Can Commodities Decouple from Stocks?

The biggest investing mistake I ever made was not getting out of commodities during the Great Deleveraging of '08/'09.

I had a pretty good beat on the major trends - stocks were highly vulnerable, the US could be in for some very bad things, etc - but I failed to project the effect that a complete financial collapse would have on commodities. I followed my stops but kept trying to re-enter the market too early. Being on the wrong side of a trade, well, sucks.

In 2004, I read Hot Commodities by Jim Rogers, and my investing outlook and thesis completely changed. I realized that commodities, not stocks, were the place to be for the next 15-20 years. That spawned my foray into trading, and eventually this blog as well.

The fundamental factors of the commodity bull market are still intact, I believe. No market goes straight up - commodity markets are certainly no exception - and now we've got a very attractive entry point for many commodities. Prices have come down considerably, and as a result of this financial mess, supply has come offline a great deal, laying the ground work for a doozy of a boom, if/when the global economy picks up again.

Now here's the risk I see - during the Great Deleveraging, correlation of all assets basically went to one (exceptions were the US dollar and Treasuries). So any well laid out diversification plans were all in vain. In fact, I think we're starting to see that diversification is a load of crap, a product of the 1980's/1990's bull market in equities. Probably something we could discuss at length in a separate piece.

Van Tharp, an excellent trading coach and author, is fond of saying that you do not trade markets - you trade your beliefs in the markets. Every decision you make is filtered through your belief system.

So while I believe in the commodity bull market in the medium to long term - I also believe this is a bear market rally we're currently experiencing. I believe stocks are still overvalued, and that we haven'tyet seen the final lows on the S&P and the DOW. I believe the DOW/Gold ratio will eventually settle close to 1, before a new bull market in stocks begins.

Now these are my beliefs. You have your own beliefs about the market, and if they're not aligned with mine, then my trades and thinking won't make any sense to you. (Actually if I am making sense to you, that's when we should all be worried!)

OK so here's my dilemma - stocks are going lower I think - maybe sooner, maybe later. The last time stocks went lower, commodities got slammed. Therefore I have reason to be nervous that the next leg down in stocks could wallop commodities as well in the process.

To test this hypothesis, I'd like to pull up some charts, and see how some of our favorite investment ideas have been performing relative to the S&P 500 - and figure out which ones, if any, have managed to decouple from stocks. (All charts courtesy of Barchart.com.)

Observations:

• I had expected a tighter price correlation between oil and the S&P.
• The Aussie dollar looks like trouble! It could be quite vulnerable to a downturn in stocks.
• OJ looks like it may have decoupled from the S&P.

CONCLUSION: I think it's safe to get back in the water on some select commodities - but be careful! I still believe agriculture is our best bet, and right now I like OJ's chances the best...especially given its performance on crappy days for the S&P.

Disclosure: The author is long 1 Australian dollar futures contract and 1 FCOJ futures contract. Each Sunday, he updates his position on his commodities blog.

Comments

[User 233462:]

Another issue people should consider is the exchange rates if they live outside the US. A profitable trade in the DBC recently turned out to be a loser once the exchange back to Aussie dollars occurred.

For example if one bought 50 DBC at 19.00 on the 6th March and sold them on the 7th May for 21.65, that would have been a 2.65 profit per share (before commissions). But if the exchange from AUD to USD on 6th March and then USD to AUD on the 7th May, would have resulted in a $1.22 loss per trade in Australian dollars.

I want to know how those who live outside the US deal with this, because if commodities are rising, for the most part (and I know not all the time), the USD is falling, which means other currencies are rising in relation to the USD and thus commodities

May 19 12:36 AM

[inflate me:]

undoubtedly, we have/will experience been monetary problems, attempts at new currency, as well priceation questions for resources amongst the new flood of fiat. This bodes well for commodities. Id stick with the essentials food, water, oil. Such prices will be off the charts in a decade. Look into companies that produce these staples. Utilities, ag, and exploration. These plays can be boulstered by choosing a market in which the home country is unlikely to print ( avoid US, UK, Eurozone). Growth, dividend income, and appreciation of currency against the dollar can make for astounding gains.

May 19 03:30 PM

[buyforeclos...:]

Be careful on currencies..how many times has the dollar tanked only to make a huge recovery on.market downtrend? If you believe the market is going higher stay long on the can dollar and aussie dollar , the real and even the euro and pound...BUT of you think the market corrects big time then you should wait for that move and go long the dollar and short the pound and Euro/aussie/can dollar....

you can make big money both ways..dont get too comfortable with any currency. Oil should be heading under 50 after summer peak...could hit 65 near term...but that will be ressistance

May 20 03:36 PM

[japan20000:]

it is common knowledge that commodities have beta>1. If you believe stocks will go down, ask yourself why they go down and who buys commodities.

May 21 05:45 AM