COMMODITY COUNTRIES HIT HARD BY FALLING PRICES -- PLUNGING YEN MAKES JAPAN WORLD'S STRONGEST MARKET -- GOLD TESTS SUPPORT BUT IS NO LONGER FAVORED OVER STOCKS -- OVERBOUGHT S&P 500 BACKS OFF FROM 2007 HIGH AND LOOKS TO BE ENTERING CORRECTION
WEAK COMMODITIES HURT PRODUCERS... This is the same headline used in my March 21 message which showed how falling commodities were hurting stocks of countries that produced commodities. A rising dollar causes foreign stocks to underperform U.S. stocks, which has been the case since the dollar bottomed during 2008. A rising dollar hurts commodity prices. As a result, foreign countries that produce and export commodities take a double hit. The March 21 message showed the close positive correlation between commodity prices and Brazil and Canada. Today, I'm adding Russia to the mix. Chart 1 compares the trend in the CRB Index (bottom line) to Brazil (blue line), Canada (red line), and Russia (green line) iShares since 2009. You can see the visual correlations. All four markets rose together until the spring of 2011. The CRB Index peaked that spring (thanks to a rising dollar), and has continued to weaken. Brazil, Canadian, and Russian stock ETFs peaked at the same time and have continued to weaken along with commodities. Russia's stock market is especially sensitive to trends in energy, which is its biggest export market. Relative weakness in the Chinese stock market (which is the world's biggest importer of commodities) has also hurt demand for commodities and country stocks that produce them.
Chart 1
PLUNGING YEN MAKES NIKKEI WORLD'S STRONGEST MARKET... Since last October, when Japan first started talking about a big quantitative easing program, the Japanese yen has tumbled significantly. At the same time, Japanese stocks soared. [Please see February 7 message entitled "Nikkei 225 Reaches Four Year High as Yen Hits Three Year Low."] I explained in that earlier message that Japanese stocks and the yen have a strong negative correlation. A rising yen over the last decade has hurt Japanese companies and their stocks, and helped make them the world's weakest developed market. A rising yen also contributed to fifteen years of Japanese deflation. Yesterday's announcement by the Japanese central bank of huge bond buying and money creation is designed to raise Japanese inflation to 2% within two years, and break the deflationary cycle. Naturally, the yen dropped on the news and the Nikkie rallied. Chart 2 shows the inverse relationship between the two since 2006. A rising yen hurt Japanese stocks between 2007 and 2008, and again between 2010 and 2011. The collapse in the yen at the end of 2012 resulted in a major upturn in Japanese shares. The falling yen gives a huge boost to export-oriented Japanese stocks. That aggressive easing and the falling yen have made Japan's stock market the strongest in the world during 2013. Yesterday's BOJ announcement pushed Japanese bond yields to the lowest level in history (from an already low level). Just as in the U.S., historically low Japanese yields are forcing some money out of bonds and into Japanese stocks. Some of that Japanese bond money is also finding its way into U.S. bonds. The plunging yen has also boosted the U.S. dollar, which has hurt commodity prices, including gold.
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Chart 2
FALLING YEN HAS HURT GOLD WHICH IS TESTING CHART SUPPORT... Along with most other commodities, gold prices have been on the downside for most of the last year. A lot of that is due to a stronger dollar. Some is also due to a stronger stock market. Gold, however, has reached a critical chart point. The weekly bars in Chart 3 show Gold Trust Shares (GLD) testing important chart support formed around the 148 level during late 2011 and spring 2012. That's obviously a very important test because a decisive close below those lows would turn the major trend of gold downward. This would also be a logical spot for gold to attempt a rebound. [Gold mining shares have already fallen to the lowest level in four years]. The daily bars in Chart 4 show GLD experiencing a minor bounce today as stocks are selling off. The chart shows, however, that gold still remains within a six-month downtrend that started last October. Notice that the October peak in gold coincided almost exactly with a peak in the Japanese yen. Both have fallen together since then. The green line below Chart 4 shows the Dollar Index (UUP) starting to bottom last October, but not turning up until the start of February (second green arrow). Chart 4 suggests that the plunging yen had an earlier and much stronger impact on falling gold prices than a bouncing dollar. That being said, a weaker dollar today resulting from the weak jobs report is giving a boost to gold (as are falling stock prices).
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Chart 3
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Chart 4
GOLD TUMBLES VERSUS THE DOW... My February 28 message included the headline "Dow/Gold Ratio Turns in Favor of Stocks". Chart 5 is simply an inverted version of the same ratio. The black line shows the price of gold divided by the Dow since 2007. Throughout most of the last decade, gold was the better performing asset. Starting in 2011, however, the pendulum has swung away from gold and back to stocks. The gold/Dow ratio peaked that year and has since fallen to the lowest level in three years. I believe that's due primarily to belief among market watchers (including myself) that U.S. stocks are emerging from a lost decade dominated by deflationary pressures, which weakened the U.S. Dollar and boosted commodity prices. Gold attracted money as the stock market struggled over the last decade. With U.S. stock indexes at or near record highs, the safe haven attraction of bullion is gradually diminishing. Over the short-run, a pullback in stocks is giving gold a boost off chart support. Longer term, however, I expect stocks to continue to do better than gold.
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Chart 5
OVERBOUGHT S&P 500 BACKS OFF FROM 2007 HIGH ... The weekly bars in Chart 6 show the S&P 500 backing off from chart resistance formed during 2007. That's a logical spot for chart watchers to start taking some profits, and they appear to be doing so. The red line is the 14-week RSI line which reached overbought territory over 70 for the first time in two years (red circle). That also suggests that the market is due for a pullback. My March 28 message showed the S&P 500 to be in the fifth wave of an advance that started during November. Chart 7 shows those five waves again. It also shows the 14-day RSI line forming a very clear "negative divergence" during March (falling trendline). [A negative divergence exists when an indicator is dropping while prices are rising]. An oscillator negative divergence in a fifth-wave is usually a strong caution signal. This week's market selloff has taken place in heavy trading, and a number of former leaders (like small caps and transports) have already rolled over. Odds favor a short to intermediate stock market correction. A correction will often retrace back to the bottom of the fourth wave. That would be the February low for the S&P 500. This morning's message showed the Nasdaq Composite falling below its March low. A close by the SPX below its March low at 1538 would turn its short-term trend lower.
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Chart 6
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Chart 7
BOND PRICES JUMP IN FLIGHT TO SAFETY... Last Thursday's message showed the stock/bond ratio hitting a five-year high which showed increased optimism as investors rotated from bonds to stocks. Over the short-term, however, those roles have been reversed. Chart 8 shows the Barclays Aggregate Bond iShares (AGG) surging to a record high today. [The AGG includes investment grade corporates, Treasuries, and mortgage backed securities]. The blue line shows bonds turning up versus stocks this week for the first time this year. With bond prices rising, the 10-Year bond yield has plunged to the lowest level for the year, which suggests that investors have turned more defensive over the short run. It's also believed that record low bond yields in Japan is pushing some fixed income money into higher-yielding U.S. bonds. Rising bond prices (and falling yields) are consistent with a stock market correction
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Chart 8
REITS, TELECOM, AND UTILITIES ATTRACT NEW MONEY... We've been remarking about the fact that defensive stock groups like healthcare, staples, and utilities have been leading the market higher during the first quarter, which showed market caution. One of the attractions of those defensive sectors is higher dividends. This week's plunge in bond yields pushed even more money into dividend-paying groups. Chart 9 shows the Utilities SPDR (XLU) hitting a new record high today. The gray area shows a relative strength ratio of the XLU divided by the SPX. The ratio turned up sharply during March and is still rising. The green line (below chart) shows the 10-Year T-note yield. Notice that the upturn in utility performance (up arrow) coincided with the downturn in the bond yield (down arrow). Two other dividend paying groups attracting money this week are REITS and telecom. The brown bars in Chart 10 show the DJ Wilshire REIT fund (RWR) hitting a new high. The green bars show Telecom iShares (IYZ) also closing on a strong note (see circle). The two biggest reasons for the telecom jump came from record highs in AT&T and Verizon.
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Chart 9
