With central banks easing and global manufacturing improving, how could the commodities not do well? Intermarket analysis shows us that commodities are the last to turn in a cycle and they appear to be at bullish inflection point now. With the S&P 500 up 26% from the October lows, commodities are a little late to the party, but better late than never. That said, it isn’t just commodities that are improving. Commodity producers appear to be bottoming, with precious metal and oil names leading the pack. A picture is worth a 1,000 words. And so, this market observation will do a lot of charting to show you, the reader, that downtrends are ending, bottoms are forming, and uptrends are beginning.
John Murphy has done a lot for technical analysis. One of the subjects he wrote a book on is Intermarket Technical Analysis. At www.stockcharts.com, he writes the definition:
“Intermarket Technical Analysis is the study of the relationships between the four major financial markets: Stocks, Bonds, Commodities and Currencies. There are several key relationships that bind these four markets together. These relationships are:
- The INVERSE relationship between commodities and bonds
- The INVERSE relationship between bonds and stocks
- The POSITIVE relationship between stocks and commodities
POSITIVE: When one goes up, the other goes up also.
- The INVERSE relationship between the US Dollar and commodities
INVERSE: When one goes up, the other goes down.”
I’m not going to get too involved with the subject of intermarket analysis, but suffice it to say, I think a lot of it is explained by the interest rate cycle. Rates go down as a central bank becomes accommodative during weak economic conditions. This causes bond values to go up. The currency falls due to interest rate differentials (i.e. the Fed lowers interest rates but the ECB holds rates causing strength in the euro). As the currency falls, goods become attractively valued and manufacturing picks up despite heavy slack. As manufacturing picks up, the LEIs improve and the equity market turns bullish. As the slack in manufacturing is removed, commodity pricing pressure arises. Finally, central banks remove accommodation and begin raising interest rates to control price inflation until something breaks. Bond values drop as rates rise, just as the currency rises due to better interest rate differentials; thus making goods less attractive overseas. The economy slows down and stocks roll over. The slack begins anew in manufacturing and commodity prices follow stocks lower. That’s intermarket analysis in a nutshell.
Martin Pring, https://pring.com/articles/article8.htm
So looking at the cycle, central banks began to apply accommodative policies in August of 2011. Once that happened, we began to see the LEIs improve for the U.S. in September of that same year. The stock market bottomed in October along with commodities, which retested those lows in December, while equities continued to climb. Commodities have lagged equities, but things look poised to change.
Now that we’ve identified how asset cycles come about as well as why, let’s look at the what. Turning to commodities, the benchmark we follow to gauge the health of commodities is the Thomson Reuters/Jeffries CRB Index. It’s been around for more than 50 years and it’s constructed with 28 commodity components. Since the leading economic indicators (LEIs) rolled over late Spring of 2011 as Japanese manufacturing came offline, in addition to the end of Quantitative easing 2.0, the CRB Index has been in decline. However, with the LEIs rising again and central banks on the easing warpath, the CRB appears to be bottoming.
In December, I talked about a possible bottom in the CRB index with the divergences in momentum at October support. Bottoms don’t make uptrends. There are a few more missing pieces to the puzzle. They are the following:
- Price above all moving averages
- Currently above the 50 DMA and the 150 DMA
- Yet to rise above the 200 DMA (currently 324.40)
- Flat moving averages turning up
- So far the 50 DMA is the first to do so.
- Higher highs and higher lows
- The last peak in the CRB was October 28th at 324.99
- Price needs to confirm a new uptrend by breaking that resistance
The probability of achieving the goals marked above is very high. All of the fundamental factors are lining up with rising LEIs (5 consecutive months of improving data) and accommodative monetary policy. Just look at some of the policy moves in the month of February:
- Bank of England increases purchase program
- Bank of Japan increases purchase program 55-65 trillion Yen
- Federal Reserve maintains ZIRP through the end of 2014
- People’s Bank of China lowering reserve requirements late Friday releasing about 400B yuan from the banking system and this probably isn’t the last cut. This was the second cut since the first one in December last year
- Next week the ECB releases the results of the LTRO program, its second of two, 3-year loans at 1%. It’s expected we’ll see demand around 492 billion euros. That will increase the ECB’s balance sheet.
With all those accommodative policies, gold should be off to the races - and it is. Gold bottomed in December along with the CRB index with support levels that held, 67 and 292 respectively. Gold’s long-term moving averages remained in an uptrend throughout the September through December correction. Traders and analysts were calling it the end of the bull market in gold. Far from it, gold is back, trading above all three major moving averages and it is looking to test the November peak near ,813. There is a supply zone between 13 and 70, but I don’t think we’ll be in the area for that very long. Short-term, gold broke out of a quick consolidation under 1770 this week and remains in an intermediate uptrend since bottoming late December.
Improvement in the price of gold bodes well for miners. The Market Vectors Gold Miners index (GDX) has been in a secular trading range for all of 2011 and year to date in 2012. Obviously, they’re being traded out of portfolios at and back in at . Recent developments show a series of higher highs and highs lows since December over the intermediate-term. Moving averages are flat as expected – there’s no trend. We’re currently testing the February 2nd high at .94 – right smack at the 150-day moving average. Momentum has improved holding above a 14-day RSI value of 40 at support. The next step is to see some overbought readings above 60 and hopefully well into the 70s – signaling a change of pace since the September decline. A positive note for the miners: today marks a breakout from the September downtrend.
I talked about copper having a possible double-bottom in October, with an Elliot Wave pattern that appeared completed at the time. Copper doesn’t quite have the bullish conditions we see in gold at this time. There are a few factors we’re still left wanting in the chart, mainly rising moving averages and a broken secular downtrend that began in February last year. Recent copper inventory and import data (copper imports fell for the first time in 8 months – down 18% in January) from China isn’t encouraging either; but nevertheless, as commodities prices rise due to improving manufacturing conditions, copper should go up.
With natural gas prices as depressed as they are, due to incredible levels of production coming out of the U.S. and warm weather during the winter, it offers an opportunity for growing margins in gas utilities as well as fertilizers. More commodity-oriented farmers and analysts could do a better job telling you why food commodity prices continue to decline than I could; however, if you take a look at the Market Vectors-Agribusiness (MOO), which is an ETF that hold a number of agricultural businesses, conditions are definitely improving in the chart. For starters, we have a higher low in December. The moving averages are flattening and price is trading above all major moving averages. There’s also a setup for a head & shoulder bottom with the higher low in December. We’re attempting to break out of that technical pattern now, but price has stalled (short-term warning) at the secular downtrend that began early last year (red line). A golden cross—when the 50-day intermediate moving average crosses above the 200-day long-term moving average—looks inevitable as well.
The last commodity I wanted to focus on is oil. Crude oil bottomed in October and broke its April downtrend. This week, WTI crude broke out above its 3 resistance, which has held it back since May. Price is trading above all moving averages. MACD is positive and turning up. There’s a large H&S bottom pattern in crude that has completed. The target price of the pattern is 8.50, just to put that out there.
Relatively speaking, the energy equity sector is improving performance versus the S&P 500 since early February. Many of the equity ETFs have staged major breakouts in the past week or two. There would be too many charts to shares if I showed you all the industry groups. Production, exploration, and service all show excellent strength here. The two laggards in the energy complex are natural gas and coal. Natural gas prices have plummeted in the U.S. due to over production and warm weather during the winter. With coal as the substitute to natural gas in power generation, coal prices have also fallen as power generation shifts to natural gas. Coal stocks have been basing since October and there has been no sign of an uptrend.
Conclusion
The business cycle suggests that commodities are the last asset class to rise as conditions improve. Monetary policy across the globe is easing with major policy changes in February that are inflationary in nature. Commodities have rallied since December, but many are facing secular downtrends or breaking out above them at this point.
Overall, I am most bullish energy with a breakout in oil and a breakout in oil stocks over the past two weeks. Relative performance versus the S&P 500 shows a steady increase over the past three weeks. Gold looks good too; however, gold miners continue to be in a secular trading range and should be treated as tradable positions until otherwise.
There are two caveats here, however, on oil: 1) There’s obviously speculation of a war with Iran causing a premium to creep into the price of crude. I don’t think it’s a major component of the current 8 WTIC price but it’s a portion of it to be sure. 2) As Jim Puplava has stated many times on Financial Sense Newshour, inflation is the new federal funds rate. As the price of oil, food, and goods rise, there comes an inflection point where costs become too prohibitive. Was 6 really the ceiling for oil in our economy last year, or did Japan’s tsunami and regulatory steps by the CFTC to curb speculation cause oil to top early? Recall that commodity prices peaked before equities in 2011 – not typically the case as in 2008.
So far we don’t have Mother Nature to cap the economy in 2012 so the price at which the economy rolls over due to prohibitively high inflation costs is unknown. Analysts will be talking about triple digit oil for some time, but don’t forget how depressed natural gas and coal prices are. Those two are helping to offset rising crude costs on the economy. You can’t have an equation where you ignore variables. Natural gas has fallen 100% from a year ago and remains depressed with no signs of a reversal yet with falling moving averages. So always try to get the whole energy story down first before you swan about rising crude prices.
On that note, notice the drop in the Dow Jones Transports Index? If there’s a fly in the bullish ointment and some truth to the price of oil and gas becoming prohibitive, it’d be seen in the transports. Additionally, the new highs in the S&P 500, the Dow Jones Industrials, and the Nasdaq composite so far are not being affirmed by new highs in the transports. In fact, the Tran has dipped below the 50-day moving average, typically an intermediate sell-signal, but today it closed right back above it. A touch-n-go would be the best scenario here. Union Pacific (UNP) is 11% of the index and it rallied off of the 50-day moving average a few days ago. Today saw some dip buying. One more trip below the 50-day moving average and it could likely take out support at 9.31. This is definitely not a development the bulls should want to see, but it could just be an intermediate hiccup to the October advance. The transports are in an uptrend and this may only be some much-needed consolidation, but it is something that should be watched closely in the week(s) ahead.
