COMMODITIES APPEAR TO HAVE COMPLETED A FIFTH WAVE ADVANCE WHICH MAKES A CORRECTION LIKELY -- CHINA AND COPPER HAVE RALLIED TOO FAR -- OIL LOSES UPSIDE MOMENTUM -- GOLD MAY BENEFIT FROM A CORRECTION IN STOCKS AND COMMODITIES

CRB TRACKS THE EURO... Yesterday's message expressed the view that stocks and commodities appeared ripe for a downside correction. Both of those markets have been rising together since March. At the same time, the dollar has been dropping. I also showed that the Dollar Index appeared to have completed a five-wave decline from its March high which suggested a likely rebound in that safe haven currency. Today, I'd like the focus more closely on commodity markets which appear to have completed a five-wave advance. That would make sense since commodities and the dollar trend in opposite directions. Another market that trends in the opposite direction of the dollar is the Euro. In other words, the Euro and commodities rise together when the dollar is weak. Which brings us to Chart 1. The green line is the Euro. The boxed numbers show a five-wave advance from the March low (which matches the five-wave decline in the dollar). Chart 1 also shows the Euro up against chart rsistance at its December peak of 144. That makes for a logical spot to expect some profit-taking in the Euro and a bounce in the dollar. The orange histogram bars show the CRB Index tracking the Euro advance very closely since both bottomed in March. It also appears that the CRB has completed a five-wave advance of its own. That makes commodities (and stocks) ripe for a correction as well.

Chart 1

CRB INDEX COMPLETES FIVE-WAVE ADVANCE... The boxed numbers in Chart 2 show a five-wave advance in CRB Index from its March low. Notice that the early August peak is slightly higher than the June peak. The 14-day RSI, however, did not confirm that higher move (neither did the MACD lines). That type of negative divergence during a fifth wave is usually a more serious warning sign. There's good and bad news in Chart 2. The bad news is that March/August commodity rally may have run its course. The good news is that a five-wave advance is usually a sign that that there's more to come on the upside once a downside correctoin has been completed. [Bear market rallies take in place in three waves instead of five]. Normally, a pulback to the bottom of the fourth wave is normal. That would suggest a pullback to the vicinity of 230 which would put it in touch with its 200-day moving average (red line). Interestingly, that the same scenario I outlined for the S&P 500 yesterday. Chart 3 puts the commodity bounce in perspective and also explains why stocks and commodities have become so closely correlated. The CRB has barely recovered a third of its 2008-2009 price plunge and remains well below its 2007 low. The chart looks more deflationary than inflationary. In a deflationary climate, stocks and commodities become very closely linked (as they did in the 1930s). So do stocks and bond yields as shown in Chart 4. That's why stock and Treasury prices have been trending in opposite directions.

Chart 2

Chart 3

Chart 4

COPPER AND CHINA HAVE RALLIED TOO FAR ... The rapid rise in Chinese stocks this year has been one of the driving forces in the commodity rally (because China imports so many commodities). That's especially true of copper. Although both markets are in uptrends, they appear to have rallied too far, too fast. Chart 6 show China iShares (FXI) more than doubling in price since last October. The FXI has also retraced nearly 50% of its 2007/2008 bear market (while the Shanghai Stock Index has retraced 38%). At the same time, copper prices in Chart 7 have retraced nearly 62% of that bear market. Copper is also up against chart resistance formed by the late 2007 low. Both markets appear over-extended and in need of correction. A Chinese correction would most likely weaken most other commodities (as well as most global stock markets).

Chart 5

Chart 6

OIL LOSES UPSIDE MOMENTUM... Chart 7 (plotted through Monday) shows crude oil having doubled from $35 to $70 since the start of the year (usually a good time to take some profits). Secondly, the key commodity has tried unsuccessively twice to rise above $73 (during June and August). Chart watchers know the inability to exceed a previous peak is often the first sign of an impending correction. Another warning sign is the negative divergence in the 14-day RSI line (falling red line). The trend in oil is still up. A downside correction, however, could take it down toward its July low near 60.

Chart 7

GOLD STILL CONSOLIDATING... One commodity that may benefit from a general correction into the autumn is gold. Chart 8 (plotted through Monday) shows bullion trading within a triangle (converging trendlines) since March. As a result, gold missed the rally in most other commodities. That underperformance can be seen by the gold/CRB ratio at the top of Chart 8. That makes gold a contrary commodity play. The same is true of stocks. The gold/SPX ratio has also been falling since March. That suggests to me that any general correction in the CRB and S&P 500 indexes could push some money back into gold. Gold, however, needs a decisive close over its August high at $971 to break through its upper resistance line to turn its short-trend higher. Chart 9 shows, however, that the more important resistance level for bullion is at the $1000 which stopped rallies in March 2008 and 2009. A breakout through that level would be especially bullish. Another nice thing about gold is that it thrives in either an inflationary or deflationary climate.

Chart 8

Chart 9

PROGRAMMING NOTE ... Arthur Hill is on vacation this week.