It’s Time to Sit Up and Take Notice of This Commodities Sector

Wall Street had a rough overnight session. The Dow fell around 1.2%, while the S&P 500 was down 1%. The reason for the selloff was a weak result from retailer Macy’s [NYSE:M]. That sent the sector lower, casting a general pall over the market.

In addition, the share price of Walt Disney Co [NYSE:DIS] dropped around 4% after disappointing quarterly earnings saw the company miss its target for the first time in years.

On the other hand, commodity prices continued to rise. Brent crude oil prices surged another 4%, and gold rose by US$10 an ounce. The benchmark commodity index, the Reuters/Jefferies CRB index, increased a healthy 1.7%.

Even iron ore did well, rising 0.6% overnight. This means the Aussie market should do OK today, at least relative to the US market’s performance.

The iron ore price has fallen sharply in recent days but may have received a boost from this news, as reported in the Financial Times:

The Chinese government is pump [sic] almost Rmb5tn into transport infrastructure over the next three years, in a sign of its determination to use state investment to keep the economy humming.

However, analysts said the announcement by the Ministry of Transport added to a sense of confusion about the direction of Chinese economic policy. Infrastructure spending served China well when it was growing rapidly and seeking to build a modern economy but in recent years has resulted in white elephants, industrial overcapacity, economic distortions and debt.

Yeah, yeah…we know all that. But who cares!

When you’ve got an economy to centrally plan and uprisings to stave off, you’ll do whatever it takes. Even if that means more of the same stupid policies that got you into trouble in the first place.

It’s a familiar theme the world over. It just goes to show how bereft of ideas our economic managers are. That’s because, once you get to a certain point (which is usually associated with a certain level of debt), there is nothing more you can do to achieve growth except to dig the hole deeper.

Actually, there are things that you can do, but they involve short term pain. And in the early stage of the 21st century, no government anywhere in the world wants to administer any pain at all.

Their grip on power is just too irresistible. Why threaten it with short term pain for long term gain?

It doesn’t matter whether we’re talking democracy, autocracy or theocracy. The final aim is the same…the retention of power.

Unfortunately for Australia, our main trading partner is under the global spotlight for these issues. China is absolutely out of ideas about how to maintain strong growth. But it recognises that more of the same will lead to the Communist Party’s long term demise.

In short, it’s confused. More from the FT:

“This week is a week of mixed signals,” said Andrew Batson, economist at Gavekal Dragonomics in Beijing. “They’re swinging between poles of emphasising support for growth and emphasising structural reform. It’s not clear what message they are trying to send.”

It is not clear to what extent the funding targets acknowledged this week are new or previously budgeted and approved projects. Many are likely to have been flagged in the five-year plan, approved in March at the annual legislative meeting.

Perhaps that’s why you only saw a muted response from the iron ore price?

If there’s one chart that shows China’s predicament, it’s this one from Morgan Stanley:

Source: Morgan Stanley

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It shows the increasing unproductiveness of China’s debt binge. It now takes 6.5 yuan in increased debt to produce 1 yuan of nominal economic growth.

I’ve talked about this a lot here before, so I won’t go into it again today. But the chart speaks for itself, no?

From a purely macroeconomic perspective, China looks toxic. And because of this, you’d have to be wary about the rally in commodities, right?

Well, this is where it gets interesting. There are an increasing number of charts pointing to a significant change in trend for commodity prices. Whether that is based on China growth hopes, the first signs of global inflation, or an improving supply and demand picture (after a five-year bear market) is impossible to tell.

But the reason isn’t important. The reason will become apparent (and obvious) AFTER the fact. What’s important is that commodity prices look like they are bottoming after a long and devastating bear market.

The image below is a weekly chart showing the CRB commodities index since peaking in 2011. From top to bottom, the index fell around 60%. A 60% fall over five years is a big bear market.

But if you look closely, you can see the index put in a double bottom earlier this year. Since then it’s rallied and corrected a few times. But, so far, these rallies and corrections are producing higher highs and higher lows, which is a good early indication that a new upward trend is emerging.

Source: Market Analyst

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The next thing you want to see is a rally to a new ‘higher high’. That means you want to see the index climb above the high from 29 April, which was around 185 points. Right now it’s trading at 180 points.

Keep in mind that this is an index only, made up of energy, precious metals, industrial metals and agricultural commodities. But it gives you a good overall feel for how the sector is performing.

Despite the ongoing bearish macro picture for commodities, the market is telling you to sit up and take notice. And because the market is far smarter than me, that’s exactly what I intend to do.


Greg Canavan,

For Markets and Money

Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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