The current bear market rally in overall commodities should be nearing an end as the final phase of the current bear market takes hold. In the majority of the agricultural complex, supplies will be increasing over the next crop cycle. That is bearish. Remember, that a necessary part of an extended bear market is to periodically provide violent snap-back rallies to keep the bulls alive and make sure the bears do not become too complacent. Parabolic rises or falls in prices lead to very short duration V-shaped bottoms/tops that quickly reverse.
None of the money flows are showing the kind of bullish reversal vigor that tends to precede major bull market moves. This means that another sharp down move in commodities as group is imminent and likely will reach the 500 level in the Continuous Commodity Index (CCI) before presenting the next great buying opportunity for long-term commodity investors. China’s economic hard landing appears to be the elephant in the room that is not being discounted adequately in most commodity markets at this time. Before delving into the reasons why this hard landing should be expected, let’s take a look at the numerous non-confirmations in the market right now.
First, if you look strictly at the stock market performance as measured by the S&P 500, you would get the impression that a major long-term bull market is unfolding. This suggests that all is well with the world, that an accelerating global economy is unfolding and the boom times in emerging economies are about to take orbit. If this were true, then commodities also would be seeing a booming global economy, surging demand potential from Asia/China and would be benefiting from an increase in liquidity of the monetary system, which should put extreme pressure on the U.S. Dollar Index. That so far has not happened. The chart below shows the ratio of the CCI to the S&P 500. For the better part of the last decade, commodities have been in a bull market and have outperformed the S&P 500 by a ratio of more than 3:1.
This outperformance is a direct response to the stagnant U.S. economy in relation to the comparatively booming Asian economies. Since the autumn of 2011, commodities have had one of their worst performances relative to the S&P 500 seen this decade. This is startling. While stocks are seeing reflationary boom times, commodities instead continue to suggest a continuation of the current deflationary bust. This strongly suggests that all is not well in Asia and emerging markets, and questions how long the current U.S. economic decoupling mantra can stay intact.
What is even more amazing is that with stocks near highs last seen in the spring of 2011, the U.S. dollar remains well above its lows and remains in a bull market trend. This, despite the stock market strength, continues to show that global capital continues to seek the U.S. dollar for safety.
This is only the second time this decade that we have seen these two markets diverge from their well-established, decade-long inverse relationship. The U.S. dollar remains well above lows seen in May 2011 when the stock market last saw current levels. This shows that global liquidity remains very tight despite the European Central Bank’s quantitative easing program. The U.S. dollar remains in a healthy uptrend. Look for a major spike up in the near future.
We can play our bearish outlook on commodities in either of two ways: Picking out those markets that we feel are most vulnerable or finding a proxy for a strong downward move in commodities. Given the dollar’s current upward bias and its negative correlation to the commodity sector in general, a long dollar play may be the best way to take advantage of the end of the recovery rally in commodities.