December 19, 2016

Dear Investors,

As 2016 winds down to a close, let us take a moment and look at opportunities in commodities, past and present. Two characteristics most important to successful trend-following are patience and adherence to your rules. The past year was full opportunities in the markets if you were patient with your trades and you followed your money management strictly. The year started with Europe in turmoil and closed with Europe in greater turmoil causing a lot of volatility in the currency markets and bond markets. We don’t anticipate this to stop anytime soon as mainstream politicians are being tossed out all over Europe and the USA. Any connection to the old order is an almost unbearable burden to carry into any campaign. Established parties, especially those of the moderate Center-Left, are tumbling. A snapshot of Europe currently looks like this: the latest domino to topple is Italy as the Prime Minister, Matteo Renzi, recently resigned after losing a referendum on constitutional reform: Francois Fillon is the favorite to win the French elections next year; in March 2017, the Dutch voters may give anti-European Union parties a much greater voice in their parliament; in September or October 2017, German voters may rebuke Chancellor Angela Merkel and the Christian Democratic Union (CDU) which she leads. We put the odds at 60% that Merkel will not be Chancellor of Germany in 2018. If the elections in France and Germany swing toward an anti-EU bent, the Euro versus the U.S. dollar could move through parity on the back of increased political fragmentation and uncertainty set against rising rates and inflation pressure in the United States. However, currency markets have been difficult to trade due to governmental manipulation in the US, Japan and Europe where we saw major trend reversals due to policy change/manipulations. However, this strong monetary/ fiscal stance by some of the world’s most powerful economies seems to be subsiding. We did have opportunities in the currency markets in the Absolute Momentum Strategy, especially in the Japanese Yen and Euro currencies toward the end of the year.

(Through DEC 15th)

With a lens on the US Federal Reserve and specifically on Janet Yellen (as her term as Chair expires early in 2018), we do not expect her to be reappointed. The Securities and Exchange Commission (SEC) will get a new Chairman in 2017, as will the Commodity Futures Trading Commission (CFTC). The leadership shifts in these three key financial regulators will accentuate the move to lighter touch regulation. The Federal Open Market Committee (FOMC) had a two-day meeting ending on this past Wednesday (December 14, 2016) with a +0.25 rate hike. Prospects of fiscal stimulus have raised the odds of possibly three or four more hikes in 2017. The Eurodollar deposit maturity curve has moved sharply steeper to reflect these changes in rate hike probabilities and Treasury note and bond yields have risen. And, we note again, a higher U.S. federal funds rate might push the U.S. dollar further upward against the Euro and Japanese Yen.

(Through DEC 15th)

The FED has started raising interest rates because it seems that there is confidence that the economy is finally on solid footing given recent unemployment and GDP numbers and Trump policies which appear to be bullish for the economy. When interest rates rise, US Treasury futures prices fall. When the economy strengthens, interest rates are likely to rise for reasons such as increased demand for loans, asset allocation out of bonds into stocks, and increased likelihood of interest rate hikes by the Federal Reserve Board. The Absolute Momentum Strategy has been short the bond markets for the past few months as we have seen the bond markets selling off. When looking at the 30 year bond chart we suspect that the run on the bond markets is not over. However, any debt ceiling compromise among the different factions within the Republican Party could very well roil both equity and bond markets.

US 30 Year Bond (2007- December 2016)

There is a general consensus that an infrastructure spending bill will pass Congress in 2017, leading to significant economic stimulus in 2018 and beyond. The US economy is more like a cruise liner than a speed boat in that it often stays on a path of strengthening or weakening for several months to a few years. This causes broader moves in interest rates that are spread over considerable time periods as opposed to very short periods. In the grain markets, we saw fund buying in early summer which drove prices in corn and soybean complex up 23% and 40%, respectively, in under just three months. We say the driver of these moves was fund buying because nothing of fundamental importance triggered these moves as we saw bumper crops here in the USA. We were at the farm conference (Wisconsin Technology Days) in July and the farmers to whom we spoke were ecstatic when prices were inflated. I hope they locked in those prices! (…and called our Ag Hedge division because those prices didn’t last long.) The Absolute Momentum Strategy participated in both markets and rode the market up and then turned around and sold the market as it came back down to earth.

Soybean chart

(Through DEC 15th)

Looking ahead, there is a good reason to be concerned that agricultural options might be underpriced. La Niña’s are associated with periods of exceptionally high realized volatility in corn, soy and wheat prices. This was the case during the most recent La Niña episode, which concluded in 2011, when soy and wheat implied volatility was around twice the current level, while implied volatility on corn occasionally spiked to around 1.5x its current level. There is little doubt that the world is headed into a La Niña. Central and East Central Pacific Ocean sea surface temperatures have already fallen from a peak of +2.3°C above normal in December 2015 to 0.7°C below normal by the end of September 2016 and they have almost certainly fallen further since. La Niña episodes, in general, have also correlated with lower prices for agricultural goods. Perhaps this shouldn’t come as too big of a surprise given that most markets tend to be more volatile on the way down than on the way up. What might save corn, soy and wheat this time is that their prices are already depressed owing, in part, to the strength of the U.S. dollar (USD). Should the U.S. currency continue to strengthen, which is a distinct possibility given potential consequences of President-elect Trump’s proposed fiscal stimulus, agricultural products prices may indeed have further to fall from a US dollar perspective. Sugar was a difficult market for the program to trade having been “whipsawed” quite a bit. We entered one Coffee trade, however it was a false breakout and exited soon after with a loss. Cotton was a “softs” strong market in 2016 with a series of nice trades in a market that supplied strong trends. The same holds true for “softs” sectors in 2017 in that La Niña will be a driving force in price volatility with a focus on South America where much of the soft markets are concentrated. La Niña is correlated with wetter-than-normal weather in Brazil and the Central Andes while leading to much drier-than-normal conditions in coastal Chile and Peru.

(Through DEC 15th)

Spring grain rally Subsequent correction

After a strong bear market in 2015 in both Natural Gas and Crude Oil, both found a floor in 2016. Not

much activity here. The few trades we did participate in were due to bounces off these lows. Much of

the year was spent in a rather tight trading range.

(Through DEC 15th)

Gold and Silver have slid from its post-election November 10thclose of $1261 and $18.82 respectively. As

of this morning as we write this letter, February Gold and March Silver are currently trading at $1164

and $16.02 down -7.6% and -14.8%, respectively, in a little over one month. It’s interesting that as these

moves have taken place, volume has consistently dropped. When you see a trending market have

decreasing volume behind it, it’s important to note that there is a real lack of credibility behind the

move. If we see a break in the stock market from their all time highs, precious metals could see strong

moves from these depressed levels. In the chart below, Gold made a big run up early in 2016 because of

uncertainty in Euro, driving safe haven buying. Copper has been really strong since the Trump election

mainly due to his rhetoric on building up the USA infrastructure. The Absolute Momentum

Strategy participated in this initial move in copper in mid-November and already booked some profit.

(Through DEC 15th)

The Absolute Momentum Strategy is finishing 2016 strong. One of the main reasons is because of the

strong US Dollar and weakening bond prices. The Absolute Momentum Strategy is primarily a medium

to long-term rule based trend following program, with a stock index day-trading overlay. It currently

looks for break-out trends in 21 different commodity markets, in six sectors of the economy and trades

in three different time frames. It has zero correlation to a traditional stock and bond portfolio and was

designed to act as a hedge against any substantial stock market correction.

Finally, Walsh Asset Management wishes you and yours a Happy Holidays and a prosperous New Year!

Warm Regards, Bill Reavis Walsh Asset Management breavis@walshtrading.com 619-672-8587 (office) 224-512-9613 (fax) An investment in futures contracts is speculative, involves a high degree of risk and is suitable only for persons who can assume the risk of loss in excess of their margin deposits. You should carefully consider whether futures trading is appropriate for you in light of your investment experience, trading objectives, financial resources, and other relevant circumstances. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.