Commodity Indexes Reach Important Breakout Points

• Gold Has Done its Work as a Leading Commodity Indicator
• The Stock Market is Forecasting Higher Commodity Prices
• Commodities on the Verge of a Breakout
• Oil VIX Signals a Major Bottom in Oil Prices

Three weeks ago, I raised the question as to whether commodities had begun to embark on a rally. My conclusion was that there were some very promising signs, as some of the background factors were starting to look interesting - however, the evidence was not conclusive.

Gold Has Done its Work as a Leading Commodity Indicator

One of those background factors involved the leading characteristics of the gold price. Chart 1, for instance compares it to the CRB Composite. Using the benefit of hindsight, the shaded areas show extended rallies in the commodity index. Note that most bottoms (i.e. the start of the shading) are preceded by a dashed green arrow under the gold price. That combination indicates that investors in the yellow metal consistently discount future commodity price inflation. There are a couple of examples when both series reverse simultaneously, but they are by far the exception.

Gold prices bottomed in the middle of last year and have been in an uptrend ever since. In the meantime, commodities have been moving in the opposite direction as the largest positive divergence in the 50-year history of the chart has developed. That suggests that players in the gold market are looking through recent weakness and expecting commodity prices to eventually firm up. So how do we figure out when this favorable gold background is going to translate to higher commodity prices?

One way is to note when the ratio between gold and commodities peaks, then observing what happens to the CRB Composite. Turning points for the ratio are shown in Chart 2, which also features its 13-week ROC. The green vertical lines flag instances when the ROC peaks from a high level. Those reversals correspond with some kind of a low in the CRB. The latest data suggests that the ROC recently peaked from a very high level, thereby offering a commodity buy signal.

The Stock Market is Forecasting Higher Commodity Prices

Also going positive for commodities is my Inflation/Deflation ratio. This series pits equities sensitive to swings in commodity prices, such as natural resource stocks, to those that do better when interest rates are falling, such as utilities, consumer staples, etc. The arrows show that this stock market relationship has a good track record of forecasting major turning points for commodities. Consequently, its recent sharp rally is a strong omen in favor of forthcoming strength in the commodity pits, but what of commodities themselves?

Commodities on the Verge of a Breakout

Chart 4 reveals the very long-term technical position, where we can see a break below the red support trendline. There are many ways that the line could be constructed, but they would all have been violated. The one drawn in the chart makes sense, because it touches or approaches six declines and, importantly, intersects with the 12-month MA. It therefore represents a very significant barrier (resistance) to upside progress. There is obviously a lot to reverse here, so when I talk about a commodity rally, I am referring to a move that attempts to regain lost ground following the breakdown point at around 160, rather than something more ambitious.

The starting point is Chart 5, which indicates that the Index is in the process of breaking above the horizontal resistance trendline. A breakout is a breakout, but the chart looks as though some additional re-accumulation may be required, as a right shoulder completion would result in a stronger foundation from which a rally could be launched. Also, gaps are usually closed and there is a noticeable one that developed between Friday and Monday.

We see the same thing in Chart 6, featuring the DB Commodity ETF (DBC) and the Bloomberg Commodity ETN (DJP).

Three important commodity sub-components, the DB Energy (DBE), DB Base Metals (DBB) and Agriculture (DBA) are plotted in Chart 7, where three more potential bases are revealed. Base metals are worth watching because they appear to be the first that are emerging from their recent trading range, and, therefore, leading the way.

Oil VIX Signals a Major Bottom in Oil Prices

The key ingredient in all this comes down to the energy, more specifically the oil price, as energy has a very heavy weighting in all three commodity indexes. Oil is shown in Chart 8 together with the Oil VIX and its 10-week ROC. It definitely looks as though the indicator has experienced a reversal from a record high. Given that, as well as the fact that spot oil was recently trading at a sharply negative price, it's a small lift to conclude that a climactic bottom of major proportion was seen in late April. That does not necessarily mean that the oil price will take off on the upside, merely that a generational psychological low has just taken place. That in itself suggests that the potential accumulation patterns featured in Charts 5 and 6 will eventually be completed. That would then leave things clear for a worthwhile test of  the CRB Composite breakdown point in Chart 4.

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.