid trading strategy while remaining flexible enough to capitalize on market opportunities when they arise. By identifying market trends, breakouts, and failures in a timely fashion, Richard tries to position his clients so that they have the opportunity to realize their objectives while effectively managing their risk. Up-to-the minute information and communication are key.
You can reach him at 800-605-0095 or via email at firstname.lastname@example.org.
Years Trading: 5
Favorite Movie: Trading Places
Phil Streible is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker-assisted division. Early in his career he began trading his own account as a screen trader focusing on the metals, grains, and stock index markets. He became a Series 7 licensed Financial Consultant with A.G. Edwards, and later expanded his trading experience as a Series 3 licensed Commodity Broker with Investment Analysis Group. In his current position as Senior Market Strategist with Lind-Waldock, all his focus is concentrated on the futures and futures options markets. His motto is: "Plan your trades and trade your plan."
Phil helps clients develop a solid trading strategy to remove some of the emotions from trading, and allow them to focus on improving their bottom line. His goal is to show clients how to anticipate, recognize, and react to bull and bear market conditions through the use of technical analysis techniques that help to define risk.
You can reach him at 800-803-8037 or via email at email@example.com.