Investment Postcards from Cape Town

The Reuters/Jeffries CRB Index - an index that was first constructed in 1957 and comprises 19 major commodities - has been rising non-stop for the past four weeks and for nine weeks out of the past 14. This surge represents a gain of 30.2% from its low on March 2. But one needs to put this in perspective: the Index fell by 57.7% from its high in early July 2008, and therefore still needs to rise by a further 81.5% to match the previous peak.

I posted an article a week ago entitled “Secular bull in commodities remains intact” and concluded as follows:

“… commodities still seem to be in a supercycle that was only temporarily interrupted by the global economic malaise. As inflation money finds its way into commodities, it is still not too late to purchase these, but only on price corrections that are bound to occur from time to time.”

David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, concurred, saying: “… what we experienced last year was a severe cyclical correction in what is still a secular bull market - you can connect the dots on the chart and see that the CRB looks a lot like what the S&P 500 looked like in the months following the sharp 1987 collapse. It seemed like the end of the world in October of that year, and yet in retrospect it was just the fifth year in what proved to be an 18-year secular bull phase.”

Bringing technical analysis to the equation, Adam Hewison of INO.com has prepared another of his popular analyses, specifically on the CRB Index. Click here or on the image below to access the short presentation.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

The Financial Ad Trader - banner ads

Email

Digg

Del.icio.us

Technorati

Stumble

Reddit

Facebook

The Chinese Purchasing Managers Index (PMI) for May remained in the expansionary zone of higher than 50%, although it moderated to 53.1% from 53.5% in April, according to Li & Fung Research Centre. Although eight of the 11 sub-indices were slightly lower than their respective levels in the previous month, it is noteworthy that the new export orders index returned to the expansionary territory for the first time since June 2008. “Strong domestic demand, together with an improving export situation, has helped resume the expansion of the manufacturing sector in China, “said the report.

China’s PMI seems to indicate that the country might have seen the worst of the GDP growth statistics. (The Hong Kong PMI is used as a proxy of the Chinese PMI prior to 2004.)

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

Importantly, China’s PMI for new export orders shows the Index again expanding (i.e. above the 50 level) and, based on the close relationship with the Metals Index, should provide further support for commodity prices.

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

David Rosenberg, the closely followed chief economist and strategist of Gluskin Sheff, argues in a newsletter on Monday that the Asian economic revival, with strength spreading across the continent, may be for real. This is, needless to say, bullish for the commodity complex, with gold, copper and oil all having broken above their 200-day moving averages just as the US dollar has cracked below its key support level.

“The US is still the largest economy in the world by far, but it is losing its dominance each year and the fact of the matter is that it is a mature service-driven economy. Emerging Asia in general, and China in particular, are still the marginal buyer of basic materials, and their economic success is more critical to the outlook for commodities,” said Rosenberg.

He highlights that the world has just endured the steepest world economic setback in 70 years and yet commodity prices across a broad front - gold, oil, copper, soybeans -  managed to bottom at their highest “recession levels” of all time. “This attests to the supply discipline by today’s resource companies compared to their predecessors, and affirms our belief that what we experienced last year was a severe cyclical correction in what is still a secular bull market - you can connect the dots on the chart and see that the CRB looks a lot like what the S&P 500 looked like in the months following the sharp 1987 collapse,” said Rosenberg. It seemed like the end of the world in October of that year, and yet in retrospect it was just the fifth year in what proved to be an 18-year secular bull phase.

My research concurs with Rosenberg’s conclusion that commodities still seem to be in a supercycle that was only temporarily interrupted by the global economic malaise. As inflation money finds its way into commodities, it is still not too late to purchase these, but only on price corrections that are bound to occur from time to time.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

The Financial Ad Trader - banner ads

Email

Digg

Del.icio.us

Technorati

Stumble

Reddit

Facebook

Commodity prices have started to recover since the massive commodity fund liquidations and inventory reductions at mine, refinery and final consumption levels, which in some instances gave rise to record stock levels of industrial metals on the London Metals Exchange.

The recovery in metal and oil prices should be seen in context, though. The sharp drop in prices rendered a significant quantity of global production uneconomical, resulting in substantial cutbacks in production already seen and planned for the next two to three months.

China continues to be the main driver in the metals market. An update on the Chinese situation, and specifically the PMI data released last week, makes for interesting reading.

The Li & Fung Research Centre reports that the Chinese PMI rebounded to 52.4% in March 2009, up from 49.0% in the previous month. The index was back to the expansionary zone of higher than 50% for the first time since October last year. The Output Index, New Orders Index and Purchases of Inputs Index were also higher than the critical level of 50% in March. Except for stocks of finished goods, all sub-indices were higher than their respective levels in the previous month.

China’s improving PMI seems to indicate that the country might have seen the worst of the GDP growth statistics. (The Hong Kong PMI is used as a proxy of the Chinese PMI prior to 2004.) The first quarter’s growth rate may surprise on the upside and could come in at higher than 8% year on year.

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

The chart below shows that New Orders and New Export Orders lead metal prices by approximately one month, providing upward momentum to the rally in metal prices.

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

And finally, China’s PMI for stocks of major inputs shows the deterioration has probably bottomed and, based on the close relationship with the Metals Index, should put a floor under commodity prices.

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

With a large part of China’s own mines uneconomical, the government is buying in domestically produced metals at set prices to keep the mines afloat. China also seized the opportunity to accumulate significant amounts of metals at the bargain prices to bolster the country’s strategic reserves. China’s aggression in the commodity markets, especially copper, is evident as some major copper smelters in Japan have sold out their total production to China two to three months hence.

The uptrend in commodity prices since the extreme lows of earlier this year (see graph below) should therefore be considered as a return to equilibrium due to cutbacks in production and China’s activity in the commodity markets rather than the start of a strong bull market.

Source: StockCharts.com

An expected further improvement in manufacturing purchasing managers’ indices in the coming months to neutral levels is likely to underpin metal prices, but significant volatility can be expected as positive news is likely to be counterbalanced by high inventory to sales ratios in mature economies. These are likely to continue to depress demand and limit rises in commodity prices.

However, the outlook for commodity prices in the second half of this year is encouraging. The closure of mines and mothballing of smelters in the mining industry are leaving the industry lean and any improvement in the global economy, as reflation measures start bearing fruit, is bound to be reflected in higher commodity prices. A weaker US dollar will naturally also be supportive of commodity prices expressed in that currency.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

The Financial Ad Trader - banner ads

Email

Digg

Del.icio.us

Technorati

Stumble

Reddit

Facebook

Can money trees in fact grow to heaven? It was certainly beginning to look that way when 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)

But the past few days have seen commodity prices pulling back from their lofty levels. What should one read in this?

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

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, indicating 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 was undoubtedly the plummeting US dollar, but very strong underlying demand from especially emerging markets, together with a tight supply situation, has naturally been a primary driver. Although I am a strong believer in a multi-year uptrend, I am concerned about commodity prices having become detached from the fundamental picture over the short term in the light of the rather dismal global outlook for economic growth.

The graph below illustrates the close historical relationship between the annual change in the US 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 that a breather of at least a few months could be on the cards for commodities in general.

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 US consumer recession is likely to suck liquidity away from the emerging-market region as the US 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 and that it is only natural to expect periodic corrections within a long-term uptrend. Profit-taking/deleveraging by hedge funds may result in sharper sell-offs than otherwise, but negative real interest rates in the US 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.

Did you enjoy this posting? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

The Financial Ad Trader - banner ads

Email

Digg

Del.icio.us

Technorati

Stumble

Reddit

Facebook