The Bear Reaches Out for Commodities

After mauling almost every other asset class, industry, and sector, the bear is now stretching out its paws for a swig of crude oil; crude oil is now down 19.9% from its high just last month. "Everyone" eagerly awaits the official pronouncement so that we can declare that justice has been served for all the pain high oil prices have caused us.

It is interesting how we look for buying opportunities and bottoms after 20% declines in the stock market, but for oil and other commodities, we just look for lower and lower prices. Call it the curse of the high prices no one wants. There may be a just a touch of irony in the rapid correction in oil prices just as the U.S. presidential candidates are calling high oil prices America's biggest crisis. Meanwhile, our national debt refuses to undergo its own correction and just goes ever higher.

Now, of course, high commodity prices are part of the problem. For example, Boone Pickens claims that the U.S. will send $700B overseas to pay for oil this year and perhaps as much as $10 trillion over the next 10 years. Americans are borrowing to pay a good portion of that bill using depreciating dollars. These loans are increasingly imported from overseas. Unfortunately, it seems the savings from commodity deflation are being earmarked for more consumption - at least this is the stated hope of those pundits looking for a quick turn-around in U.S. economic growth. All this to say that I recommend checking out an independent film called I.O.U.S.A.: "One Nation. Under Stress. In Debt."...
 

(Thanks to Trader Mike for pointing this one out to me!)

 

Yes, that was a naked plug and segue, but I feel that America's growing indebtedness simply does not get enough attention even though its malignant growth is intertwined with the commodity story.

Anyway, back to the commodities themselves. The past few missives, I have included a few notes about the sell-off in commodities but never posted any charts, including one missive where I talked about the accumulation of shorts in the USO just as oil was peaking. I finally want to spend a little time on the commodity-related stocks that I often track. The July 2nd sell-off in so many commodity stocks was dramatic, but I am finding the fades after earnings to be even more telling...especially after the CEOs of these companies insist that the commodity bull remains healthy and strong and global growth is as robust as ever.

By now, you all have heard that July was the 2nd worst month on record for the CRB Commodities index. But it is all too easy to forget that this tremendous drop came immediately on the heels of the best first 6 months of a year for this very same index since 1973! So, all we might have is an extremely volatile basket of goods and not a dramatic correction underway. Time will tell.

I have become accustomed to hearing calls for the end to the commodity bull throughout the last several years or so. Each time, the planet has decided it still cannot get enough. These latest huge moves mean "something," but we likely will not know what that something is until we get the benefit of hindsight. I personally am watching for signs that the global growth story is unwinding (all those international companies who proudly announce that their U.S. business holds an insignificant share may come to regret their global over-weighting by next year!?!).

Let's take a look at Bucyrus (BUCY), Arch Coal (ACI), U.S. Steel (X), and Dryships (DRYS).

Earnings call quotes from BUCY on July 25th (from Seeking Alpha):

High demand for our products and services continues to be driven by high international commodity prices and strong markets for commodities that are mined by our machines, including coal, copper, iron ore and oil sands.

Market indications have not abated it whatsoever. I think you see some of the things that have kind of created some noise in the marketplace here in our industry in the last couple of weeks. But there has been absolutely nothing to slow down the pace of activity that we have got in the marketplace right now.

The market got religion again on BUCY after comments like that, sending the stock up 15% that earnings report. BUCY gained a full 28% before giving it all back, and then some, and now sits right back where it started before earnings. I bought in yesterday on the expectation that if commodities do recover soon, BUCY will relaunch.

(Color code for text on all charts: red for a "bad sign", yellow for "caution", green for a "good sign")

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Earnings call quotes from ACI on July 25, 2008 (from Seeking Alpha):

[W]e would argue the fundamentals have gotten stronger as we've seen it from a supply demand basis over the last three weeks, the last quarter from a quarter ago and then which you might see in just the trading in the couple of financial coal market.

Just as in BUCY's case, the market got religion and sent ACI hurtling back upward, but unlike BUCY the stock price never even touched the July 2nd correction levels. ACI essentially confirmed a short-term downtrend. ACI is now 10% below its pre-earnings price, well-below the 2006 highs again (around $56/share), and it is flat overall for the year. For you technicians, the pullback from the earnings pop confirmed a very bearish-looking head & shoulders top. All very ominous.

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Earnings call quotes from NUE on July 17, 2008(from Seeking Alpha):

...[W]e've obviously seen a record price increases in steel as I've said and we don't have the ability to cover our backlogs with the inventory. So we're always trying in these times just like in 2004. We're certainly attempting to very aggressively get our prices up because we know the higher steel prices are going to flow to us, that's number one.

 

..If stock is down as much as you [say it is], I would argue...there is an excellent buying opportunity.

 

..the direction of pricing is not flat, it's not down, it's up. And with the global demand for our products, the way it's been and the lack of imports, we are just in that direct, as I said before many times, we are in a direct opposite condition we were in 1999 and 2000, where we had great demand and lousy profits, because the world was flooding our shores with excess steel. Today, we have just the opposite of that. And demand is good globally; raw material prices as a result have gone up. And we have been able to have pricing power and we see that continuing into the third quarter...

NUE dropped 11% after its earnings and has not recovered since. It is now down for the year again and back to 2006 prices. The stock price was hurt by a dilutive stock offering at $74 that sure looks very shrewd on NUE's part. During the conference call, several analysts practically begged NUE to buyback stock since a buyback must offer a much better return on cash than any other investment or acquisition NUE could do.

I imagine the stock will continue to experience strong overhang until the company makes a move with all that cash on its books. I show the long-term monthly chart below to emphasize that NUE's two years of churn follow a tremendous four-year run. This run was a break-out from nine years of doing almost nothing. A break of 2006 and 2007 lows may initiate another extended period of non-performance. If those lows hold, I want to put NUE at the top of my shopping list of commodity-related stocks.

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U.S. Steel (X) also faded hard after a nice post-earnings return (14%). It has now twice made inroads into the July 2nd sell-off and failed. If support from the past two days can hold, X might get on the buy list. However, X will not return to a bullish position until it conquers overhead resistance at $170.

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The price index for dry bulk shipping has been plummeting over the past month. Folks can quickly point to this as a sign that the global economy is grinding to a halt. However, during this time, the stock prices of these shippers has been idling. This week, those stocks have finally started to fall out of their comfortable, low-volume, "congestion" areas. Before this week, it was looking like the decline in shipping rates had already been priced into the stocks. Follow-through on the selling could be a true warning signal for the robustness of global trade. I show the chart of Dryships (DRYS) as an example of what is happening. Charts of Excel Maritime Carriers (EXM) and TBS International (TBSI) look similar although recent selling has been even more pronounced for these two.

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These are just a few examples of many that demonstrate the recent break-down in commodity-related stocks. I did not even include any examples from the agriculture complex or commodity-related infrastructure companies. In many cases, long-term uptrends remain intact and overall, bear or no bear, it seems too early (again) to call an end to the commodity boom.

Full disclosure: Long BUCY. For other disclaimers click here.

 

Comments

[Urbane Gori...:]

Well! I'm convinced... Sure would be nice to have an end to being stopped out all the time though!

Actually, I think we have to wait for September to see any revival of the commodities play. And after being whipped like slave and watching the market churn... I suspect that we'll be seeing more of what we've seen the last few weeks. Flip a coin daily! Banks or energy.

jegan ;-)

2008 Aug 06 12:48 PM

[CLH:]

John you have a long wait. The last commodity spike was in the early 1970s. The next one? Maybe 25 years. Smile

2008 Aug 06 01:26 PM

[Dux:]

Commodities are not a fad. They are the stuff that growth is made of. When everyone in China, India and other emerging economies has the same standard of living as the U.S, Europe and the rest of the world's fatcats, or the Earth spins out of orbit, the demand for commodities will continue to grow. Until then we will endure cycles of profit-taking, bargain-shopping, and silly panic until the "experts" lift their noses off the charts and look at the big picture.

2008 Aug 06 02:16 PM

[Tom Szabo:]

Everyone in China, India and other emerging economies will never have the current standard of living as the U.S, etc. The numbers simply make it impossible. Perhaps OECD living standards will decline and meet the emerging economy standards in the middle sometime in the distant future. No matter, the commodity cycle will continue to exist and it isn't based on "profit-taking, bargain-shopping, and silly panic" but rather on the very real business cycle that impacts supply and demand. Simply put, we may have entered that part of the commodity cycle where supply balances or exceeds demand. This is a temporary condition, a small cycle within a larger cycle if you will.

That larger cycle is what's really important and often gets missed. Probably because it is so large, spanning centuries as it does. I'm not talking about Elliott Waves, Kondriateff theory or anything like that. Rather, what I'm talking about is a mega-shift in the entire global system where commodity prices are in the midst of reversing their centuries long decline (driven by technological improvements that increased yield, access and efficiency) and starting a climb that may last centuries as well. If not centuries, at least until nanotechnology or some science we haven't event dreamed of will allow humankind to cheaply manipulate matter at the elemental level and thus create unlimited supplies of just about any material.

2008 Aug 06 03:02 PM

[stvcomment:]

Dux said it. Those Chinese and Indians and South Americans and Mexicans and so on and so forth are all going to want the same things we have. How will they be made and how will they run after there made.
Pickens said we need bridges to gap the switch from fossil fuels to solar and wind and God knows what. Well those bridges will be needed for a good 10 more years, at least.

2008 Aug 06 03:06 PM

[Think-About-It:]

Silveraxis,

Cool thinking. "Centuries," didn't you know that the Seeking Alpha thinking horizon is "days"?

Why can't China's standard of living equal or pass ours (U.S.)? Hope your answer is not that 'their population is to large' because that is not a prohibitor.

2008 Aug 06 03:26 PM

[phdinsuntan...:]

short bucy rigth now and join the party

2008 Aug 06 04:11 PM

[Dux:]

What business cycle, silveraxis? From where I'm looking, the U.S. isn't pulling the train like it used to.

2008 Aug 06 04:45 PM

[ca8906:]

The author states "Boone Pickens claims that the U.S. will send $700B overseas to pay for oil this year and perhaps as much as $10 trillion over the next 10 years. Americans are borrowing to pay a good portion of that bill using depreciating dollars. These loans are increasingly imported from overseas."

The US government is not spending this money. The oil companies are buying crude, refining it and selling it to Americans. It is wrong to imply the national debt is related to oil prices. Congress is responsible for the debt and never held accountable.

2008 Aug 06 10:20 PM

[Dr. Duru:]

I took a bit of a shortcut with that statement. Think about it this way: the government spends a lot of $ to support consumer spending. For example, the latest stimulus package that went out was not paid out of a surplus...it was simply added to the debt. And some portion (a lot?) of that spending went to oil. All the tax cuts that we hear about? Again, mostly just added to the debt. And, again, this money helps support consumer spending on energy, etc... And how do we fund these programs? Selling Treasuries. And who is increasingly buying these Treasuries? Overseas governments and investors... And don't forget to add in the huge energy budget of the military... Oil is certainly not driving up the debt all by itself. Just one piece of the puzzle.

2008 Aug 07 02:09 AM

[investor88:]

Realistic conclusion by author that it is too early to call an end to the commodity boom, bear or no bear in prices of commodities and stocks. We have to observe carefully as events unfold.

2008 Aug 07 10:21 AM

[Tom Szabo:]

Dux, I refer to the global business cycle, which is very real and has not been vanquished. Think-About-It, the standard of living for the average Chinese cannot equal or pass our current level due to a number of preventive factors. A clumsy way of summarizing these would be to say China simply has too many people, but I'll try to add in some nuance. (1) China's one child policy has created incredible demographic headwinds that will become very fierce in the years ahead. Basically, the population is aging at such a rapid rate that the majority of consumer income will be spent supporting the hundreds of millions of elderly. You think the $50 trillion social security liability facing the U.S. is a big deal? China's problem is an order of magnitude larger, and not only is it off-balance sheet but it isn't even acknowledged. (2) The Chinese economic miracle has failed to reckon with the environmental, social, health, safety, social and other costs attendant to industrialization. These all have to be factored into standard of living, and when you do that, the Chinese are actually further behind then raw per capita income or GDP figures would suggest. (3) Absent weird science, there will never be enough energy or beef (just 2 examples) produced on Earth to satisfy Chinese consumption were it to equal the current level enjoyed in the U.S. (4) Chinese growth has been accompanied by gross misallocations of capital. A large portion of the nation's wealth has been squandered on "investments" with zero merit. We too overbuilt in New York, California and Miami, but that excess will eventually be absorbed by domestic dreamers, immigrants, or foreign bargain hunters. But how many people are going to buy that empty, crumbling office building or shopping center in a Beijing or Shanghai suburb? I'd say it's about par with Detroit. And as nuts as the building craze got in the U.S. over the past few years, we weren't doing a lot of building in Detroit. This will haunt the domestic Chinese economy for decades. (5) Political change in China will be required at some point for advancement past a certain "achievement plateau" that looms in the not-to-distant future. The struggle for control of the government will likely create major upheavals that will periodically stall economic progress. The Chinese have set up a system with zero flexibility. That's okay if you're a Communist, but dangerous when you are a Capitalist.

2008 Aug 07 12:28 PM

[mouth:]

What goes up must come down. I can only tell you after it happens. But commodities will go down. As for China, silver axis has it right. China is attempting to move over 300,000,000 from rural existence to urbam life over the next 20 years. This will put an tremendous strain on both "cement" Steel and infrastructure. The biggest problem is the lacjk of education that these people have. It has the potential to create a politicial upheaval with unknown consequences. I guess the commodity fall might not happen for a few decades, except it will fall when you least expect it. I just can not make up my midn when it might happen

2008 Aug 07 12:56 PM

[NOWHEREMAN:]

300 million people, 20 years? Hmmm, how long do you think it takes to educate people? Granted it may take that long to educate us regarding Global Economics but I doubt that the Chinese will need that long.

The CRB should hold around 380, I went back 40 years and a lot of trendlines to come up with that number. I'm not even sure how I did it. But a lot of charting is artistry rather than graphical accuracy. And while some people may think your painting is great others will say it sucks. Thats why the great artists are the dead ones, they no longer care and won't change their styles to appease the living.

The stronger dollar is about to screw the only sector we had going for us and at the same time raise Eurozone inflation dramatically. Be careful what you wish for.

2008 Aug 08 12:06 AM