FALLING DOLLAR IS BOOSTING COMMODITIES -- CONTINUOUS COMMODITY INDEX PAINTS STRONGER PICTURE THAN CRB INDEX-- A COMPARISON OF TWO COMMODITY FUNDS -- STRONGER ENERGY SHARES HINT AT OIL BOTTOM -- WHY STOCK RALLY INCREASES ODDS FOR ANOTHER COMMODITY RALLY

TWO DIFFERENT LOOKS AT COMMODITY TREND... When we talk about the trend of commodities in general, it's important to know which trend we're looking at. The next two charts show two versions of the commodity price trend. Chart 1 shows the Reuters/Jefferies CRB Index having fallen to a new 2006 low and still trading 15% below its spring peak. That's because the CRB has an unusually heavy weighting in energy prices and has been pulled down by those markets. Chart 2 shows the Continuous Commodity Index which is the older version of the CRB Index. The CCI has a smaller energy weighting and a higher agricultural weight. Notice that the CCI is testing its 2006 high. That suggests that the drop in energy prices has made the commodity price drop look much worse than it's really been.

Chart 1

Chart 2

COMPARING THE USD TO THE CCI ... When we use the more broader-based CCI Index (instead of the energy-dominated CRB Index), the inverse correlation between commodities and the dollar is seen more clearly. Chart 3 shows that the Dollar Index (green line) and the CCI Index (red line) have been mirror images of each other during 2006. Most of the recent commodity strength has been in agricultural markets. [While a lot of the recent grain strength has been based on drought conditions in various parts of the world, American grains become more competitive on the world market when the dollar falls]. The point I'm trying to make here is that, outside of energy, the major uptrend in commodities looks a lot stronger. Knowing which commodity index to track may also influence which commodity fund to invest in.

Chart 3

TWO DIFFERENT COMMODITY FUNDS ... The next two charts compare the price trends of two commodity mutual funds. You'll notice that the one in Chart 4 (Oppenheimer Real Asset Fund) looks much weaker than the one in Chart 5 (PIMCO Commodity/Real Return Fund). That's because the Oppenheimer Fund is based on the Goldman Sachs Commodity Index which has a 74% energy weight. By contrast, the PIMCO fund tracks a broader commodity index that has a smaller energy weight and a higher agricultural weight. While both may start to climb from here, I would favor the PIMCO fund shown in Chart 5. Having said that, it's hard to imagine another upleg in commodities without a stronger oil market. We may be about to get one.

Chart 4

Chart 5

CRUDE IS BOUNCING OFF MAJOR SUPPORT LEVELS... A glance at a some longer-range charts shows that crude oil has declined to a couple of major support points and is starting to rebound. The first major support point is the trendline drawn under the lows of the last five years (Chart 6). [The chart uses a log scale which is usually better for longer-range work]. Notice that oil is starting to bounce off that major support line (third arrow). The weekly bars in Chart 7 also show that crude is finding support along the low formed during the fourth quarter of 2005 near $56. That's a logical support point for new buying to emerge. That's especially true with the Commodity Channel (CCI) Index rebounding from deeply oversold territory. Another sign that crude is oversold is the stronger action in energy shares.

Chart 6

Chart 7

ENERGY SHARES HINT AT STRONGER OIL ... There has been a strong historical tendency for energy shares to trend in the same direction as energy prices. At the moment, energy shares are acting a lot better than the commodity. Chart 8 shows the Energy Select SPDR (XLE) moving toward the top of its 2006 trading range. The solid line on Chart 8 is the relative strength ratio for the XLE, and it's been rising (versus the S&P 500) over the last month. That's hinting at a stronger commodity. Chart 9 compares the Oil Service Holders (OIH) to the price of crude (black line). Notice that the OIH peaked in May, which was two months before oil did. Over the last month, however, the OIH has been rising while oil has stayed flat. If the OIH is able to clear its 200-day average, that would increase the odds for a further rally in the energy pits. That would give even more support to the general commodity price trend. A rally in oil could tempt short-term traders to take more profits in an overbought stock market.

Chart 8

Chart 9

COMMODITIES USUALLY PEAK AFTER STOCKS... One of the factors driving the stock market higher since August has been falling oil prices and the reduced threat of commodity inflation. As a result, a lot of people believe that the commodity bull market has ended. One of the problems with that scenario is that commodities usually peak "after" the stock market, not "before". In other words, the fact that the stock market has reached a new high increases the odds for another upleg in commodity markets. Charts 10 and 11 show the stock/commodity peaking sequence during the last two bear markets. During 1994, the S&P 500 (red line) peaked several months before the CRB Index (blue line). Stocks also peaked before commodities during 2000 (Chart 11). Chart 12 shows the current comparison which seems to be out of sync. If another upleg in commodities does materialize, the major catalyst could be the falling dollar. A falling dollar, and rising commodities, could combine to cause some profit-taking in the stock market. In addition to the increased inflation threat from rising commodities, a falling dollar makes it harder for the Fed to lower interest rates.

Chart 10

Chart 11

Chart 12