Perspective On Commodities - Part II

By: Erik Swarts | Fri, Sep 30, 2011
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Perspective

Although I have been trading in very short timeframes as of late, I like to keep an eye on the bigger picture as a sort of ballast to my approach in the markets. Lately, there has been a tremendous amount of debate and discussion on the collapse of bellwether commodities, such as copper, and what it means downstream for the economy and the stock market. You may hear the old market axiom, "Every bull market has a copper top", used by various pundits in the financial media. And while there have been enough occasions for that dynamic to ring true - a broader perspective towards the long term commodity cycle should be introduced in the discussion for greater context.

I believe we are now on the backside of one of, if not the greatest - commodity super cycles the world economy has had to absorb. The ramifications of this towards the global economy will be far reaching - from the lower input costs in manufacturing and shipping, to the considerable benefits of cheaper energy to the average consumer. I spoke tangentially to these points in my note, the Usual Suspects in August.

- Our economy through tremendous gains in productivity (and accounting) has transitioned to profitability at such a historically high petroleum and commodity cost multiplier, that by dialing energy and commodity prices lower here through the relative tightening (no additional QE) of monetary policy could in fact provide the most comprehensive stimulus to the economy and the consumer - just when the Fed was perceived to have no additional rounds left in the chamber. To think that even five years ago before the financial crisis hit, that the US economy would be able to maintain the degree of profitability it has exhibited today (with over 9% unemployment, a 12% output gap and until last week - $100 oil) would have been perceived as pure academic fiction. No economist in their right mind would have believed that these economic conditions could have produce such results. -

Certainly, it will not come without the perceived negative effects to those emerging economies that have up until this year, led the global markets and have benefited disproportionately from the booming commodity trade. However, that has historically always been the case with emerging markets. Those that have managed the profit windfalls responsibly, and have found a foothold on the global stage - will transition to a more developed economy.

But for the sake of argument and clarity, I created the chart below from a historic chart of the DJIA and the excellent long term commodity chart created by Hackett Financial. I estimated the retracement move since the chart was created based on the CRB index. I did not scale the components to each other for the basic reason that its utility is to simply convey what directional relationships between the two asset classes develop after the commodity cycle peaks.

As evident in the last two occasions where the commodity cycle has peaked, the stock market has initially followed commodities lower for only a spell - before breaking out of the long term trading range it was confined to. This makes rational sense, in that investment capital that was riding the commodity boom will eventually make its way over to the market that had been underperforming on a relative basis.

Historical Perspective of: DIJA & Commodity Cycle
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Long Term Perspective of SPX & CRB
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Reuters/Jefferies CRB Index
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* This last chart was created in mid June - Long Term Scale

 


Link to Part I: Perspective on Commodities - Part I

 


 

Erik Swarts

Author: Erik Swarts

Erik Swarts
Market Anthropology

Although I am an active trader, I have always taken a broad perspective when approaching the markets. I respect the Big Picture and attempt to place each piece of information within its appropriate context and timeframe. I have found that without this approach, there is very little understanding of ones expectations in the market and an endless potential for risk.

I am not a stock picker - but trade the broader market itself in varying timeframes. I want to know which way the prevailing wind is blowing, where the doldrums can be expected and where the shoals will likely rise. I will not claim to know which vessel is the fastest or most comfortable for passage - but I can read the charts and know the risks.

I am not a salesperson for the market and its many wares. I observe it, contextualize its moving parts - both visible and discrete - and interpret.

I practice Market Anthropology - Welcome to my notes.

Erik Swarts is not a registered investment advisor. Under no circumstances should any content be used or interpreted as a recommendation for any investment, trade or approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational and informational purposes only. All opinions expressed by Mr. Swarts are subject to change without notice, and the reader should always obtain current information and perform their own due diligence before making any investment or trading decision.

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