Has the tumble in commodity prices over the last 6 weeks signaled the end of the "reflation", "inflation", "green shoots" trade? Evidence suggests not. While the CRB CCI index has fallen by a respectable 9% over the last 6 weeks it still remains above "support" and has yet to violate the essence of an up-trend, that is, higher highs and higher lows. In fact on a 6 month rate of change basis it is still positive (+7%), which indicates the primary bull trend is still intact. We like to use the CCI instead of the CRB index because the CCI is an equally weighted index of 17 liquid commodities where each commodity "sector" has about a 20% weighting. It gives more of an indication as to what commodities are doing in general than the CRB which has a heavy weighting to energy (40%) as with most other commodity indices.
We can find little evidence of genuine bearish activity in individual commodity counters. We look far and wide and outside of the traditional commodities tracked by the CRB......from greasy wool in Sydney, to rubber in Thailand, to lumber in the US. The only bearish activity remains in Natural Gas and Livestock (although evidence suggests that bear trends in these commodities is nearing an end).
Commodity prices advance for essentially two reasons "growth" and "inflation". Let us look at what other markets are suggesting with respect to growth and inflation. There are many ways of analyzing world economic growth. The best leading indicator of world growth expectations that we have found is the performance of emerging market small caps relative to world equity markets. We suspect this is because small cap equities are the most sensitive stocks to growth from a global perspective. Emerging market small cap stocks continue to outperform world large caps and it appears that this trend is not under threat. This behavior should be supportive of higher commodity prices.
Regarding inflation, let us take a quick look at what the bond market is telling us. If one expects inflation to hit and you can only invest in government bonds then you would certainly want to hold inflation protected bonds. The graph below depicts the performance of inflation protected non US government bonds relative to unprotected non US government bonds. The trend is clear with "little" to suggest that this outperformance is about to fail. This is also very supportive of higher commodity prices.
While the up trends in the two charts above hold (equities and bonds) we continue to expect higher commodity prices. The weakness in commodity prices as of late is probably no more than a consolidation of the up trend that began in March (what sane trader wasn't expecting a pull back in crude after it went from $35 - $72 in 4 months). With this in mind why not consider a contrarian commodity trade. There is of course natural gas but there is also something else. Take a closer look at livestock. There is an ETF that tracks hogs and cattle (COW) and it has been advancing over the last 4 weeks when the broad commodity group has fallen significantly and it continues to escape the attention of the crowd.
