Commodities Remain on a Knife Edge

• Where Are We in the Cycle?
• The Economy is Currently on the Side of the Bulls
• The Technical Position of the DB Commodity ETF is Precarious

Where Are We in the Cycle?

Back in December, I wrote an articlepointing out that the business cycle was nothing more than a set series of chronological sequences. The importance of this observation, for investors, is that the primary trend peaks and troughs of bonds, stocks and commodities fit nicely into that chronology, as shown in Figure 1. At that time, my models for the three markets indicated that the the cycle was likely somewhere in the green-shaded area. They still do. The diagram implies that the US economy is emerging from a recession, but, clearly, that's not the case. However, since the last recession, which ended in 2009, the economy has undergone three growth slowdowns, which were all associated with that bond, stock, commodity chronological turning point sequence.

Figure 1

My work shows that the latest slowdown, which began around at the end of 2017, now appears to be ending. Since bonds and stocks are already in a confirmed bull market, the next event to look out for is a bottom in commodities. Last December, it seemed that commodities were just about to break to the upside, but the confirmation that I called for never happened. That confirmation was a month-end close in the CRB Composite above 190, which would have taken it above the green down trendline in Chart 1. Instead, the CRB experienced a sharp drop due to economic fears concerning the coronavirus. Now, it is back to support just above the red trendline. In the meantime, nothing has yet changed for the worse on the economic front; indeed, things have actually improved.

Chart 1

The Economy is Currently on the Side of the Bulls

In that respect, Chart 2 shows that housing starts, a very long leading economic indicator due to their sensitivity to interest rates, literally exploded in the last couple of months. This is also reflected in its KST. This series has now reversed sharply to the upside, yet remains at a subdued level, meaning that it has plenty of upside potential until it gets to its traditional warning level. Ironically, the recent drop in commodities has had a stimulating effect on housing, since the drop was accompanied with a decline in rates themselves. Swings in the housing start numbers are not very helpful in forecasting commodity trends. However, since they are a forward-looking indicator, they are of invaluable help in forecasting trends in other parts of the economy. Chart 2, for instance, shows that housing start momentum consistently leads that for industrial production, a coincident indicator at peaks.

Chart 2

On the other hand, Chart 3 demonstrates that same leading characteristic at bottoms. If the normal sequence repeats again, I would expect to see the KST for Industrial Production soon reverse to the upside.

Chart 3

That's important for commodities, because Chart 4 tells us that upside reversals in industrial production momentum are consistently associated with major commodity buying opportunities. All indicators and relationships fail from time-to-time. The two dashed arrows show that this one is no exception, given two failed signals in 1981 and 2014. Note also that, in the majority of cases, lows in production momentum lag the actual bottom in the CRB by a few months.

Chart 4

Chart 5 underscores the critical nature of the inflation/deflation picture. That's because the 10-year yield has fallen to support in the form of the 2012-2020 red trendline. By the same token, a key commodity, copper, is also just above support, as indicated by the two converging trendlines.

Chart 5

A similar message is being telegraphed in Chart 6, which compares the 10-year yield to the spread between the iBoxx High Yield and the iShares 7-10-year Treasury ETF; both are trading between two converging trendlines.

Chart 6

The Technical Position of the DB Commodity ETF is Precarious

When we look at the technical picture of the DB Commodity ETF (the DBC), we get a mixed but potentially bearish picture, unless the price can quickly stabilize and move to the upside. It has already violated the red up trendline, but has so far held at last summer's low by the horizontal dashed line. The short-term KST is bearish and its intermediate counterpart looks as though it might soon join it in the negative camp.

Chart 7

Finally, Chart 8 shows the sharpness of the recent decline, as well as the fact that the 9-day RSI recently recorded an extended period of oversold readings. Since then, it's also reached the support zone, from which the price should bounce. If commodity prices are still in an ongoing bear market, any bounce will probably not amount to much, especially as it follows on the heels of the false upside breakout that developed at the end of 2019. False breakouts, it should be noted, are typically followed by above-average moves.

Chart 8

On the other hand, if commodities are in the process of turning around on a primary trend basis, as suggested by an improving economy, the bounce will be more significant. Of course, things could quickly change in the event that the coronavirus spreads faster than expected. While that is an unknowable black swan event, it seems unlikely since the stock market, sold off on virus fears, but has gone on to register a new high. Remember, there is an old Wall Street adage that says the market never discounts the same thing twice. Let's hope so!

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 Groupof Walnut Creek or its affiliates.