Several Intermarket Relationships Are Forecasting Higher Commodity Prices

• CRB Composite nudging through mega resistance
• Key intermarket relationships starting to point in an inflationary direction
• Inter-asset ratios also confirm the inflationary scenario
• Euro breaks to the upside

CRB Composite nudging through mega resistance

Late last month I wrote about several charts I was watching for a possible breakout in 2018. One of them was the CRB Composite, because, it was caught below some pretty formidable resistance in the form of a mega trend line. Early January has seen a small move back above the line. However, Chart 1 is based on month-end data, which means that the latest plot doesn’t count yet. Even so, some of the weekly charts have started to break out, and more importantly, have some key intermarket relationships. Let’s start with the relationship between commodities and the dollar.

Chart 1

Since the dollar and commodities move in opposite directions, Chart 2 plots the Dollar Index inversely, so that both series swing in a similar direction.  As you can see, each has broken to the upside. That for the CRB is fairly decisive, the one for the dollar relatively anemic. Given the close relationship between these two series, any additional dollar weakness will confirm its breakout. In turn, that would likely drive commodities still higher, thereby enabling the CRB Composite to decisively  break through that resistance in Chart 1.

Chart 2

Key intermarket relationships starting to point in an inflationary direction

Sometimes, when we are trying to understand what’s going on in a particular market it’s a good idea to check on other markets to see if they agree. In this case we can look at what the bond and stock markets might be saying about commodity market prospects.

Chart 3 zeros in on the bond market as it experiences its own inflation/deflation battle. That’s best expressed by comparing the price performance of inflation protected bonds versus regular ones in the form of the TIP/IEF ratio. Generally speaking, when the ratio is rising, it indicates that the inflation adjusted series is out-performing the Barclays 7-10-year Trust. That of course, means that bond market participants are betting on inflation, because they want the protection provided by these instruments. Note that the ratio moves sympathetically with major trends in the commodity index itself. Last week the ratio broke above its 2011-2017 down trendline, and the KST, in the bottom panel, turned positive as well. Clearly, the bond market is voting for higher commodity price inflation.

Chart 3

Chart 4 tells us what the stock market thinks about this in the form of a ratio between a resource based ETF, the Goldman Sachs Natural Resource (IGE) and a defensive one, the SPDR Consumer Staple (XLP). Once again, you can see that the swings in this stock market relationship are similar to those for the CRB.  More to the point, the IGE/XLP ratio has just broken out from an inverse head and shoulders formation and is experiencing a positive short-term KST. That breakout says that traders are expecting inflation hedge stocks to do better than their defensive early cycle leading counterparts.

Chart 4

We look at a different relationship in Chart 5. This one compares my Inflation sensitive stock Index to a similar measure that does well when deflation sensitive assets are out-performing. These are more widely based indexes than just using two ETF’s. The upper panel substitutes the DB Commodity ETF, the DBC. This series has experienced a much sharper breakout than the CRB Composite as has the Inflation/deflation relationship over the IGE/XLP ratio.

Chart 5

Inter-asset ratios also confirm the inflationary scenario

Charts 6 and 7 feature two inter-asset ratios. The first is between gold, which discounts inflation, and bonds, which do well in a deflationary environment. Once again we see similar action between this series and the DBC. After experiencing a rangebound environment since late 2014 this inflation/deflation relationship broke to the upside last month. What is intriguing is the fact that it experienced a false break to the downside  late last year, and this has now been confirmed with a break to the upside. Gold has a habit of shaking out weak holders ahead of a big upside move, so it will be interesting to see if the same thing happens in this instance.

Chart 6

Finally, what could be described as the ultimate inflation/deflation relationship, that between commodities and bonds, has also broken to the upside. We can see that in Chart 7 because of the break above the 2015-17 dashed down trendline and that through the neckline of an inverse head and shoulders. That latter breakout has been flagged by the solid green line.

Chart 7

Putting it all together

Many of these charts look similar, but all take different paths towards the same objective, figuring out the likely future for the inflation/deflation relationship in financial markets. The fact that they are all pointing towards an inflationary outcome is very significant. When the currency, stock, gold and bond markets are indicating a similar outlook we should listen. The message? Think more about emphasizing inflation hedge against deflation sensitive areas.

Euro breaks to the upside

Finally, Chart 8 shows that the euro broke out pretty decisively last week against the dollar. Since this currency has a 57% weighting in the Dollar Index, that strongly suggests that the Index itself is headed lower.

Also featured in the chart is a ratio between the euro and the Barclays 20-year Trust. I don’t normally follow this relationship, it just happened to appear on my screen after plotting another chart. However, there can be no mistaking that a major breakout, in favor of the euro has just taken place. Remember this is a total return relationship since it takes account of dividends paid by the TLT.

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.