YES, COMMODITIES DO PULL BACK DURING A RECESSION -- COPPER IS THE MOST VULNERABLE WHILE GRAINS ARE THE LEAST VULNERABLE -- GOLD SHOULD HOLD UP BETTER THAN OIL IN A FALLING ECONOMY

COPPER WAS OLD LEADER ... A lot of questions have cropped up this week about what commodities as an asset class do in an economic downturn, and which commodities (if any) are more immune. During a recession (which often follows a stock market peak), most commodity markets do suffer pullbacks. Some are more vulnerable than others however. Chart 1 plots four major commodity markets over the last year against the CRB Index, which is the flat line. Copper prices (green line) have weakened noticeably since October. That makes sense since copper is considered to be a barometer of global economic strength which is also weakening. Crude oil (blue line) has started to slip since November. Energy prices do have a history of pulling back back during recessions. The rising pink line represents agricultural markets. At the moment, that's the strongest commodity group. Since grain markets are less effected by the business cycle, they may suffer less in an economic downturn. Which leaves gold. While it's true that gold can correct with stocks during an economic downturn, that's not always the case. In fact, gold continued to rally during the 1974 bear market when stocks lost 50% of their value. That's because gold is often viewed as an alternative to stocks.

Chart 1

COMMODITIES STILL IN UPTRENDS... Chart 1 plots the DB Commodity Tracking Fund (DBC). This ETF allows exposure to a basket of commodities. It has pulled back over the last two weeks, but remains well above its 50-day moving average. Its relative strength line (versus the S&P 500) continues to rise. The message here is twofold. Yes, commodities may pull back if the stock market continues to weaken. But they'll probably pull back a lot less. That's because commodities remain in major uptrends, while the longer-range trend in stocks has turned down.

Chart 2

AGRICULTURAL ETF HITS A NEW HIGH ... Even more impressive is the action in the DB Agricultural ETF (DBA). That fund is hitting a new record high today on the back of rising grain prices (Chart 3). Its RS line is doing the same. I'm not suggesting that this is a good time to jump into agricultural markets. They certainly look over-extended and due for a pullback or consolidation. A sudden drop in agricultural stocks this week may be hinting at that (see Chart 4). But this is an area that should be relatively immune to an economic slowdown. People still have to eat.

Chart 3

Chart 4

GOLD STILL DOING MUCH BETTER THAN STOCKS ... Regarding gold, Chart 5 puts things in better perspective. It plots the performance of gold (blue line), gold stocks (red line), and the S&P 500 (black line) over the last year. Since the start of 2007, the S&P 500 has fallen nearly 5%. During that same time span, bullion has gained 37% while gold stocks are 23%. Which of those two asset classes would you rather be in -- precious metals or the stock market? I'd vote for precious metals. That doesn't mean that precious metals are immune from selling (gold fell $20 on Wednesday). It does suggest, however, that precious metals should do a lot better than stocks. If you're nervous about holding gold assets, sell anything that falls below its 50-day moving average.

Chart 5

WHY GOLD IS PREFERABLE TO OIL ... Of the two commodities, gold appears to be a better holding than oil. For one thing, oil is vulnerable to the business cycle while gold is less so. In fact, gold usually does better in a climate of falling rates which is a hallmark of economic weakness. If you're trying to chose between the two commodites (or their related stocks), take a look at Chart 6. It plots a ratio of gold versus crude oil. The falling ratio had been favoring oil until late November. Since then, the gold/oil ratio has been rising. That suggests that folks are rotating out of energy and into precious metals. We see the same pattern when comparing the relative performance of gold and oil equities.

Chart 6

GOLD/ OIL STOCK RATIO FAVORS GOLD ... Chart 7 plots a ratio of the Gold Miners Index (GDX) divided by the Energy SPDR (XLE) over the last ten years. It shows definite trending patterns. Gold stocks did better than energy equities from late 2000 to early 2003 (during the last bear market). Oil stocks did better from 2003 to mid 2007 (during the bull market). The ratio has just hit a 52-week high, which means that gold stocks are doing much better than energy. One way to look at it is that energy stocks do better in a stronger economy, while gold does better in a weaker one. That may have something to do with the direction of interest rates. The green line in Chart 7 represents short-term interest rates. Notice the inverse correlation between the two lines. When short-term rates fell from 2001 to 2004 (implying a weak economy), gold stocks did better than oil. Rising rates from 2004 to 2007 (implying a stronger economy) favored oil equities over gold. The drop in rates since mid-2007 has shifted the pendulum back to gold assets as the economy shows signs of weakening. In my view, that makes gold assets a better holding than energy assets in the current environment.

Chart 7

COPPER HELPS PULL MATERIALS LOWER ... Material stocks, which had been market leaders until today, are falling. Part of the reason is falling chemical-farming stocks like Monsanto which is down 10% and the group's worst performer. The second worst is Freeport McMoran Copper & Gold which has fallen below its 200-day moving average (Chart 9). Despite its name, FCX is primarily a copper stock. By contrast, Newmont Mining is showing only a modest loss. Chart 11 shows NEM still trading well above its 50-day moving average. NEM is a gold stock. It just goes to show that all commodities (and their stocks) aren't equal.

Chart 8

Chart 9

Chart 10

ENERGY ETFS ARE ROLLING OVER... There usually comes a time in each bear market where almost everything starts to fall. One of the traditional signs of a major market top (and recession) has been a breakdown in basic material and energy stocks. Chart 8 shows basic materials being sold. Chart 11 shows the Oil Service Holders (OIH) trading below their 200-day average for the first time in nearly a year. It's also threatening to break its November low. Chart 12 shows the same thing happening in the Energy SPDR (XLE). Energy had been one of the few pockets of strength in the market. Not anymore.

Chart 11

Chart 12