Overbought Oil Doesn't Mean Excessive Commodity Speculation

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 |  Includes: DBO, GLD, IAU, OIL, SLV, SPY, USO, XLE
by: Cam Hui, CFA

As oil prices topped $130 and later $135 there was a cacophony of calls from market commentators that the parabolic rise in crude signaled a top in commodity prices and that this is a commodity bubble that would end badly soon.

Oil and Energy stocks overbought

The chart below shows the log price graph of crude oil futures. Prices moved to the top of the rising channel line, from which it has corrected in the past. So a pullback in oil prices in the next month or two would not be a surprise.

The relative return of Energy stocks tells a similar story. The chart below shows the returns of the Energy Select SPDR (NYSEARCA:XLE) compared to the S&P 500. The XLE moved to the top of the relative trendline against the S&P 500 and appears to be overbought. I would expect a near-term pullback but the relative uptrend would remain intact.


No sign of excessive speculation in resource stocks longer term
 
At the top of every mania, the junk starts to fly. Stupid deals get done. People start talking at parties about how they made a killing in this mining junior or that penny stock. Even here in Vancouver, one of the resource penny stock capitals of the world, there is no sign of that speculation.

The chart below shows the relative returns of the small cap speculative TSX Venture Index compared to the large cap S&P/TSX Index. Small caps have been underperforming large caps since the end of 2006. This is excessive speculation???

No sign of excessive speculation in gold stocks

If we were to look at the pure gold stocks, it appears that we are still early in the move. The chart below shows the relative returns of the equal weighted CBOE Gold Index [GOX], which gives bigger weight to smaller gold stocks, compared to the capitalization weighted PHLX Gold & Silver Index [XAU], which is more large cap oriented. After drastically underperforming the large cap gold stocks, small cap golds only caught up in mid-2006 and it wasn’t until October 2007 that they definitively began to outperform the bigger stocks.

Putting my technician’s hat on, this is a classic cup and handle formation. The breakout in October 2007 would yield a relative return target of roughly 70-80% outperformance of the GOX against the XAU. This suggests that small cap golds have much further to go against their large cap senior brethrens – indicating that this bull move in gold (and commodities) is nowhere close to being over.