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The long-in-the-tooth commodities correction plunged
to new lows this week. Traders were disappointed the Fed didn’t
announce a new quantitative-easing campaign, so they dumped the popular
commodities with a vengeance. But realize the primary driver of the recent
commodities weakness is not the Fed, but a strengthening US dollar. The
coming commodities price action heavily depends on its fortunes.
This strong interrelationship between commodities
and the US dollar is perfectly logical. Thanks to the United States’
economic dominance over the past century or so, commodities are generally
priced in dollars globally. While they have local-currency prices, the great
majority of the time these are actually a direct function of a
commodity’s global dollar price and that local currency’s
exchange rate with the dollar.
As capital inflows bid the US dollar higher in the
global marketplace, this reserve currency strengthens. And the more highly
valued it is, the fewer dollars are necessary to buy a given unit of
commodities. Thus futures traders around the world have long been conditioned
to sell commodities when the dollar’s price is rising. And the inverse
is true for a weakening dollar, it ignites universal commodities buying.
The recent commodities correction is not a
fundamental prediction of a weakening global economy as the financial media
loves to claim, but the simple mechanical result of a rallying US dollar. So
speculators and investors interested in commodities and the companies that
produce them need to focus on the US dollar for insights. Why is it rallying,
how high will it likely go, and when will it turn south again?
Answer these questions, and you will get a great
idea of where commodities are heading over the near term. But first, the
strong inverse correlation between commodities and the US dollar
couldn’t be clearer on the charts. The best proxies for each are the Continuous Commodity Index
(CCI) and the US Dollar Index
(USDX). The whole commodities story in recent months is simply the
strengthening US dollar.
Since spring, the USDX has surged higher three
separate times. I highlighted these big dollar rallies in red. In May this
flagship dollar index climbed 4.4% in just over 3 weeks, straddling September
it blasted 7.9% higher in just under 5 weeks, and in
the past 7 weeks or so it has surged another 7.4% higher. Realize these are huge moves for the world’s
reserve currency, which usually moves at a glacial pace.
Note above that the
entire commodities correction since late April happened during these
major dollar rallies! If you look at the sharply-falling blue CCI line within
those red dollar-surging zones, the overlap between all three more than
accounts for every bit of the past half year’s commodities weakness.
Commodities have been struggling simply because the dollar has been
strengthening, full stop.
Back in late April, this flagship commodities index
actually hit an all-time high. The
global commodities market was robust and investors were excited about
commodities’ global supply-and-demand fundamentals. Then commodities
started correcting in May, which is healthy and expected within any ongoing
bull market. It was the 14th correction of
commodities’ decade-old secular bull, no big deal at all.
Periodic corrections are essential to keeping
sentiment balanced, which prolongs the ultimate longevity of bull markets. So
they are utterly inevitable. Still, it is typically some external catalyst
that sparks a particular correction at a particular time. And in May it was
the sharply-higher US dollar. Why did the dollar start rallying then? As I
wrote at the time, it was simply oversold so
a bear-market rally was due.
That rally to rebalance away excessive fear in the
dollar didn’t last long, and the moment the USDX started grinding
sideways again so did the CCI. This was even true in early August, an extraordinarily-scary
time in the US stock markets. As you recall, Obama’s profligacy forced
the first-ever downgrade of US Treasuries in this nation’s history.
Stock markets plunged while fear rocketed up to its effective ceiling.
Yet over that frightening 2-week span when the
benchmark S&P 500 stock index collapsed by 16.8%, the CCI only lost 5.3%.
Commodities losses ran only about a third as deep as the stock markets’
because the dollar barely budged despite the extreme fear. The USDX was only
up 0.6% over that span, so there was no currency catalyst to frighten futures
traders into another wholesale exodus from commodities.
For several reasons, those early-August lows looked
like the bottom in the commodities correction at the time. The CCI was down
10.7% by that point over a 3.6-month span. The average CCI correction in the
decade before that (excluding the brutal stock panic) was 8.8% over 1.6
months. 11% was about as big as commodities corrections got with the
exception of that once-in-a-century stock panic.
In addition the CCI was very oversold by early
August, trading at 0.968x its 200-day moving average. Normally when this
slow-moving equally-weighted geometrically-averaged index falls below its 200dma,
it is a great buying opportunity. And if the US dollar couldn’t rally
significantly despite early August’s massive fear spike, then what could
possibly drive major dollar buying? That really should have been the
commodities correction’s bottom, so we loaded up accordingly on
beaten-down commodities stocks in August.
But alas, the markets are a probabilities game and
sometimes the least-likely outcome still flares up to scuttle even great
opportunities. The resilient and fully-corrected-by-bull-to-date-standards
CCI started plunging on a gigantic US dollar rally in September. This
unforeseen event was extremely unlikely based on dollar sentiment and technicals heading into that month, but it happened
anyway.
Several drivers contributed to the USDX’s anomalous
strength. Chief among them was weaker US stock markets. Ever since
2008’s once-in-a-century stock panic, the USDX has tended to surge
whenever the stock markets are weak enough to spawn meaningful fear. Though
this tendency curiously failed to work in early August’s
sharp selloff for some reason, it is powerful and crucial to understand.
The most-important US economic report that month was
released in early September, when US jobs growth came in sharply lower than
expected. Even though that was an erroneous read subsequently revised away
the following month, it ignited widespread fears of a US recession. On top of
this Europe was a mess as always, its leaders inanely diddling while global
investors exited troubled sovereign debt.
The dollar’s rally higher accelerated later in
September on a non-news development. Even though the Fed had been
telegraphing for months that it wasn’t
going to embark on another inflationary quantitative-easing
campaign anytime soon, currency traders were still relieved that the Fed
didn’t launch one. So the dollar surged. This happened again near the
Fed’s early-November meeting, and again this week.
While the steep commodities selloff straddling
September was way overdone, its
cause was inarguably the surging US dollar. When weak stock markets,
recession fears, Europe worries, whatever, lead capital to flood into this
safe-haven reserve currency, commodities get hit. But the CCI plunging 14.8%
on a 7.9% USDX rally was very excessive, as the CCI hit hyper-oversold levels not
seen since the stock panic.
Of course the US stock markets were radically
oversold too heading into October, when the irrational US-recession fears
founded upon a single bad data point
peaked. That month the S&P 500 rocketed 10.8% higher in its best month in
two decades! And look what happened to the US dollar as stock markets surged.
Flight capital hiding in this zero-yielding parking lot quickly exited, and
the USDX plunged.
Commodities immediately started rallying sharply,
and didn’t stop until late October when the USDX started powering
higher again. What drove it that time? More Europe fears. Just as Europe had finally scraped together a deal to
bail out overspending Greece, the socialist Greek Prime Minister dynamited
the entire package. So the euro collapsed
that day. And since it accounts for 58.6% of the USDX’s weight, the
dollar rocketed.
And naturally what happened to commodities? Again
they were crushed, as the strengthening dollar led to widespread futures
selling. There was nothing wrong with commodities’ bullish
fundamentals, as they take years to
change. The only reason commodities spiraled lower again was because the
dollar was strengthening. This rally continued throughout November, driven by
a sad comedy of European blunders explained in our current monthly newsletter.
By late November, the USDX regained its
early-October high. Seriously overbought both times, it looked like a double
topping. Indeed the CCI stabilized and started rallying again immediately
heading into December. But an event transpired this week that pushed the USDX
a bit above its topping levels and hammered the CCI lower still. The
absurdity of this episode just blows my mind, I can hardly believe it.
Ever since the Fed’s last quantitative-easing
campaign ended at the end of June,
the FOMC has been very clear in communicating that it wouldn’t monetize
more Treasuries unless something very dire happened. The so-called QE3
program has been off the table completely for the better part of a half year!
In fully 4 previous FOMC meetings since QE2 ended, including an emergency
one, the Fed has steadfastly said no
QE3.
So this Tuesday during the FOMC’s 5th post-QE2
policy meeting, for the umpteenth time it again declared economic conditions
were far too good to warrant a QE3. Yet for reasons that utterly defy me, and
I live and breathe the financial markets all day long every day, currency and
commodities traders were surprised
by this. Do they live under rocks? Where on earth have they been since the
end of June?
Even though there was absolutely zero reason to
expect a new quantitative-easing announcement, the US dollar was immediately bid sharply higher. And
starting out near highs already, this drove the breakout above its topping
range shown above. A stronger dollar along with less monetary inflation than
some apparently expected just crushed popular commodities including gold and
oil. It was a bloodbath.
Thus the flagship CCI plunged to fresh-new
correction lows. Its total correction extended from an already-outsized 18.3%
in early October to 20.6% this week. Having actively traded this commodities
bull since its very beginning, to me this looked and felt like a desperate
capitulation. Plunging commodities were driven to their most-oversold levels
since the stock panic, which are clearly unsustainable.
The key to this entire commodities correction continues
to be the fortunes of the US dollar. The world is not consuming less oil, nor
producing more gold, than it was back in April near that all-time CCI high.
Global commodities demand growth continues to outpace supply growth. The only
material thing that changed was the value of the US dollar in the global
marketplace. Can this safe-haven currency keep on rallying?
This next secular chart offers some insights into
this critical question. Running from 2001, it encompasses the entire secular commodities bull and
secular US-dollar bear. Commodities prices have been rising on balance, and
the US dollar falling on balance, for good fundamental reasons over this long
span. Secular trends rarely change, and only when fundamentals do a radical
turn-one-eight.
These inverse supply-and-demand-driven secular
trends remained pretty steady until the epic disruptions of 2008’s wild
stock panic. The most extreme fear we will ever see in our lifetimes led to a
deluge of capital fleeing the stock markets and commodities to temporarily
weather the storm in cash and Treasuries. This drove the biggest and fastest
USDX rally in history over such a short span, the dollar rocketed 22.6%
higher in just 4 months!
Back then, just like today, there were widespread
fears about whether or not the euro would survive. Believe it or not, they
have flared up periodically ever since this composite currency was born in
January 1999. Yet the euro keeps chugging along and Europe gradually gets
more and more integrated. There was even a full-blown euro panic in the spring
of 2010, yet the euro is alive and well and
higher today.
Despite all the extreme-dollar-bullishness (and
extreme-euro-bearishness) hype in late 2008 and early 2009, the USDX couldn’t continue higher once
its panic buying abated. Why? Because its fundamentals are utterly rotten!
The Fed continues to create vast new supplies of fiat US dollars out of thin
air every year, yet a world awash in depreciating dollars is demanding fewer
as it diversifies away from them.
Perpetually-higher dollar supplies coupled with
waning global dollar demand equals lower dollar prices, there is no other
long-term economic outcome possible. Sure, demand can spike from time to time
as stock-market selloffs or Europe fears drive temporary flight-capital
rushes. But once the intense fear passes, and it always does, the
fundamentally-bearish US dollar continues to drift sideways to lower. The Fed
simply prints too many new dollars for global demand to ever keep up with.
Since that epic fear-driven dollar spike during the
stock panic, the US dollar has largely been grinding along sideways. This
sorry consolidation isn’t much above the USDX’s all-time low
carved in April 2008. If the dollar is as fundamentally bullish as traders
argue today, why on earth hasn’t it gained an inch of ground since the
stock panic? Because the supply-and-demand fundamentals of this
rapidly-inflating currency are still
bearish!
In contrast consider commodities. The panic’s
dollar rally drove a brutal 46.7% plummeting of the CCI, utterly
unprecedented. Bearish analysts came out of the woodwork, including many
commodities stars prominent today, utterly certain the secular commodities
bull was over. Just look at the
charts, they reasoned. The technical damage was so apocalyptic that there was no way the commodities bull could be anything but dead.
But the legions of commodities naysayers then were
dead wrong, the secular commodities bull resumed immediately after the
excessive fear started abating in early 2009. The CCI extended its old
pre-panic ways of powering higher on balance with little interruption,
blasting to new all-time highs in
late 2010 and early 2011. And the weaker the dollar was, the faster
commodities surged. Just like in the old pre-panic days.
How could commodities continue rallying so
dramatically after being nearly cut in half? Simple, their underlying global
supply-and-demand fundamentals remained
bullish. We live in an industrializing world where billions of people are
working tirelessly to raise their families’ standards of living. This
ups consumption and hence commodities demand, and there is no way scarce
supplies can keep up.
Regarding the state of commodities and the dollar
today, there are really only two questions to consider. Will global dollar
demand, even after this latest Europe scare inevitably fades, continue to
grow faster than the Fed’s endless supply growth? Remember that the
world is drowning in dollars, and central banks have spent a decade trying to
diversify away from their
depreciating dollar-dominated portfolios.
And will worldwide commodities supplies suddenly
miraculously start growing so fast that they outpace voracious global demand
for the first time in a decade? I think the most logical answer in both cases
is no. The Fed will continue to create endless new dollars out of thin air,
increasingly necessary to monetize Obama’s unprecedented national-debt
growth, far faster than the rest of the world will want to buy this paper.
And hard-working Asians, Americans, and even
Europeans are not going to stop striving to increase their families’
standards of living simply because Europe’s bloated socialist
governments are too large to sustain. Even after a decade of
relentlessly-rallying prices, the world still cannot produce enough
commodities to fully offset the surging global demand. The dollar is
bearish, commodities are bullish.
Even from a pure short-term technical and
sentimental perspective, the USDX and CCI are due for an imminent and violent
turn. The dollar is overbought today by its own bear-to-date standards, while
commodities are wildly oversold by their own bull-to-date ones. Sentiment is
nearly euphoric on the dollar, and nearly terrified on commodities. Traders
expect the currency to soar forever while commodities keep plunging.
If you have even a single contrarian bone in your
body, you have to love this setup! When everyone thinks something is heading
higher indefinitely, that means the top is in and its rally is over. When
everyone thinks something is going to spiral lower forever, there is no
clearer sign the bottom is in and a major rally is due. The smart contrarian
play is to short the overbought currency and buy the oversold raw materials,
without any doubt.
At Zeal we’ve been doing this over the past
decade, with great success. If you want to buy low, you have to be brave when others are afraid. Only when fear
reigns, when everyone is convinced prices are never going to rally, are the
best bargains found. Our track record earned from buying fear is outstanding.
Since 2001, all 591 stock trades
recommended in our subscription newsletters have averaged annualized realized
gains of +51%!
You actually have an amazing opportunity today
thanks to this latest CCI plunge. We added our latest commodities-stock
positions, companies with amazing fundamental prospects, back in August when
the CCI looked to be bottoming.
They got dragged much lower in the subsequent selloffs. But this
doesn’t bother us, as they will likely soar to big profits after the
USDX and CCI inevitably turn. Right now you can buy many of our existing
trades at incredible bargains. What a great way to prepare for 2012!
We publish acclaimed weekly and
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take advantage of super-oversold commodities stocks!
The bottom line is commodities have been crushed by
the surging US dollar. This sharp dollar rally, amplified by unsustainable
Europe fears, is the sole reason this latest commodities correction has been
so long and deep. But this doesn’t change the underlying fundamentals
for the raw materials or the currency, which remain bullish and bearish respectively.
Thus a sharp reversal is inevitable.
Just like after the stock panic, speculators and
investors smart enough and brave enough to buy commodities and commodities
stocks when few others dare are likely to earn fortunes. Once the dollar
starts sliding again, which will be exacerbated by rallying stock markets,
commodities ought to be off to the races given how extremely oversold
they’ve been. Opportunities of this magnitude are quite rare.
Adam Hamilton,
CPA
Zealllc.com
So how can you profit from this information? We publish an
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of actual stock and options trading based on all the lessons we have learned
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… www.zealllc.com/subscribe.htm
Questions for Adam? I would be more than happy to address
them through my private consulting business. Please visit www.zealllc.com/adam.htm for more information.
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I
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read all messages though and really appreciate your feedback!
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