Commodities may be the market to watch this year. After nearly a decade of underperforming financial assets—specifically stocks—it could well be time for the resurgence of hard assets.
The Bloomberg Commodity Index, which tracks more than 20 commodities in energy, agriculture, industrials, and precious metals, seems to be on the verge of breaking out to the upside (see Chart 1). Indeed, the index set its low point back in January 2016, which was also when the current leg of the bull market in stocks began.
Rising off a low point doesn’t necessarily mean a bull market is in place, of course. Indeed, the commodities index has traded more or less sideways since May of that year. The good news for the bulls is that it also formed a base or consolidation zone that could serve as the launching pad for a real bull market ahead.
The chart shows where major-component commodities scored their individual peaks and troughs. This is important to know because various commodities, such as sugar and aluminum, do not correlate with each other very well. Also, energy comprises more than 30% of the index’s weight, making it a big mover for the overall asset class.
What stands out most in the chart are the apparent coincident bottoms about two years ago in gold, oil, and copper. That alignment arguably shows that a true bottom is already in place and all we need now is the “all clear” signal on the charts in order to really get excited.
I am not quite as impressed by gold’s recent rally over the past month. As I outlined last month, this particular market remains below significant resistance in the $1,390-$1,475 area. (It traded at $1,320 Thursday afternoon.) I will concede, however, that gold has made technical improvements since that time.
A good deal of gold’s, and silver’s, strength is due to the sharp decline of the U.S. dollar over the past few weeks. Gold and most commodities are priced in dollars, and a weaker dollar translates into higher commodities prices, all else being constant. We’ll take a closer look at the greenback in a little while.
Crude oil did, in fact, break out above its own resistance zone of $55-$60. (It traded at $62 Thursday.)
Copper shows the sharpest gains since late 2016, and it scored a major trendline breakout to confirm a true bull market is indeed in place. The problem with copper right now is that it is high relative to its trend—and that puts it at risk for a pullback.
Indeed, commercial hedgers in this market, according to the Commitments of Traders report from the Commodity Futures Trading Commission, are in a rather bearish net short position right now. This is the so-called smart money, and it appears a bit apprehensive.
But that alone doesn’t signal the end of the rising trend, at least not yet.
The U.S. dollar index, which tracks a trade-weighted basket of currencies, cracked a rather important support level last month (see Chart 2). This puts it on a downward path to take out last year’s low of 91.01 and head toward the 89 level. (It traded at 91.85 Thursday.)
I derive the 89 target from several technical retracement levels of the 2014-15 rally. The more important point is that there is still downside pressure on the dollar that could last several weeks. Such a decline could spark a breakout in the Bloomberg index, gold, and a few other commodities.
From the fundamental side, Bloomberg’s commodity index team also sees strong performances ahead for crude oil and industrial metals, including copper. “All cylinders firing for industrial metals in 2018 thanks to dollar weakness and strong global purchasing managers’ indexes,” the team wrote in its December report.
It also forecast that agricultural commodities have greatest potential upside surprise, as global grain demand is set to outstrip supply. Technically, they have been depressed and flat for so long that it would not take much of a breakout to get a rally going.
Because stocks still have gas in the tank, correction possibilities aside, we may not see the actual performance ratio of commodities to financial assets change direction. It could just flatten out. That would still be a win for commodities bulls, and it pays for investors to now consider adding a little bit of their favorites to their portfolios. And if stocks do stumble, it would be all the more reason to take a few commodities bites.
Getting Technical Mailbag: Send your questions on technical analysis to us at firstname.lastname@example.org. We’ll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.
Comments? E-mail us at email@example.com