After posting our three scenarios yesterday, we have been alerted that the panic into gold may have been caused by the belief that the CFTC will curtail or eliminate the ability of funds to use commodities as a speculative asset class.  The official CME/NYMEX reason cited by a Reuters story is:

NEW YORK, Sept 2 (Reuters) – The CME Group will not list additional futures contract months for the New York Harbor No. 2 Heating Oil Futures contract beyond the August 2012 contract due to proposed sulfur-content specification changes.

“The proposed legislation, currently pending in New Jersey and New York State, intends to reduce the sulfur level in heating oil,” CME Group, which owns the New York Mercantile Exchange, said on its website.

“The existing New York Harbor No. 2 Heating Oil Futures and corresponding Option contracts, listed below, will continue to be listed for trading through August 2012.”

We have not been able to confirm the rumors that the CFTC will lock out speculators, though they have certainly made overtures to that effect before, and the belief in the rumor would be justified.

Once again, we repost our three scenarios and revise the conclusion slightly:

1)  Recent correlations hold and gold is simply forecasting another inflation-led [stock] rally that will begin in the next few days (meaning yesterday’s correction is not the bearish bellwether everyone thinks it is), or

2) Recent correlations hold and the move today in gold is a bull trap that will be reversed in the next few days, or

3) Recent correlations have broken and gold is decoupling from other markets, including equities.  Because correlation-changing paradigm shifts are rare, this is the least likely scenario; however, should it end up being the case, the significance is tremendous.  A break above 1,000 on a declining stock market would be definitive evidence for this scenario.

As to 3, because the move in gold may be a result of large investment funds looking for the most liquid commodity play that is the least likely to be subject to overt government interference, a breakdown in the correlation between equities and gold is no longer remote, and it would be possible for gold to advance, equities to decline, and the US Dollar and bonds to rally.

To confirm that gold is advancing on its own merits and not the result solely of US Dollar weakness, we want to see eventual confirmation of an up move in gold priced in other currencies.  Below shows gold priced in the Canadian Dollar (CAD), Australian Dollar (AUD), Japanese Yen (JPY), and the Euro (EUR).  When gold began its last advance in November 2008, it was confirmed by higher lows in the commodity currencies of the CAD and AUD, as well as the EUR (even though there were lower lows in the JPY and USD gold).  Eventually, there were higher lows in the JPY and USD gold at the beginning of December 2008.  Accordingly, for the gold bull case, early confirmation would be to see current lows in AUD, CAD and EUR gold respected on the first pullback, especially in the former two as they are commodity currencies.

* Thanks to the members of the Value in Time group for their comments and postings on this issue.

10:39 am EDT:  The daily gap/pivot area of 994.00 to 995.25 has not been respected and, though we have hit the first potential reversal area of 989.75 to 991.00, we are wary of fading long here with the early weakness, and would prefer to hold out for longs at the 984.00 to 986.25 area.  If however, we see a break of yesterday’s low of 991.00, the price does not move through 989.75 and there is a quick upward reaction off this area, we will jump in long.  If the price takes off from here without going down again, we will wait for a break of 996.25 and attempt to go long on a 50% retracement of the move off the low of 991.25.  If it shoots up without retracement, we will miss it.  We will not consider shorts until the 1004-1006 area is reached, and then only cautiously.

The Precise Take – Markets positioning ahead of Friday’s Employment Report and 3 day weekend

Gold:  Thanks for all the responses to our posts yesterday regarding the breakout in gold.  We will have additional thoughts to be posted intraday today.  For now, gold has indeed advanced higher again overnight, but we don’t expect a confirmation of the breakout until at least tomorrow, if not early next week.

Time Profile:  Today is an Agency POMO day; however, as we wrote Tuesday morning, the POMO edges have dwindled to nothing recently.  Additionally, we believe the Agency POMO effect of the last two months was helped in part because most of these days were Friday’s, which have had a bullish bias since March.  Accordingly, we’re not posting a Time Profile for today.

Employment Situation (NFP):  As we have noted before, the March rally was kicked off on an NFP day, and every subsequent report has been at an important support or resistance level.  As we are now in the bottom range of the week’s range, the probability (if the pattern holds) is for tomorrow’s report to result in a spike low that confirms ~991 as support in the ES, and leads to a rally into next week.  This would also confirm the positive correlation between gold and equity prices.  As always, though, we must be prepared for when patterns break, so it could be that tomorrow’s report will result in an extension of the down move.  We will have more information in tomorrow’s report (published just after the report) for what we expect the resulting move to be.

Market Profile:  As evidenced by the market profile chart below, the ES is still in the value area centered around the 995.25 point of control.  Should it break out of the value area (higher than 1006.00), it will likely test at least the minor point of control at 1016.50.  A quick rejection off that area is a very strong sell signal, but not likely to be reached today.  Above 1016.50, and the next point of control is 1024.75.  If the ES breaks above and starts accepting value there, new highs are likely.  To the downside, a break below 991.75 suggests a test of the 973.25 point of control, again not likely today.

Trading Today:  We are expecting another low range day and would fade the 1004.00 to 1006.00 area short on weakness (quick rejection of the area).  If the ES hangs around in the upper range and starts building volume there, then we would prepare for a move up to at least the monthly pivot at in confluence with daily R3 at 1011.50 to 1012.50, where again we would…

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