INDUSTRIAL COMMODITIES DON'T PARTICIPATE IN WEATHER-RELATED COMMODITY RALLY -- PLUNGE IN COPPER HINTS AT PROBLEMS IN CHINA -- NEW SELLING IN EMERGING MARKETS BEARS WATCHING -- DOW NEARS A TEST OF JANUARY HIGH -- WEEKLY S&P 500 INDICATORS RAISE CONCERNS
MAJOR DIVERGENCE IN COMMODITY RALLY... I've written several messages about the recent rise in commodity prices. I've also pointed out, however, that most of the commodity gains were in weather-related agricultural markets (and natural gas). From an intermarket perspective, however, weather-related markets have much less impact than industrial commodities that are more sensitive to global economic trends. Since the start of the year, the Power Shares Agricultural Fund (DBA) has surged 19% to make it the strongest commodity group. [The DBA includes grains, livestock, and tropicals like coffee and sugar). By contrast, PowerShares Base Metal Fund (DBB) has lost -6% to make it the weakest. [The DBB includes aluminum, copper, and zinc]. The two lines in Chart 1 show the huge disparity between the two commodity funds. As I suggested recently, true signs of economic growth require much stronger action in industrial commodities like copper. Unfortunately, copper has plunged recently. And a lot of that is being tied to problems in China.
(click to view a live version of this chart)
Chart 1
COPPER PLUNGES TO THREE-YEAR LOW... The weekly bars in Chart 2 show the price of copper plunging to the lowest level in three years. The chart also shows that copper has been in a downtrend since 2011, and has formed a pattern of "lower highs" since then. A lot of that recent selling is being tied to potential problems in the Chinese economy. That's because China is the world's biggest user of that commodity (accounting for 40% of world consumption). Many analysts fear that the collapse in copper hints at bigger problems in the Chinese economy. There are several reasons for that concern. One is simply that the price of copper is positively correlated to the Shanghai Stock Index (red line). Another is that the recent drop in the Chinese yuan (green line) makes it more expensive to import commodities like copper. Chinese imports have dropped 29% since the yuan started tumbling in February. Chinese companies also import copper and use it as collateral to obtain loans. As a result, copper weakness threatens wider financial problems in China. And, finally, last week saw the first corporate Chinese bond default in the country's history (amid fears that it may not be the last). That's worrisome because China is the world's second largest economy.
(click to view a live version of this chart)
Chart 2
CHINA ISHARES WEAKEN... Chart 3 shows China iShares (FXI) retesting its February low after failing a test of its 200-day moving average and chart support along its November low (horizontal trendline). That's not an encouraging sign for it and other emerging markets (since China is the world's biggest emerging market). Problems in the Ukraine are also weighing on Russian stocks. Chart 4 shows the Market Vectors Russia ETF (RSX) tumbling to a two-year low. That's adding to downside pressure on emerging markets. And, as we saw earlier in the year, weakness in emerging markets can spill over to developed stock markets.
(click to view a live version of this chart)
Chart 3
(click to view a live version of this chart)
Chart 4
DOW NEARS TEST OF PREVIOUS HIGH ... Chart 5 shows the Dow Industrials nearing a test of its January highs. Any time a major market index nears a test of a previous peak, it's worth paying attention. Because that's a spot when a market uptrend often encounters some profit-taking. The fact that most other major stock indexes have already hit new highs is a positive sign for the market's long-term trend. However, I continue to believe that the market's uptrend could experience increased volatility (in the form of a downside correction or period of consolidation) as we move into spring. [Problems in emerging markets could be a catalyst for that to happen]. Another reason for some profit-taking might simply be the fact that the Dow is nearing chart resistance around its January high while the rest of the market is in an overbought condition.
(click to view a live version of this chart)
Chart 5
S&P 500 UPTREND IS OVERBOUGHT... Although the trend in the S&P 500 is still up, some weekly indicators raise some short-term concerns. One is the fact that the 14-week RSI (top of chart 6) has touched overbought territory at 70 and is slighty lower than its fourth quarter peak. That potential "negative divergence" suggests that the uptrend is overextended. The weekly MACD lines overlaid on the weekly prices are also at a critical spot for the SPX. After turning down during January, the two lines are still negative. As I suggested in a February message, for the uptrend in the S&P 500 to have staying power, the weekly MACD lines need to turn positive. The current position of the lines shows that an important technical test of the market's uptrend is taking place. A failure of the two weekly lines to cross would increase the odds for a market pullback. The green bars below the chart show the MACD histogram testing its zero line. [The histogram plots the difference between the two MACD lines]. The histogram needs a crossing above zero to reverse the negative signal given during January.
(click to view a live version of this chart)
Chart 6
DOLLAR WEAKNESS STRENGTHENS GOLD... Gold continues to strengthen. The daily bars in Chart 7 show the Gold SPDR (GLD) gapping higher today to the highest level in six months. Part of the reason for gold's strength is a weaker dollar. The green line shows gold and dollar trending in opposite directions. A dollar peak last July concided with a gold bottom. A dollar bounce last October weakened gold. A dollar downturn at the start of February has pushed gold higher. The green line is now testing chart support at its October low. What is does from there will hurt or help gold.
(click to view a live version of this chart)
Chart 7
GOLD RALLY MAY BE HINTING AT STOCK PULLBACK ... Gold also benefits from a weak stock market. Historically, gold does better when stocks are weak. That's why the "lost decade" in stocks starting in 2000 was very good for gold. Not anymore. The spring 2013 upside breakout by the S&P 500 to a new record ended the secular bear market in stocks and the bull market in gold. During 2013, gold experienced its worst decline in thirty years as stocks rose. Chart 8 shows the generally inverse relationship between gold and the Vanguard Total World Stock ETF (VT). Notice that gold rallied during 2011 when global stocks fell. Those trends reversed during that fourth quarter -- gold peaked and stocks rallied (see arrows). Another gold peak near the end of 2012 helped launch another upleg in stocks. During 2013, gold continued to fall as global stocks continued their uptrend. Which brings us to the present. Gold has risen during this first quarter. Gold has also bounced off chart support at its mid-2013 low which is a positive sign for the metal. So far this year, gold and stocks have rallied together which is unusual. The fact that the January gold rally coincided with a sharp drop in emerging markets is worth noting. And has me wondering if the 2014 rally in gold is a warning that stocks are due for a correction. Seasonal considerations (combined with the midterm election cycle) suggest that the spring is a likely time for that correction to start.
