Commodities Experience a False Upside Breakout -- Or Did They?

Earlier in the month, I pointed out that the long-term indicators for commodities were still bullish, but getting overbought. At the same time, several intermarket relationships were signaling danger, which suggested some degree of vulnerability. Prices have not moved very much since then, but, bearing in mind that overstretched technical condition, market action is now starting to take on a more ominous tone. In the meantime, those intermarket relationships have continued to point in a southerly direction.

Chart 1 sets the scene from a long-term perspective, as it shows the extended nature of the long-term KST for the CRB Composite. The solid red arrows indicate that KST reversals are usually associated with some kind of bear trend. The two dashed arrows warn that a price drop is not inevitable. At the moment, that point is moot, since the indicator remains in a rising mode. The Index is also above its 12- and 24-month moving averages, further boosting the bull market case.

That said, recent price action is showing some cracks that could feed over into a more meaningful decline, which might result in a long-term KST sell signal. Chart 2 shows the weekly action of the Bloomberg Commodity ETN (DJP). Last week, the price formed a bearish Pinocchio bar. These one-bar price patterns develop when the intra-bar activity pushes the price through resistance. However, by the close, it is unable to hold above that resistance, thereby resulting in a false breakout. In this case, the resistance took the form of the green trendline that had turned back multiple attempts to clear it. Candlestick fans will also recognize that Pinocchio bar as a bearish gravestone doji.

Note also that the 9-week RSI has gradually been diverging negatively with the price since its late April peak. The Pinocchio is just one piece of evidence that the trend may have reversed, so it makes sense to look around for some confirmation, thereby raising the odds of a valid signal. In this instance, that would come from a decisive break in the 2020-2021 up trendline, say, at $26.50.

Chart 3 features a daily chart where six previous attempts were made to clear the resistance trendline. The seventh last week has so far proved to be false. Most concerning is the protracted weakness in the indicator in the lower window. This one monitors a universe of individual commodity ETFs registering net new highs over a 50-day period. At the September 15 peak in the DJP, barely any commodities were at new highs, hardly a sign of a healthy market.

Energy Confirms Last Week's High

One area that did register new high ground was energy, in the form of the Invesco DB Energy Fund (DBE). That said, failure by the price to hold above the horizontal resistance trendline line is a distinct worry, as it suggests that traders who bought on the breakout may be trapped on the wrong side of the market. This matter is likely to be resolved in the near future, as the short-term KST is still in a bullish mode. It is therefore in a position to support a rally above the September 15 high, which would cancel the "false" part of the breakout.

On the other hand, the price is not that far above the blue 50-day MA, a negative crossover of which would offer some confirmation that the September 15 breakout was a false one.

Dr. Copper Getting Sick?

Copper is an important commodity on the metals side of the ledger. It is shown in Chart 5, together with its Special K indicator. The Special K, which you can read about here, has a strong tendency to peak and trough on a primary trend basis with the price it is monitoring. These major turning points are easy to spot using the benefit of hindsight, but are a bit trickier in real time. One way is to construct a trendline for the price and the indicator. When they arebothdecisively violated, a valid trend reversal is usually signaled.

Three examples since 2015 have been flagged in the chart. In the current situation, the Special K has already violated its bull market trendline. Since it has turned back numerous reactions, its penetration represents a fairly significant technical event in its own right. The price itself dropped below its dashed up trendline earlier in the year and is now right at the 200-day MA. Also intersecting in the same area is the neckline of a potential head-and-shoulders top. A downside break that can hold would confirm Special K action and suggest some kind of a bear trend. Since copper has reached a critical technical juncture, it needs to be watched very carefully in the period ahead.

What Do Credit Spreads Say about Commodities?

The final two charts feature the ratio between the iBoxx High Yield and the 7-10-year Treasury ETF (HYG/IEF). When the ratio is advancing, it means traders are gaining confidence, as they show a preference for the higher-yielding and riskier HYG. Those swings in confidence, as you can see from the arrows, show that there is a strong correlation with commodity prices. Recently, these two series have been on diverging paths. Commodities have edged to new highs, but confidence has been slacking off. Who to believe?

Chart 7 shows that the answer to that question could easily go either way. On the one hand, the ratio is still below its 2018-2021 down trendline. On the other, it remains above its 65-week EMA, which, the small arrows tell us, is a great support/resistance zone. Unfortunately, we not only have a conflict between the three KSTs, but none are in a decisive mode and could easily reverse.

That combination makes the ratio too close to call. Two points to monitor going forward are a decisive break above the trendline in Chart 7 or a drop below that 65-week EMA. Given its close relationship with commodity prices, such action would also go a long way towards appraising whether the DJP can overcome the negative undertow of its false upside breakout or if will succumb to the long-term overbought technical condition for commodities in general. Please remember, you can update these charts in future by simply clicking on them.

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.