Another six months of wild volatility and a bull commodities market ends on a slightly bearish note, seeing several key markets retrace significantly from their respective highs.  However, let us not be fooled again.  The ebb and flow of this commodity bull run is about to make another major move, shifting several key markets in unexpected ways.

A weak stock market and a potentially stagnant interest rate market sets the stage for increased money flow into a rapidly expanding industry.  Where do U.S., and for that matter global, investors turn for profitable opportunities?  Real estate, stocks and interest rate vehicles are all at pivotal points of declining investor confidence.  But money flow into commodities doesnââ,¬â"¢t automatically translate to rising prices.  Remember that the world is paranoid about inflation, and extreme spikes in commodity prices will only give this paranoia a head of steam.  A stronger U.S. dollar means a slow down in global demand for commodities and it also compliments a tighter economic policy that resists inflation.  Dare you say the U.S. is not strong enough to force the global strength of its currency?  May I remind you that literally from the moment that ex-treasury secretary Rubin said ââ,¬Ëœwe believe in a strong dollar policyââ,¬â"¢ we witnessed a seven year rally in the dollar that ended with over a 50% rise in the dollar index.  Moreover, the most recently shafted ex-treasury secretary Snow communicated this same message and caused the double bottom in the dollar.  The recent pullback off of the highs (nearly 15% above the low) following that ââ,¬Ëœnoticeââ,¬â"¢ still leaves us 7% above the lows and gave the market a healthy retracement.  Not only is this evidence of the long term significance of U.S. economic policy and its impact on global currency prices, but a sign of its effect on commodity prices moving forward.

The rise in managed commodity funds and introduction of exchange-traded funds has added a new dimension to the growing world of futures.  This is perhaps the best way to introduce commodities to general public, and to further awareness of the great industry we are apart of, but danger comes from this expansion.  Exposure to wild swings and huge volume flow in markets that have never seen such interest can make for a bumpy ride on this bull roller coaster. 

This increase in volatility is an options traderââ,¬â"¢s dream -- as without price action there is no opportunity for profit (of course increased risk is inherently built into this idea).  The next six months offers an excellent opportunity to play several major shifts in commodity prices, and all you need to do is be a step ahead of the pack.  Sounds easy enough, right?

Energies
The ongoing geopolitical concerns in the Middle East and the recent developments of a potential long range nuclear missile test launch out of North Korea have kept crude prices near contract highs.  Meanwhile, the benign weather to start the summer high demand season has been offset by underlying concerns over supply issues that may arise from hurricanes passing through the Gulf of Mexico.  Despite the timing of Katrina last year, the greatest likelihood of a Gulf hurricane is actually right now.  The potential upside volatility combined with strong technical weekly trend line support suggests that, weather permitting, the energy complex is set for new highs in the near term.  My target is just under $80 and then a strong sell from there as the longer term outlook is not likely to sustain these prices.  If you see the front month break above $78 then look to sell $90 calls 6-8 weeks out in time and collect some serious premium, especially if it spikes on weather issues.  Be prepared for increases in margin requirements across the energy spectrum.  For the less risk averse, a bear put play at that target price with 8-10 weeks of time is recommended.  Unleaded gas diverged from the energy complex, as anticipated, by breaking to fresh ââ,¬â"¢06 highs ââ,¬â€œ a strong bullish sign and a leading indicator.  I continue to be long unleaded versus short heating oil in a seasonal play that should last another month or so.  Natural gas remains the underdog, but the potential for a significant rally remains, and the spike in call premium after a one-day surge on the 15th suggests long call plays are a worthwhile play if purchased on the cheap.

Financials
I suppose there is a part of me that appreciates the fact that a market based on the premise that everyone is a buyer can fall apart like it has, but this market is the lifeblood of the American investor and I certainly do not want these investors to bring down our economy.  So this epic shift of commodities into the mainstream is a spectacular event to be a part of, and one that will hopefully change the average speculator into a more diversified investor.  The recent failure in the stock market has found price support, but the ambiguity of the Fed and interest policy, along with growing concerns over inflation, has burdened the stock market with too much to sustain a bull rally.  Expect consolidation in the near term, but once this market realizes the Fed and interest rates arenââ,¬â"¢t finished then this market should fall apart.  The Fed may very well stop the 1/4 point hikes in the near future, but that by no means says they are done - the market will catch on eventually.  This means bond prices will see fresh lows and rising rates.  The flattening yield curve is ideal for the Fedââ,¬â"¢s long term goals ââ,¬â€œ tighter access to money but steady long term rates to avoid a housing collapse. 

The U.S. dollar, as I discussed in the general overview, has likely seen its long term bottom.  Remember that currency trends happen in years, not days, weeks, or months.  The Japanese Yen has established an impressive long term consolidation pattern despite a current bearish technical pattern, and will likely be range bound for the rest of the year.  The Canadian dollar, however, is on the cusp of a major move as it establishes an impressive top after a sustained rally that has lasted over 3 years.  If we close below 8898 on the September contract I do not see much holding this market up from a serious retracement.  The euro will likely see continued weakness as the dollar strength tests the recent highs.

Grains
Grains feel a bit overlooked at the moment, after failing to sustain a premature summer rally.  The 6-10 day weather forecasts are all anyone cares about, as the summer weather has been more benign than anticipated.  But since when has the summer ended in June?  There is still plenty of opportunity for the weather to turn.  Keep an eye on the acreage report this Friday to help set a bottom in grains and look for a late summer run to make the grain market a place of focus for the rest of the year.  Funds walked away from this market too early and their money will flow back in a hurry.  The wheat crop is devastated but everyone seems to ignore the fact that wheat or more global then a U.S. dependant corn crop that is trading at a much better value.  I like the risk to reward of a short wheat to long bean play (3 wheat to 2 beans) or a short wheat to long corn play (1 wheat to 3 corn) for the next several months.  Also look to take advantage of dirt cheap OTM call options and take a shot at bull run in these grain markets.  Rough rice is another play worth a look, with calls still under priced despite a nice bull run already underway in this market.

Meats
Volatility in cattle prices is a tough thing for long time traders to get used to, but it is likely here to stay.  So far this year we have already witnessed a 17% plunge and a 19% rally, the latter of which caught more than half of that move just in the past three weeks!  Declining supplies coupled with a shift in global demand has many thinking that a test of the all time highs and a long term sustained bull run is ahead.  I say we are looking at a market getting way ahead of itself and this is a great opportunity to play a pullback.  It is tough to stand in front of a speeding locomotive but this market is unlikely to sustain itself.  I know a lot of ranchers who see this spike as an opportunity to take the money and run, especially after watching their profits almost disappear when we took a run at 70 cents.  Regardless of which side you stand on, options are under priced and volatility is here to stay, so long strangle plays are highly recommended.  Hog prices have followed along side this cattle run, and the overbought situation here begs for the same correction.

Metals
So a year of premature short recommendations on my part finally shows some life ââ,¬â€œ I suppose I was destined to be right at one point if I screamed sell long enough.  Like I always say, if you are a step ahead of a market then ride it ââ,¬Ëœtil it bucks you off, but if you are step behind then step aside.  Regardless, the market has spent the better part of the last few weeks faking a possible support, begging specs to come back into the market before setting a fresh low.  The signs are all there ââ,¬â€œ platinum sets an overnight all time high and then plummets $5,000 a contract within ten minutes of the open.  Then copper retraces 25% in a blink of an eye.  I mean the market sold off more in a week and a half than the entire value of the contract just three years ago!  When the margins increased in silver the market plunged almost 20% in two hours and then failed again when it tested the highs.  Most traders didnââ,¬â"¢t even know silver had a lock limit rule.  I suppose it still all comes down to the dollar ââ,¬â€œ dollar bulls sell metals and bears say new highs are coming ââ,¬â€œ we shall see.

Softs
Most of these obscure markets have never seen volume like this ââ,¬â€œ sugar and OJ pits used to be a couple of guys standing in the pits thumb wrestling.  Now we have two commodities making epic moves and everyone is trying to get a piece (lately it sounds like the crude pit down there).  OJ remains very susceptible to price action throughout the hurricane season, and I would be more inclined to see the benefits of the upside potential as opposed to down side risks.  My only issue here is how much can you ruin a destroyed Florida OJ industry?  Cankor fungus and more hurricanes than I can count on my hand have made the industry more Brazilian than Floridian, so whatââ,¬â"¢s another hurricane going to do?  It takes a good five years to plant a tree and get real production out of it, and then you got everyone in the business going broke with a lucky few benefiting from the price spike.  You can plant more all you want, but there is still going to be a shortage.  So are they rallying it because of the permanence of the supply issue or the psychological damage of more hurricanes?  Either way this market would have to go the whole summer without bad news to hold any type of retracement - $2 here we come (scoop it up if it even comes close to 1.40). 

Sugar broke key technical consolidation and failed before finding critical price support and setting up another major price move just around the corner.  If we break 1650 this market will scream higher on hysteria buying, but if it holds I would buy some cheap puts as the fundamental picture doesnââ,¬â"¢t justify the price.  Not to sound ambiguous here but volatility is about the only predictable attribute in this market.

Coffee died a slow, low volume, quiet death over the past couple of months, but is setting a major rally despite seasonal bearishness.  I know frost season isnââ,¬â"¢t what it used to be, with coffee supplies shifting from South America to countries like Vietnam, but look what could unfold here.  Brazil is still #1 and this is peak frost season.  The Brazilian government is giving producers of 100 million dollars in financial support, which could give them the cushion to hold out for higher prices and squeeze the supply side of the market.  The entire Asian supply is indirectly exposed to potential issues with North Korea and the bird flu pandemic.  The market is down 30% and just above producer breakeven.  If I am a commodity bull looking for a market to play value and a cyclical supply issue then I am throwing a big chunk of my chips into coffee.  Bull call spreads in this market are still dirt cheap and we could see $1.50 in a heartbeat. 

Cocoa made a key technical break above 1550 and then gave bulls a gift with a quick pullback and a solid entry price.  Now we are set to surge through this ugly long term consolidation and make a bull move as ending stock supplies are at their lowest levels in 19 years.

Lumber prices continue to fall amid declining new home building and a lack of global demand issues.  To me lumber is a simple market ââ,¬â€œ buy below 250 and sell around 400 ââ,¬â€œ seems to work every time.

Cotton prices remain weak, and while the market is exposed to weather, there is little to make me bullish here.  The long term price consolidation is more an indicator of a dead market than a argument to go long. 

James Mound is the head analyst for www.MoundReport.com, and author of the commodity book 7 Secrets. For a free email subscription to James Mound's Weekend Commodities Review and Trade of the Month, click here.