At the start of the year thanks mostly to unstoppable rally in crude, commodities were attracting a lot of media hype and interest from investors. New investment vehicles such as commodity-based exchange-traded funds (ETFs) were launched, and fueled interest in underlying commodity futures markets. We as futures traders felt the influence of these new funds in a big way, and I'm going to discuss the impact on the underlying futures markets, and how to cope with the volatility.

The stock market started the year generally blasé, with the only real buzz tied to natural resource stocks and companies associated with any type of commodity-related business. Wall Street wanted to get in on the fun.

A perfect example of this Wall Street commodity buzz came with the introduction in late January of the giant Deutsche Bank-designed fund, the DB Commodity Index Tracker. There was also a new iSshares silver ETF from Barclays (which launched in April of this year) to join gold versions which had begun trading already. The idea behind the DB Commodity Index was to invest in seven different major futures markets, from a long-only standpoint. This vehicle had a more substantial influence on underlying commodities markets than most directional hedge funds, active participants in the futures markets that also influence price action. The key difference, however, is that the DB fund is substantially larger than a single hedge fund, is a non-discretionary vehicle, and takes a buy-and-hold approach, similar to a mutual fund.

As the launches of these new funds grew imminent, market participants reacted in anticipation of their impact on various commodity markets, driving prices higher. Game theory would dictate "get long in front of them," embrace the theme, and enjoy the wave of cash upsetting the market's fundamental balance and pushing prices to exaggerated levels. Basically, that's what futures market participants did late in the first quarter of the year. Obviously, some fundamental factors came into play to augment the buzz. These included a poor hard wheat crop, endless hype about ethanol's potential as a savior for the American motorist, Iran's plans for atomic weapons, North Korean missile launches, flare-ups in the Middle East, and terrorist threats. Spectacular blowups of short positions in markets like copper, where some big traders just didn't "get" the new commodities market paradigm added to the bullish atmosphere. The same thing just happened in nickel recently. What will be next? Time will tell.

Let's go to the chart of the DBC Index for example and then look at some of the individual futures contracts that are its component commodities. The index is approximately comprised of 12.5 percent aluminum, 10 percent gold, 35 percent crude, 20 percent heating oil, and 11.25 percent corn, and 11.25 percent wheat so let's look at what's developed in these sectors.

The index saw a runaway rally in late March after some initial choppy activity. That push lasted until an island top traced out in May, at the same time metals prices topped out. Gold ran out of buyers up near $725 per ounce, while silver collapsed from near $15.25 an ounce. The severe break in all the metals led to a pullback in the price of the index into mid-June. A common gap that was left back on the May top later came into play as war broke out in Lebanon. Once the gap was filled on Friday July 14, that put a lid put on the rally off the June lows. The markets stalled at this point, and bulls were on thin ice once again.

The next rally attempt, the high failure and subsequent break, involved the grains more than anything else. Once again, the productive capability of the U.S. corn and soybean belt proved rather astounding and has overwhelmed the ethanol-inspired speculative craze that had carried corn (and especially back-month corn) to relatively unprecedented levels.

Let's look how the bull trend line in the index has held up various tests and influence of different sectors. Looking at gold, the market has had a serious pullback from July highs. Action has been volatile since. After a big drop early on Friday, August 18, 2006, the market bounced off its lows at same time the DBC Index approached an upside trend line. The rally continued into Monday, August 21, on news of Iran's resistance to the United Nations Security Council. The UN has given Iran until Aug. 31 to accept a package of incentives to stop production of nuclear fuel or face the threat of sanctions. December COMEX gold futures rose $13.50, or 2.2 percent, to $635.20 on Monday. Other news impacting gold revolves around an accord known as the Washington Agreement. European central banks agreed to limit gold sales to 500 tons a year, and banks have not reached that limit. There has been some market speculation banks in Europe may make sales before a September 26 deadline. Given this volatile fundamental backdrop, I would caution traders not to get caught up chasing news! Key support is at $617.50, with resistance at $642.

Meanwhile, October crude oil futures have jumped up above $73 a barrel amid Middle East turmoil, and from a technical standpoint, resistance is currently at $74.20. If the market breaks support under $71, it would be a bearish development, and confirm a downtrend.

Grains have been a basic disaster for market bulls after a strong start to the year tied to fund interest, and over-hyped ethanol speculation that impacted corn in particular. I hope you didn't get caught in the hype. Corn saw a downside breakout after the July crop report. The market is still under that influence, and favorable weather has kept corrective rallies from developing. I think lower prices are in store for the next few weeks and the charts are firmly bearish, but the market may be close to a low. There really is no reason to consider buying until we get a technical signal lows are in, but sell stops have likely been cleared out, and eventually some of the downside gaps will be filled.

The long-term, buy-and-hold funds won't likely get shaken out very easily, as indicated by still-strong open interest. So I think these markets will remain two-sided. Pay attention to the charts, and use stops. We don't all have to trade like the long-index funds, or follow them like lemmings when fundamentals dictate otherwise. Just as the rush of new money provided solid trends earlier in the year, I believe their large participation should continue in commodities markets and create opportunities in the coming months. While the index funds dictate waiting out the storms and ignoring downtrends, that might not be the most ideal strategy for you as an individual trader. Stick to your technical rules, take advantage of opportunities on the short side when they present themselves, and use good money management techniques.

Please feel free to call me at 866-419-7698 or via email at jbarrett@lind-waldock.com if you have questions on this topic or to discuss specific trading strategies for your unique situation in this or other markets.

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