Commodities as a Leading Stock Market Indicator Are Pointing Down

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 |  Includes: CRB, DBA
by: Brett Owens

Soon after stocks bottomed on March 6, 2009, we noticed that commodity prices - most notably agriculture prices - were starting to rally. In early May, we wrote about the rally in soft commodities, and what it implied for the inflation/deflation outlook:

A few weeks ago (April '09), we noticed that not only had commodities appeared to have formed a bottom, but they were starting to climb.

So which will it be, inflation or deflation? Don’t get too hung up in economic theory – remember that the markets are always right. And right now, the (commodity) markets appear to be casting an emphatic vote for inflation!

At the time, many of the softs were breaking out to the upside - sugar, cotton, soybeans, orange juice - so it appeared that worries about deflation were exactly that - just worries. And in retrospect, that proved to be the right call for the remainder of 2009.

Fast forward to January of this year - when commodity prices quietly topped - essentially issuing a somewhat muted warning that "all is not OK."

click to enlarge

Commodity CRB Index Price Chart 2010Commodity prices quiety topped BEFORE the blue chip indices in January 2010. (Source: StockCharts.com)

Also disconcerting was the fact that commodity prices rallied back to what Dennis Gartman refers to as "the box", and then stalled. The box - aka, Fibonacci retracement range - refers to the countertrend move you usually see in financial markets of 38-62%.

(There are various theories as to why this happens - empirically, though, it happens often enough that it's worth paying attention too. Especially if you play short or intermediate term moves.)

Now that commodities have turned down again, the logical move to expect would be a breach of previous lows. It appears this move has begun - and it is beginning to accelerate. Hat tip to fellow deflationist and friend Carson, who sent this along from Bloomberg:

The biggest slump in commodities since Lehman Brothers Holdings Inc. collapsed is undermining Wall Street forecasts for accelerating economic growth and higher prices for everything from copper to crude oil.

The Journal of Commerce Industrial Price Commodity Smoothed Price Index that tracks the growth rate of steel, cattle hides, tallow and burlap plunged 57 percent in May, two years after a decline that foreshadowed the worst recession in half a century. The index of 18 industrial materials declined the most since October 2008 as Europe’s debt crisis widened and China took steps to curb growth.

I love following the commodity futures markets, because I think they're usually very "smart"- they often lead the way. Right now though they appear to be leading us right back to the porcelain throne.

Ignore at your own peril. I find it tough to be worried about inflation, or bullish on equities, as long as commodities are in a general downtrend.

Disclosure: No positions