Are Commodities Reversing or Consolidating?

It has been a dramatic week in the markets, with the long oil and short financials trade reversing hard and a number of the relationships that have been intact for the past nine months being thrown into disarray.

As I have been maintaining since early in the year, speculative money is likely to be flowing into either commodities or equities, but not both. That basic premise has not changed, but what has been called into question is whether the second half of 2008 will be more friendly to commodities or equities.

I believe the answer to the commodities or equities conundrum is that it is still too early to tell, but commodities still have to be considered the preferred asset class. Two charts below tell a good deal of the story. The first graphic is a weekly chart of the Reuters/Jefferies CRB index, which is heavily weighted toward energy. It shows that the recent pullback in commodities is consistent with previous pullbacks and consolidation periods. Neither the magnitude nor the duration of the recent reversal in the bullish commodities trend suggests that the bull market in commodities is winding down.

The second chart last appeared on this blog two months ago. It reflects the ratio of the commodities basket in the Rogers International Commodity Total Return Index (RJI) to the SPX. [RJI is an ETF linked to the Rogers International Commodities Index that has a broad weighting, with less emphasis on energy than most commodity indices] The ratio chart also shows much more of a consolidation ongoing in the present market environment than a reversal.

Of course, one more week of soaring financials and plummeting oil prices will dramatically change the tone of the chart, but for now at least, consider the commodities trend to still be intact (and susceptible to buying on the dips), which means the case for a reversal in equities is still a weak one at this stage of the game.

 

Comments

[Ames Tiedeman:]

This commodity pull back will be massive but short lived.

2008 Jul 19 01:09 PM

[Dame Daxx:]

Carter Worth of Oppenheimer (frequent guest on CNBC Fast Money) makes the point that Commodities is the only sector that has been working this year. If it falls, there is nothing to take its leadership place. The Financials? The Homebuilders? The Gramophone Manufacturers?

I think it's notable that Gold closed above $955 on Friday (which had been its resistance). Perhaps we will see a rotation within commodities from oil to gold, which could keep the CRB Index trend intact.

2008 Jul 19 02:04 PM

[investor88:]

Very informative article by Bill and useful comments by readers. This puts into some broad perspective the recent strange behaviour of commodities and equities. As Bill points out, the behaviour of commodities and equities in the week ahead will be critical in deciding if the theme of strong commodities/weak equities which worked for 1h 2008 will continue into 2h 2008. Looking forward to Bill's insightful analysis in the week(s) ahead.

2008 Jul 19 05:56 PM

[buyitcheap:]

I I'm in complete agreement with Ames - he's exactly right, a major pullback to the 370's and then a resumption of the uptrend. Recommend the AGA - inverse Ag ETF for the ride down with very tight stops.

2008 Jul 19 06:29 PM

[dieuwer:]

From the comments above I get the impression that all we care about is the ultra short term, < 1 year.
Is anyone at all investing for the long term, > 3 years? I own a few shares of RJI and buy when the stock gets hammered. Not planning to sell all until well after 2010. Likely when DOW/GOLD is back to 1.

2008 Jul 19 08:41 PM

[dieuwer:]

I just made a chart of the ratio of the CRB to the S&P500 and a chart of the ratio of the CRB to gold.
Total surprise! Against the S&P500, the CRB trades at the lowest levels in more than 10 years!!! Against gold, it trades at the lowest level in more than 20 years!!!

Commodities are in a total anti-bubble...

2008 Jul 19 08:51 PM

[ICouldBeWrong:]

Sorry but the CRB chart given in the article going back to 2004 looks like nonsense to me. The formula used to compute the CRB changed in July 2005. See here www.zealllc.com/2008/c.... I would recommend using the CCI for long term charts instead.

This is similar to the VIX/VXO issue I mentioned in my last post. This is basic stuff guys, don't you care about the money you manage? Please at least know how your indexes are computed!

dieuwer: I agree with you that Dow/Gold ratio is likely to return to 1. But the way I compute it the CRB:SPX ratio is at a two week low not a 10 year low, maybe you need to check your chart. (And as I just said for charts more than 3 years old you should use the CCI not the CRB).

Personally I'm very bearish on equities, and have turned bearish/neutral on commodities in the medium (2 year) term. I own some commodities for the long term but are expecting to lose money on them in the next 2 years.

I believe we are beginning to see substantial demand destruction in energy. Global stock markets have been going down now for about 12 months, that should be long enough to start to flow through into reduced demand for commodities.

Long Yen. Short Equities.

2008 Jul 20 02:47 AM

[CLH:]

I dont know if this is the time for the reversal. However, stocks that are over priced (commodities) will go down and financials will go up. Always buy what is cheap and sell what is is expensive. Common sense.

The timing is the important factor, but investors can forget and buy for the long term.

2008 Jul 20 07:56 AM

[Blue collar...:]

For a number of reasons, there are probably more than a few of us out here in the vast universe of stock market investors who limit there main interest in what happens market wise to one year or less. For example, a person nearing the end of their life who has not managed to provide a big enough lay away plan for his or her successors. And.....Las Vegas odds while very much the same in principle are somewhat less than those of the stock markets.

2008 Jul 20 02:31 PM

[Brahm:]

What is known as commodities is too broad a classification, especially as it includes territory such as chemicals (which should be its own sector since it is somewhat significantly different from the metals as far as pattern of uses is concerned). With regard to the metals --such as steel, copper, aluminum -- I expect some (not too much) softening in the next six month or year period. The major reason for this can be indicated by one word: "China". The Olympics which involved a lot of heavy construction/reconstru... development is essentially over. China also is a heavily export influenced economy. The slowing we will be seeing in the US and Europe will affect China's exports moderately. Hence China's economy will cool somewhat till its export engine recovers fully again. This will probably constrain China's internal development and its investment rate moderately. In conclusion, I expect some softening of metal commodity demand and prices in the next six months or year. Perhaps, there will be some pressure on oil prices as well because of the cooling of the growth rate of the global economy by 1 to 2%.

2008 Jul 20 03:52 PM

[Kunst:]

dieuwaer: "Is anyone at all investing for the long term, > 3 years?"

Sure. Tell me what's going to be a good 3-year investment and I'll buy it 2 years from now.

Is this a moral issue or something? It's OK to look for profit long-term but not short-term? Do you know what the world is going to be like in 3 years? How about that 8-year zero return on the Dow?

2008 Jul 20 04:54 PM

[dieuwer:]

It's a tax issue, K.

2008 Jul 20 09:38 PM

[Kunst:]

Well, hold it for a year or hold it for 3 years, it's long-term capital gains. Personally, almost all my money is in retirement accounts, so I don't worry about taxes on a trade-by-trade basis.

2008 Jul 21 02:14 AM