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Sept. 8, 2006

Interest Rates
Both short and long term interest rates have been quietly falling as reflected in the bullish upswings on the Eurodollar and Treasury Bond charts shown below (they move inversely to interest rates and rise when rates are falling). While the Fed has repeatedly stated (as they always do) they will remain vigilant on inflation, the minutes from their most recent meeting reflect their opinion, over and over, that 17 straight 1/4 point tightenings are now having the intended effect of beating down inflation...which should be a major positive for the Bond market.
Excerpts from the minutes of that August 8th Fed meeting:
"...most participants thought that, with energy prices possibly leveling out, aggregate demand moderating, and long-term inflation expectations contained, core PCE inflation likely would decline gradually from its recent elevated level..."
"...inflation expectations appeared to have remained contained despite adverse news about prices. In light of these factors, most participants expressed the view that core inflation was likely to decline gradually over the next several quarters..."
"...most members anticipated that inflation pressures quite possibly would ease gradually over coming quarters..."
"Core consumer price inflation was projected to drop back somewhat later this year and next, mainly as the effects of higher energy and import prices abated."
"The full effect of previous increases in interest rates on activity and prices probably had not yet been felt (my bolding), and a pause was viewed as appropriate to limit the risks of tightening too much." 
The bottom line is the price of money (interest rates) is undoubtedly an extremely significant factor in any economic equation and what the Fed has done for the past few years will have its desired effects...For this and many other reasons (one being nobody really wants to sell quality long term US government paper), I continue to think the Bond market is going a lot higher and am still a buyer.
This first chart is of implied volatility in bond options. Implied volatility has been falling steadily as the market has moved up, which indicates (to me anyway) nobody believes what is happening, or for that matter, that anything big is coming...
The Eurodollars (not the Eurocurrency and nothing to do with Europe) are basically the benchmark for short term interest rates (90 day money). Since July 1st, while everyone has been wondering whether or not the Fed was "done", Eurodollar futures have been indicating they are and have already taken a full half percent off of what short rates were anticipated to be six months from now. I am still long this market and am still a buyer.
More and more, the Crude Oil market appears to be rolling over...As I have pointed out previously, in today's marketplace, jammed full with billions of hedge fund dollars that have entered the futures arena during the past few years, it seems that every time a popular futures bull market ends, it does so by dropping 20%-30% (or more) in virtually no time at all. I don't think Crude is any different, and if it is breaking down, I see no reason why the "$60 floor" it supposedly has can't be seriously violated. One thing I KNOW about this business is that however good the story, however perfectly bullish the fundamentals, any market can, at any time, just totally blow that story to pieces...I don't know what is going to happen in the oil market, but I do know the story there is now an old one, that everybody in the oil business was certainly loaded up with product for another monster hurricane season that has not occurred (I know it's not over) and we may have reached one of those lulls in the market where there is immediately a hell of a lot more supply than there is demand to soak it up...Whatever the long term fundamentals, this can be the recipe for a classic futures bloodletting, which is, I believe a distinct possibility in the Crude market...I'm looking for the low 60's, but would not be surprised if Crude fell to the mid 50's....This may sound nuts but these are the futures markets...And if I am only moderately right here, with Oil's impact on inflation, the bond market should just love it.
Both the Lean Hog and Feeder Cattle contracts still look very much like classic bull markets. I won't even try to tell you what is making them go up, just that I love the charts and note that, per the CFTC's most recent Commitments of Traders reports, small speculators are still net short (2 to 1) Cattle and Hogs...As I was so harshly reminded last year in Copper, top picking is about the toughest trade there is in futures...and when I see a hoard of small traders essentially trying to do the same in the meats as they are moving into new highs, I am very comfortable being a buyer. As I have noted before, as the meats sometimes have a tendency to make mind-boggling non-stop moves, I believe they offer some of the best option leverage you ever find in the futures markets. Into pullbacks, I am still very much a buyer in both of these markets.
Cotton is still wearing me out but I continue to see this as a market that will, at some point, just lift off and a very big way. This has nothing to do with ego or not being willing to give up on a market I have recommended (and lost a lot of money in) for seemingly forever now...It's just that every time I look at Cotton, which hasn't gone down, just sideways for over two years at very low historical levels, I see major upside potential. I've said it before (many times) but this is a market that traditionally does make some very large moves...and the fact it has not done so for so, so long just tells me the opportunity has gotten better.
Though the USDA seems not to have accounted for it (yet), our current crop has been rated the worst in years. Take this together with world demand setting records every year, as well as US exports doing the same (China's imports in 2006-2007 are expected to be virtually the equivalent of our entire US cotton crop), and I can't help but tell you I still believe this is a market you want to own.
One last small note....Without going into detail, due to the way the government loan program is set up in cotton, during the last month, a tremendous amount of cotton from last fall's harvest has finally left the farmer's hands and is now owned by the merchants who market our crop to the world. While this doesn't mean cotton is going straight up from here, if it were to do so, it wouldn't be the first time an agricultural market took off as soon as the farming community let a crop go (after sitting on it forever)...
I am now buying the March, May or July 2007 contracts, primarily owning out of the money calls, as I think...and I may be dead is impossible for cotton to be laying here in the 50's six months from now.
Give me a call if you are interested in any of the ideas here...or have any of your own.
Bill Rhyne
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