Commodities Soar - But Volatility Works Both Ways

There is a dichotomy occurring today. Gold is at record highs. Stocks are jumping. And bonds -- well, today's Treasury auction was oversubscribed.

If this does not have you scratching your head, it should. Because on the surface it does not much sense. So let’s break today's events down.

Gold traded as high as $1.045 per ounce, a new record. Speculators put new money into the metal after two events weakened the U.S. dollar further.

First, Australia unexpectedly raised interest rates by 25 basis points. The Reserve Bank of Australia opined, "It is now prudent to begin gradually lessening the stimulus provided by monetary policy."

Second, a rumor spread about secret talks between Russia, China, Japan, France and Gulf States to replace the dollar as the chief currency for oil. These talks were flatly denied, but the rumor is still having an impact.

Stocks are jumping because of both the rally in commodities and optimism about the economic recovery. Several other metals, in addition to gold, are rising. So is oil. The Australian rate action has some traders betting on a stronger-than-thought global recovery.

Some of the gains might also be attributable the covering of short positions initiated last week.

Treasury bonds are off slightly, but there were a lot of buyers at today's auction. The bid-to-cover ratio, which compares the number of bids to the number of available bonds, was 2.76. This was higher than what we've been seeing over the past several auctions and signals that demand for Treasuries remains strong.

It's pretty easy to draw a correlation between the dollar, gold and stocks. However, if the outlook for the future is so bright, then why did investors compete with each other for the right to lock up their money for 3 years at a yield of 1.445%? (That is what the Treasury notes sold at in today's auction.)

Clearly, not every investor believes the recovery will be V-shaped.

Today is purely a trading rally ahead of the "official" start of third-quarter earnings season. (Alcoa (AA) reports tomorrow.) We will need a good reaction to profit reports to sustain this rally.

As far what your own portfolio, pay attention to trends in earnings estimates. Several analysts have recently cut their 2009 and 2010 forecasts on Barrick Gold (ABX). Conversely, estimates are rising on some cyclical stocks, such as DuPont (DD). Even Caterpillar (CAT) is seeing upward revisions, though changes have not been enough to move Zacks Consensus Estimates higher.

But since the economic recovery will be slow, also keep an allocation to more conservative holdings. For example, food companies such as General Mills (GIS) and ConAgra Foods (CAG) are also seeing rising earnings estimates. Some large drug stocks are also trading at cheap valuations.

Volatility works both ways, and today it is helping stocks. However, this is just one day, and the movement should not sway your opinion any more than last week's activity did.

Comments

[richjoy403:]

Good article, professional, takes a balanced view.

Agreed, it will take good earnings reports to keep the market moving (mostly) higher. I do suspect/hope we may get enough favorable surprises to confirm the upward bias...but if not, look out below!

OTOH, foreign developed and emerging markets, plus commodities, may continue to attract net buyers even if the USA markets take a breather for a few weeks.

Oct 06 04:54 PM

[Living4Divi...:]

It does make sense. Investors are moving out of cash and into risk assets.

Oct 06 05:24 PM

[Wildebeest:]

"The Australian rate action has some traders betting on a stronger-than-thought global recovery."

That would be a bad bet. Australia is atypical. Prior to the crash it had run budget surpluses for a decade. When things looked like going from bad to worse globally earlier this year, China started stockpiling minerals and metals, big beneficiary: Australia through large exports of iron ore and coal. Also its housing bubble never burst and all government efforts, both federal and state, have focused on keeping the bubble inflated (Australian state governments receive a large amount of tax from house sale). transactions).

Oct 06 05:55 PM

[bottoms-up:]

So does a double-edged razor when you go to slit your wrist if you buy into this hyped market.

Oct 06 05:57 PM

[bottoms-up:]

Really now...

Do you think they'll let things get out of control again?

The Fed is buying up paper left and right to prop prices up and equities is no exception.

They'll print $10 trillion before they would ever let the Dow fall to 9,000


On Oct 06 04:54 PM richjoy403 wrote:

> Good article, professional, takes a balanced view.
>
> Agreed, it will take good earnings reports to keep the market moving
> (mostly) higher. I do suspect/hope we may get enough favorable surprises
> to confirm the upward bias...but if not, look out below!
>
> OTOH, foreign developed and emerging markets, plus commodities, may
> continue to attract net buyers even if the USA markets take a breather
> for a few weeks.

Oct 06 05:59 PM

[ebworthen:]

Is it just me, or does this whole picture not look like a bad reproduction of an M.C. Escher print with a little Salvador Dali and melting clocks thrown in?

Oct 06 07:52 PM

[Chaser12:]

Sitting and watching others make easy money is a difficult pill to swallow. I think we still have some upward movement yet but safe buys and cash on the side for a possible mini crash when the Govt starts withdrawing support ( if it ever does ) or for whatever "reason" would be prudent at this point.

Oct 06 09:53 PM

[TonyNed:]

The US dollar's momentum made a downward turn two days ago and it looks like we're going to make some new 52 week lows in the next several sessions. This should keep propping this market up. The commodities stocks bottomed on the technical indicators just as the dollar topped on its technical indicators. Some of those stocks however have broken their uptrends which makes me a little bit nervous.

Oct 06 10:11 PM

[Bill S. Friend:]

Not another commodity guy scratching his head.

Oct 06 11:10 PM

[Moon Kil Woong:]

The only thing that seems strange is the demand for US Treasuries. Well until the Fed stops buying their own auctions it will be hard to determine real demand there. Even so we see the dollar still weakening.

As far as I can tell people are increasingly moving towards the buy anything camp in light of collapsing dollar. I know someone that just bought 1,000 boxes of magic cards in exchange for US$. Apparently they have more faith in them than greenbacks. That's just sad. Across the board I am seeing asset prices go up for anything that may have the slightest whiff of appreciating as the dollar falls. Thank goodness it's not just collector comics, cards, and antiques. The odds of increased demand in these things will create enough jobs to dig us out of the recession are 0%.

Oct 07 02:55 AM

[Michael Clark:]

"Night cycle' phenomena. Necessary madness is a basic condition of the Night-Cycle. Escher, Dali, definitely.


On Oct 06 07:52 PM ebworthen wrote:

> Is it just me, or does this whole picture not look like a bad reproduction
> of an M.C. Escher print with a little Salvador Dali and melting clocks
> thrown in?

Oct 07 03:03 AM

[Michael Clark:]

Yes, until Bernanke stops gobbling up every unaccounted for TBond and TBill we won't really know about demand. His aim is to keep interest rates down for as long as he can. Maybe he wants to try to do this through 2011, to minimize mortgage resets tragedy. I'm not sure. We'll know he's backed off when yields go up on long-term bonds -- this is what he DOES NOT WANT to happen.

Until then, gold should soar.

There is a chance, if foreign buying of TBonds does not come back after yields rise, that TBonds may become junk, with very high yields. Then we're really in deep water.

What do high yields on Treasury Bonds do for the price of the Dollar? You would think the dollar would rise. But if no one wants TBonds because of a fear of US Government insolvency or even default, then who is going to want to own dollars? And if the global economy does not recover, who is going to want to own oil and copper and heavy materials...? Gold, again, becomes the winner in this scenario Gold wins when uncertainty wins. And we are in a VERY BIG period of uncertainty.


On Oct 07 02:55 AM Moon Kil Woong wrote:

> The only thing that seems strange is the demand for US Treasuries.
> Well until the Fed stops buying their own auctions it will be hard
> to determine real demand there. Even so we see the dollar still weakening.
>
>
> As far as I can tell people are increasingly moving towards the buy
> anything camp in light of collapsing dollar. I know someone that
> just bought 1,000 boxes of magic cards in exchange for US$. Apparently
> they have more faith in them than greenbacks. That's just sad. Across
> the board I am seeing asset prices go up for anything that may have
> the slightest whiff of appreciating as the dollar falls. Thank goodness
> it's not just collector comics, cards, and antiques. The odds of
> increased demand in these things will create enough jobs to dig us
> out of the recession are 0%.

Oct 07 03:09 AM