This year has certainly seen its fair share of volatility spikes and price moves, major news events and critical fundamental market shifts, but we are only at the half way point and all signs are pointing to an even wilder second half ahead.  The mid-year review will take a look back in the hopes of getting clues to the future as we enter the back stretch of 2005.

Overview
So far in 2005 the focal points of the markets have been energy, the U.S. dollar and weather.  As the dollar makes a genuine effort to shift to a bull market after a three year downtrend we have seen the effects of a shift in the import/export relationships once exploited by the cheap dollar.  China has remained a focal point as well, not only in the demand arena for tangible commodities, but also in U.S. investments and currency valuation issues.  The China issue will not go away, it will become more of an epidemic than anything we have ever witnessed.  Throw in India as a close second and we got ourselves a global shift in economic and core commodity usage.  Hot and dry weather in the grain states in the middle of summer?  Why I never heard of such a thing!  When will the market accept weather as its own cycle?  Anyway, I digress.  Let's just get to the meat and bones of it all (and a side of mad cow please).

Energies
Lately I feel like I am watching a Presidential Debate when I listen (and I try oh so hard not to) to those analytical debates on CNBC, the WSJ, etc. argue about the next move in crude and why it goes up $2 today or down $1 tomorrow.  I suppose I listen because it is one of the few debates that I can genuinely acknowledge a part of both sides.  I mean on one hand you do have an ever-growing demand base in a limited supply and limited capacity market.  You have the foundation for WW III in the Middle East  - only the largest and main supplier of oil in the world.  Throw in an OPEC that is having a hard time getting the press to believe them let alone the market or the members and you got yourself an out of control market with hysteria written all over it. 

Take a look at how many Friday short covering rallies we have seen since the beginning of the year, and for that matter, how many Monday pullbacks.  The market is scared.  As I write this the market is building a several dollar premium into a hurricane that hasn't caused a single evacuation, not a single off-shore driller to stop, and yet the market is so paranoid that the disruption will cause a massive oil shortage that we are making new highs  - on nothing!  The market is really sold on this crude to infinity nonsense.  You got everyone on CNBC saying $60 crude, no $80 crude, how about $100 - well that's just a little more than the inflation adjusted price high anyway, right?  Go look at cattle over the past two years.  I think, if I remember correctly, the pitch was that low carb diets are causing a surge in demand that will enter cattle prices into a permanent bull market.  Give me a break!  The internet was the new stock market too, right?  Who was long the Nasdaq at 5,000 - sorry for your loss.  You can count on your hands the number of times in the history of US futures markets that a commodity has entered a permanent shift in the supply and demand function of that market.  Remember silver at $50 - the Hunt Brothers sure say thank you.  Let's get this straight once and for all.  Call a top in crude if you want, God knows I have taken my fair stab at it, but it is not about the top - it's about the market condition.  Remember crude was $11 not too long ago - and crude was $40 before that.  This is when a trader can realize his fortune, if it was ever intended for him. 

Jump on the bandwagon before they build the road and plan a long term strategy using and reusing an intermediate approach to play a breakdown in the technical price of energies over the next 6-12 months.  This means go 2-3 months out in time and buy bear put spreads, go a month out and sell calls $10 out of the money on a $2 up day - collect the premium they so graciously are giving you.  Since when does heating oil cost more in the summer than unleaded gas?  Something is awry here.  Did you notice crude broke through $56 on its way through $60 like it was no big deal and yet the distillates held back under the highs?  The market is being pushed, and markets getting pushed will eventually get tired and push back.  The inventory levels speak for themselves.  Stop listening to the debates - we have more crude than we have had in over a half decade at this point in the year - and the catch up on distillates will happen better than the market thinks.  Hurricanes aside, and that hysteria will subside as well, the energy market is the place to be in the second half of 2005 - and you better be short and you better be patient.

Financials
The stock market spent the first half of '05 plaguing trend traders and paying off channel traders as the market offered more false breaks of support and resistance than I care to remember.  I am resolved to acknowledge the market as a consolidating mess that will likely fail to the downside as a rising dollar and global trade fails the market over the next year or two.  Nevertheless I avoid the stock market like the plague and will wait patiently for the market to break a significant price point and look for volume and momentum indicators to back up the move in order for me to want to participate.  Premium collection is a great thing in this environment, but premiums are so low and margin so high that the ROI for the risk is just not worth it when you look at what else is out there.

Bonds defied FOMC and common logic over the past several months as higher prices came amid 9 consecutive rate hikes and growing pressure from U.S. monetary policy.  Overall, the bond market intrigues me.  The setup is definitely there for the fallout.  You got inflated prices due to obscene foreign investment, fighting a powerful Fed with Alan making his last stand.  You got a rising dollar diminishing US investment from abroad and a real estate market threatening to wreak global havoc if it is not dealt with properly.  So the Fed has to keep a moderate interest rate to hold up housing, raise the dollar to slow foreign buying, and keep the curve intact to avoid a recession (some say the inverted curve is a sign of recession, but I say it can be a self-fulfilling prophecy as well).  My bet is that it may take a year or two (the gut says more like a few months), but the fallout is coming.  Bonds could conceivably be below par before everyone wakes up from the explosion.  Even if the fallout doesn't happen and we just get a reduced demand from foreigners bonds should fall to 112 or lower.  Buy puts and sell calls, short futures if you got the stones to fight the power.  Wait it out and watch the wall come crumbling down.

The dollar acted like I had predicted and hoped for throughout the first half of the year, but now we face a critical juncture.  My broad based views of the end of the bear US dollar market are holding up, but the market runs in longer cycles than the 3 years it took to breakdown from 120 and it shouldn't rally to par in less than a year.  With that said, stage 1 appears to complete in the US dollar rebound.  We may see 92 but overall I am not a short term buyer or a seller - I am a currency premium collector.  The euro is now officially oversold and selling put premium is a bold move.  Why not look at strangling the pound, yen and Canadian instead.  The market should be choppy as a whole and I suspect the dollar will be stuck between 87 and 92 for the rest of the year.  By all means keep a base position long the U.S. as the market will ultimately get the dollar through par - just don't expect too much too soon.  There is a lot riding on a stable currency market.  Just a quick additional note here in case you missed it in my weekly commentary - The French bailing on the EU constitution was no small issue.  For the first time since the creation of the euro they hit a stumbling block , and a big one at that.  Global confidence in the euro took a major dive and it will take a while before we any real bullish momentum return to this market.  Throw in economic woes and hypersensitivity to oil prices and you got an uphill battle if you buying the euro for the long haul - but it is still oversold for the time being.

Grains
So far so good on the grains this year - fairly typical for a market that has not been typical for some time.  I always viewed the grains as a weather market that tries and fails to predict the weather, but all the while keeping the market participants believing in their amazing ability to forecast it accurately.  The market sells off ahead of the growing season, rallies ahead of genuine weather problems, ignores a real rust issue and then fights back and fourth playing catch up to the most recent over reaction.  But now, at this critical juncture, we got ourselves a real market that seems to have worked its premature reaction problem out.  This week should mark a significant technical and fundamental turning point as grains set the stage for a major summer run.  Every time I have seen grains make a major move you blink and you missed a good entry, but in fact the entry wouldn't matter because the move sticks.  I saw that over the past week and I tell you now grains have a real run in them ahead.  Corn and wheat call premiums are cheapest and buying bean puts for November along with long futures allows you to effectively play the wide ranging volatility I see lying ahead.  Oats completely broke out and has the look of a market heading for much higher prices, which I admittedly bailed on too early.  Rice is the sleeper here and while it is coming off of historical highs (not unlike beans did recently), rice does have tremendous potential to offer an historic rally.  If you can by rice around 550 consider yourself lucky.  I say go half in now and mortgage the farm if you see that kind of value show itself.

Meats
The crazy cow returned and no one blinked an eye.  That darn mad cow was sitting in their hands for seven months and the worst case scenario plays out.  So the PR job by the USDA makes them seem like heroes for not letting it out to the public before catching the cow.  You have got to be joking!  So they test a bunch of cows and don't test a heck of lot more. That is like saying we are not letting illegal immigrants into our country because our borders are safe due to heightened border patrol and security - they still get in.  The low carb craze got a boost from the USDA because they changed their 30 year old food pyramid to reduce carb intake.  So the USDA needs the meat industry as much as the meat industry needs them.  Cattle is in for a fall and it has already begun.  The market will see 70 before we see 90 - if we ever see 90 again.  Bellies took the plunge - like I always say it's a sell above 100 and a buy below 40 otherwise forget about it.  Hogs remain an oversold market on the rise but let us not forget prices were half what they are now not too long ago. 

Metals
I have been writing about gold for sometime now, and those that followed me long from 250 and went short with me at 450 understand that for two to four week stretches the market can make a false move, but the longer term shifts are definitive and pronounced.  Over the past several weeks gold has seemingly diverged from its inverse correlation with the US dollar, but I wait patiently.  The dollar correlation is alive and well and showed itself last Friday.  I maintain the short view in this market, not because I am stubborn, but because I am right.  So I begged you to short it at 420 and the market nailed us for $20.  The bottom line is if you bought puts like I suggested you would still be in the game.  Up until last Friday puts in gold were the best value play around, and they remain a solid approach to play continued downside.  There is a bit of a problem, however.  I am not the dollar bull I once was at 80 or even 85.  The dollar is the main price determinate in gold and will be for some time.  The next few months may paint a foggy picture, but it is getting clearer.  The euro makes up over 50% of the US dollar index, and the euro is oversold and due for a bounce.  The yen is playing catch up and everyone knows when the yen is cheap the Asian buying demand that supports gold disappears.  The initial phase of China gold buying is in decline.  The overall outlook suggests that a channeled dollar and a turning point in the euro/yen relationship can still push gold below $400.  The monthly saucer/arch formation is broken, and using technical history as a guide, these formations can often lead to devastating reversals when they fail.

Silver broke through critical trend line support and lacks upward momentum.  I am impressed, however, with the inexpensive call options available in the market and recommend an inter-market hedge by buying gold puts and silver calls.  This strategy would require a couple of months in time on the options for an effective volatility play.  Alternatively for the more aggressive bear trader, you could sell silver futures and buy calls as protection (for example, sell one silver futures at $7.00 and buy two August 720 calls for $500, then roll into September calls when the August's go off the board).  The daily volatility can easily provide winners on both sides if you keep your strike prices close and keep your time frames tight.  All the silver to $50 prayers for Hunt Brother Part Two out there isn't going to help this market. There have been times over the past couple of years where all the sellers in silver evaporate and short covering rallies ensue.  For example the last run to $8.50 had that feel - like you couldn't pay someone enough to sell their silver.  But the sellers came back, on the heels of a gold failure, and I haven't felt that nervousness since.  When silver makes several intraday recoveries from 20 cent down moves and also holds onto a couple of 20 cent up days I might get bullish, but until then silver is a sell.

If I may interrupt myself for a brief aside on silver.  I listen to all types of customers and traders who hoard physical silver and gold and for the most part they fall into one of two camps.  The first camp falls for the chaos theory and thinks currency is for suckers and raw and precious metals will be the future because the world as we know it is coming to an end.  The second camp says a shortage of physical deliverable silver will cause a rush to the market for delivery thereby igniting an explosive surge in silver prices.  There is a part of me that can empathize with the first argument because the world is getting seemingly more screwed up every day, and the idea of our impending doom has a growing argument.  Nevertheless I stopped the acid trip a long time ago and I can't for second wager my financial well being on the egocentric view that this will happen in my lifetime or my family's.  As for the second argument, about the shortage, you are missing a big piece of the puzzle.  Those that bite on this viewpoint see the ever declining inventory and increasing usage of raw metals through the US inventory reports that are freely available to public.  And, after your E=MC2 calculation, you figured out that we will eventually run out of the stuff.  Of course, everyone else sees the same thing you see so you must be telling yourself at this point that it is only a matter of time before the market wakes up and smells the coffee, right?  Not to burst your bubble, but huge hoarders of physical silver like Warren Buffet, Bill Gates, Michael Dell, George Soros, etc. don't keep their metal in US storage and are not required to report it.  So, the moral of this story is looks can be deceiving and what appears to be a shortage is more like a squeeze in the making - which, by the way, is not such a bad thing for you silver bulls out there.  But a squeeze like that doesn't mean you need to have physical possession of silver - you will be just fine with your undeliverable futures contract at $20/oz because even if they can't deliver you will get paid.  If you don't believe me call the exchange and ask them yourself.  Meanwhile you are missing out on leverage, short term plays, option protection and/or speculation - all the while paying a nice transaction premium and delivery and storage costs, all just to show your buddies your coin collection - but I digress.

Platinum prices have remained at an unusually high premium, and while fundamentals are hard to come by, the market is technically begging to fall.  Palladium on the other hand, almost entirely controlled by Russian influence and hidden supply, offers a technical buy for the patient trader.  I believe that buying three palladium for every short platinum is a great spread trade for the next several months. 

Copper is struggling to hold on to these outrageous highs, but keeps bringing in the suckers on these fake downshifts in the market.  I beg you - do not falter or wane in your struggle as you are on the right path.  The dollar strength coupled with declining demand from China is setting up a turning point in the near term.  This may well be a long term bull market, but in the near term I expect sub 130 prices.  Short futures with stops above 165 or create a synthetic futures play by buying an OTM put and using a short OTM call to pay for it.  

Softs
The first half of the year was a banner one for coffee as the market surged to fresh highs on the heels of a global short squeeze and growing supply concerns in an expanding demand market.  Not to mention it was coming off of historical lows.  Now we are retracing - wait, wait, wait a second - you mean to tell me a market can double and pull back a bit and still be a bull market during critical frost season?  Coffee is one of the most cyclical weather markets in the world, and with declining supply from the world's #1 producer Brazil and a shift to Vietnam and Indonesia for the new #2 and #3, we got a real shifting supply situation.  The last and only two recorded times US coffee futures broke under 50 cents/lb and rose back above $1, it didn't stop until we broke $2 and were two of the largest rallies in recorded history.  Big cycle shifts like this only come along once in a blue so take advantage of the discount and get long now.

Orange Juice traders finally put some real premium into the market once they weighed the long term destruction of the largest grower of OJ in the world and realized the one year carryover inventory they had wouldn't make up for the six years it will take for a plant to produce OJ in Florida again.  Throw in a cankor fungus problem and the flat demand is not going to help OJ head south.  I am cautiously bullish, though as we have surged some 80% plus from the lows and the market volume and lack of volatility make for a questionable environment.  I fall more into the camp of buying bull call spreads and betting on a hurricane or two jump starting this market over the next few months.

Sugar is showing strength as crude oil makes fresh highs.  For those not familiar, sugar can be used as an ethanol substitute for energy and as energy prices rise the demand for sugar will too.  I got two problems here.  For one, Brazil was ahead of the game here and the sugar production there is already on the rise.  When a big supplier is a head of the curve the upside will be somewhat limited.  Secondly, I am not an energy bull so I have little hopes for a sugar run.  However, I must admit this market is a lagging one and offers the potential for moves into double digits before failing.  So, for now, I am a buyer on dips.

Cocoa has been a bloody mess this year - literally.  The Ivory Coast three way war came to a head earlier int eh year when France decided to stomp out the entire 6 plane air battalion of the Ivory Coast government and run things for a bit.  But with elections ahead, an under supported UN protection and growing violence the situation is about to get out of control.  We could have another Rwanda on our hands if the UN bails when things get worse - and they will get worse before they get better.  Since the Ivory Coast represents about 2/3rds of the world's supply of cocoa I would keep a close eye on the UN.  If they leave I would get long in a hurry.  I would buy calls to play the volatility ahead of time anyway - they are pretty cheap at the moment.  Until then, cocoa will break to fresh lows on US dollar strength/

Cotton is gut play for me and has been all year.  If cotton doesn't break below 40 it will have found long term support at a price point that it has never supported out at in history.  So I am short until then.  Sometimes we see historic firsts, but I just don't think this is one of those times. 

Lumber has been a short play all year.  I lay much like bellies - the heck with the fundamentals - if it's above 400 sell and below 250 buy.  Otherwise leave it alone.

Conclusion
Volatility remains high in the broad spectrum of commodities, and the US dollar shifts will continue to have a powerful influence on commodity price fluctuations through the end of the year and beyond.  Several markets remain at or near all time or recent highs and maintain an underlying level of market hysteria that will not last.  Options become a traders best friend in volatile environments and if used properly can offer higher ROI against rising margin requirements in the underlying futures while offering degrees of protection and trade definition.

Disclaimer
There is risk of loss in all commodities trading.  Commissions and fees vary per individual and therefore are not included in profit, cost and risk scenarios.  Please consult a licensed 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.

James Mound, owner of JMTG Brokerage LLC, MoundReport.com and author of the book 7 Secrets, writes the Weekend Commodities Review Newsletter. Receive your free weekly subscription to the Weekend Review by e-mail. Click here.