Last week I
talked about the strong probability that bond yields are headed significantly higher. I also pointed out that peaks in bond yields are almost always preceded by a top in industrial commodity prices. If commodities are a leading indicator for the bond market, it makes sense to see what upside potential, if any, they may still have. I find three reasons to believe prices are headed higher for the next three months, or longer.
My first reason is based on the chart below, which features the CRB Spot Raw Industrials together with an oscillator derived from the Conference Board's Leading Economic Indicators. The CRB Spot is not a widely followed commodity index like the CRB Composite or the Goldman Sachs or Dow Jones AIG Commodity indices. I use it because the prices of virtually all of its components are sensitive to the economy, as opposed to the weather. This means that it has a stronger relationship with the bond market.
The concept behind the chart is that when the economy expands, it eventually will put upward pressure on commodity prices, and vice versa. The oscillator is calculated as a trend deviation indicator. In this instance, I calculate the relationship between the three-month and 24-month moving averages of the leading indicators. A reading of zero corresponds to periods when both averages are at the same level. The green highlights show when the oscillator is above zero and the CRB Spot is above its 12-month moving average.
Since the 1950s, virtually every time this model has been bullish for commodities, they have risen in price. In order for the model to move into neutral or bearish territory, we need to see either the oscillator fall below zero or the CRB Spot index itself (375) fall below its 12-month moving average. The average is currently around 355.
It's true that the oscillator looks as though it may be in the process of peaking, but it's going to take at least two or three months for it to fall below the equilibrium level. Even then, a commodity peak is not guaranteed, as the experiences of 1968, 1973 and 1979 testify. In those cases, a negative 12-month moving average crossover provided the best signal.
The second reason commodities are likely to head higher comes from their relationship to the price of gold. Many people believe that gyrations in the price of gold are determined by political instability and the like, but in effect, players in the gold market anticipate advances and declines in commodity prices just as stock market participants discount corporate profits. Political events may be responsible for some of the movements, but the big price trends anticipate changes in commodity-price inflation and deflation.
The relationship between gold and commodity prices is featured in the chart below. The blue arrows show that, with the exception of the December 1975 period, gold has led every other major commodity peak. The December 1975 example may be a special situation, because that was the time when holding gold was legalized in the U.S. and the gold market rallied to anticipate this event. Gold shares, it should be noted, peaked in early 1974, along with the commodity markets.
The two series in the bottom panel represent the smoothed momentum (
KST) of both series. Here, the green arrows flag that lows in gold momentum have consistently led lows in the momentum of commodities, without exception since the 1970s.
This is important because the gold momentum recently has accelerated to the upside, which strongly indicates that commodity momentum will soon follow suit. Unfortunately, the leads and lags are different in each cycle and there is no way of measuring how long the extension to the commodity bull market is likely to last. Remember, even if gold is in the process of peaking around the $600 level, based on previous situations commodity prices are likely to continue their rally for at least a couple of months.
My third reason for expecting commodity prices to rise is that my Inflation Barometer remains at a pretty high level. This model comprises 10 different economic and technical indicators, each of which has had a good record of identifying important reversals in commodity prices but each of which has failed from time to time. The process of combining them in a consensus indicator is an attempt to get around this problem.
The Barometer goes bullish for industrial commodities when it rallies above 51%. These periods are highlighted in green on the chart. Bearish periods are flagged in red. The current reading of 80% is well into positive territory, and a review of the trajectories of several of its components shows that it's likely to stay bullish for a while.
Markets can and occasionally do reverse on a dime. However, it would appear that the economic case for a decline in commodity prices is not yet in place, and if that's the case, we should look for at least three more months of rising prices and bond yields.
At the time of publication, Pring had a small long position in commodities futures. Martin J. Pring is president of
pring.com, and is actively involved in Pring Turner Capital Group, a money management firm. He also publishes the monthly market letter "Intermarket Review." Pring is the author of several books, including
Technical Analysis Explained
, and numerous educational, interactive CDs. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Pring appreciates your feedback;
to send him an email.
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