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Prieur Perspective: Is Commodity Run Over?


Expect sharp selloffs even as long-term trend persists.

Can money trees in fact grow to heaven? It was certainly beginning to look that way considering the frenzied surge of many commodities to new highs week after week.

The following table shows the strong performance of most commodities over various measurement periods.

Source: Plexus Asset Management (based on data from I-Net Bridge)

So what should one read into the recent pullback in commodity prices from their lofty levels?

Let's firstly consider a picture of the Reuters/Jeffries CRB Index, a basket of agricultural, energy, industrial metal and precious metal commodities.

Click to enlarge image

Source: StockCharts

The graph only shows the last portion of the seven-year bull market in the CRB Index in order to illustrate the parabolic rise over the past six weeks, resulting in a heavily overbought condition. Considering a combination of technical indicators, a sell signal seems to have been given.

Of special note are the Bollinger Bands, where a top was made outside the top band, followed by a top inside the top band. This indicates a trend reversal. A move originating at the top band often tends to decline to the bottom band.

Part of the reason behind the strong rise in commodity prices has undoubtedly been the plummeting U.S. dollar. However, strong underlying demand from emerging markets and a tight supply situation have also driven prices higher.

Although I am a strong believer in a multi-year uptrend, I am concerned about commodity prices. They appear to have become detached from the fundamental picture over the short term, particularly in the light of the dismal global outlook for economic growth.

The graph below illustrates the close historical relationship between the annual change in the U.S. Leading Indicators Index (blue line) and The Economist Metals Index (pink line).

Source: Plexus Asset Management (based on data from I-Net Bridge)

Unless one expects a turnaround in economic activity, it would seem a breather of at least a few months could be on the cards for commodities.

Andrew Garthwaite, chief global equity strategist of Credit Suisse, remarked: "Sharply rising commodity prices may ... exacerbate a growth downturn, but eventually weak growth gets its revenge, as falling real demand triggers speculative liquidation."

Also emphasizing growth concerns, but specifically from an emerging-market point of view, Albert Edwards, co-head of global strategy of Société Générale, said:

"The unfolding U.S. consumer recession is likely to suck liquidity away from the emerging-market region as the U.S. current account deficit declines and emerging-market accumulation of foreign exchange reserves slows sharply. As emerging-market asset prices slide and decoupling arguments evaporate, commodity prices will react sharply as recent speculative 'safe haven' froth unwinds."

I believe that irrespective of high demand from China and other emerging markets, commodity prices will remain cyclical. It's only natural to expect periodic corrections within a long-term uptrend. Profit-taking and deleveraging by hedge funds may result in sharper sell-offs than normal, but negative real interest rates in the U.S. should temper the downside potential.

Different commodities, needless to say, will behave in different fashions, but in general one's approach should be to be patient and await better buying opportunities down the line.
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