Chart 1: Important news this week is the commodity index break out!
Source: Short Side of Long
To say that commodities have under-performed other major asset classes in recent times (equities, bonds and cash) would be an understatement. Both the CC Index and CRB Index peaked out in May 2011, during the optimism of the Chinese economic growth and time of huge M&A deals such as Glencore merger with Xstrata. Fast forward almost three years later and the CC Index has barley managed a 5% gain over any recent 12 month period. Furthermore, over the last 52 weeks, most individual commodities have been sold off sharply (in particular agriculture and precious metals). However, interesting development took place this week, as the technical downtrend was broken (see chart above).
Chart 2: The reason behind the breakout is rising Agricultural prices
Source: Short Side of Long
After a sharp correction over the last 18 months, it seems that the Agricultural sector of the commodity index is finally starting to bottom out. And since agriculture makes over 40% of the CRB Index, it was one of the main reasons behind this weeks breakout. The chart above shows that hedge funds and other speculators held incredibly low net long exposure towards this sector until this week. Buyers are now stepping in as prices break out technically.
Chart 3: Industrial metals still remain in the three year downtrend…
Source: Short Side of Long
Other sectors are still lagging the Agricultural rally. In my opinion, it is important to get confirmation from the economically sensitive commodities before one should take a bullish stance. For example, Chart 3 and Chart 4 show that Copper and Brent Crude are yet to break out of their respective downtrends.
Copper is one of the most important metals in the building sector and a great barometer of the overall Industrial Metals space, which has also not broken out yet. Moreover, Brent Crude Oil is a better gauge of global Oil prices relative to West Texas Intermediate Crude and a great indicator of the global economic activity (high demand continues to keep prices elevated above $100 per barrel).
A breakout on the upside by these two industrial commodities will surely confirm the break out witnessed in the broad index this week. Contrarians should note that over the last several months, heavy short positioning by hedge funds on both Copper and Oil could definitely increases the possibility of a short squeeze. Finally, the Precious Metals sector is also worth watching, as it remains close to breaking out too.
Chart 4: … while Crude prices are moving towards an inflection point!
Source: Short Side of Long
I find it ironic that commodity prices are breaking out just as majority of the Wall Street banks have sold out or closed down their commodity businesses. They have recently laid off majority of their staff and once again totally disregarded commodities as an asset class. As Warren Buffet famously said:
Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.
