Why Commodities Prices are Bouncing Higher

Jesse Livermore, the legendary Wall Street Trader of the early 20th century, was fond of saying that the market never does what you expect it to. It is never obvious. After many years of observation, he thought the market’s role was to fool most of the people most of the time.

So what’s the wily old bugger up to now?

Commodities prices are bouncing higher. Oil surged 5%, while copper jumped 2%. The Aussie dollar is up over US$0.72 cents.

Global stock markets are in on the act too. The EuroStoxx 50 index jumped more than 2% while US stocks closed up around 1.3%.

In short, after squealing like a stuck pig for the past few weeks, markets are now happily gorging again.

So what are we to make of it? Is the market fooling everyone again, putting in a big and convincing rally only to turn around in a few weeks and wallop everyone?

Let’s take the commodities sector first. BHP is a good proxy here.

In fact, BHP just released its results for the six months to 31 December this morning. Revenue fell 37% in the same period last year, while the headline loss came in at a massive US$5.7 billion.

That number includes some significant asset value writedowns, but even the underlying net profit figure was ugly, down a whopping 92% to US$492 million.

Only the iron ore division made any decent money. Copper contributed US$100 million to operational earnings, but all the other divisions, including petroleum, lost money in the period.

Importantly, BHP’s cashflows took a big hit. Operational cashflow came in at US$5.26 billion. But subtracting capital expenditures of US$4.04 billion and the dividend of US$3.27 billion, means that BHP had to borrow to keep its head above water.

No wonder the ‘progressive’ dividend policy got the chop today.

But enough of the numbers, what does the market think? Have a look at the share price chart below:

Source: BigCharts

As you can see, BHP’s share price has enjoyed a decent rally over the past month. In fact, it’s rallied into the results release which means the market already knew the result would be an ugly one.

That means today’s news is not news to the market at all.

But importantly, you can see that the overall trend, as indicated by the moving averages (blue and yellow lines) is still down.

The other thing to note is that trading volumes (see lower panel) have trended down slightly since the rally began. This suggests there isn’t a huge amount of conviction in the rally. I take this as a reason to remain wary on this rally.

As an aside, for all you kids out there looking to get into management of a resource company, here’s some advice — pick the right commodity.

BHP also announced a management reshuffle today. There was no room for Jimmy Wilson, head of the iron ore division, or Tim Cutt, President of Petroleum. These commodity prices fell the hardest in the commodity bear.

Getting back to the market, the reason why they tend to fool us most of the time is because we don’t listen to its message in an unemotional way. If you’re a commodity bull, you probably think the bottom is in and this rally represents the start of a new bull market.

Jesse Livermore never used the words bullish or bearish. He thought they came with too many emotional connotations. It made it more difficult for him to change tack when the market told him he was wrong.

He simply looked at a market or stock and worked out whether the trend was up, down or going sideways. This told him what to do in an unemotional way.

Livermore was a pro. He made millions and lived the high life. He also lost his millions and ended up with a bullet in his head. Put there by himself. The market, and life, broke him at the age of 63.

So don’t think the market is easy. It doesn’t hand out freebies to anyone. You have to work hard and think harder to tame the beast. And it doesn’t make it any easier reading the mainstream business press, who regularly quote ‘analysts’ who change their mind with each change in the direction of the price.

For example, the ongoing rally in the iron ore price is predictably changing opinions. From the Financial Review:

Iron ore’s rally – up 11 per cent over the past week – may not have much further to go but the days of rock-bottom prices are probably over, say analysts.

Why are the days of rock bottom prices ‘probably’ over? As far as I can tell, it’s simply because the price has moved sufficiently away from ‘rock bottom’ to give confidence that it won’t return to rock bottom.

Top analysis, huh?

But when the herd moves, it moves on emotion, not on cold hard analysis.

Don’t get me wrong, this could well be the bottom. But you need to see more evidence before increasing your bets.

On the positive side for the commodity complex, US inflation numbers out late last week were higher than expected. Core consumer prices rose 2.2%, the highest rate since 2012. So much for deflation…

Also providing some added fuel for the rally is the near record short position in US stocks. This means that a large amount of traders are betting on further prices falls. According to Zerohedge, it’s the largest bet against the market since July 2008.

The problem with large ‘short’ positions in the market is that any bit of good news can spark a big short covering rally. Short sellers have to buy back their shares at some point. That’s how they close out their positions. So an increase in short sales actually represents a lot of future buying power.

This recent rally then could well be short sellers buying back their positions.

As Livermore said, the market is never obvious.

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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