Commodity Stock Markets: a Technical Look

By: Bruce Zaro | Thu, Sep 29, 2005
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For some time, I've been watching the global commodity trend closely for signs the game has ended. Concerned with the prospect of economic slowdown in the US and/or China, investors have shown occasional nervousness in 2005 after a multi-year commodity rally only to find their moves to the exits to have been false alarms thus far. The late summer commodity rally of 2005 has particularly showcased precious metals, mining companies and coal. With commodities in mind, today I review three commodity-related stock markets, Canada's Toronto Stock Exchange Index (TSE), Australia's All Ordinaries Index (XAO-AU) and the ETF proxy for the Sao Paulo Bovespa, the Brazil Fund (BZF) to try and determine where things currently stand.

Toronto S& P TSE Index (SPTSE)

The S&P TSE Index is a capitalization-weighted index of the 60 largest and most liquid companies on the Canadian Market.

The TSE is quite clearly in a strong up-trend. From the August 2004 bottom at 452, the Canadian index's upside move was refueled with a slight break in October. The TSE again paused in the spring of 2005 around the time I first wrote about commodity stocks (Commodity Stocks - Trouble or Opportunity 5-13-05), later rallying once more to its recent 620 reading. So, what now? Is it wise to chase the Katrina rebuilding/spending binge and its likely inflationary impact by way of investing directly in Canada?

In addition to Point and Figure charts, I look to a couple of indicators from the toolbox to help me assess whether a pullback or further upside is likely.

Trading Bands. On the chart below, this index's trading band is highlighted. This band represents the average price of a holding over the last 40 trading days and its expected standard deviation range from that average, a useful indicator to help judge whether an asset is overbought or oversold in the short-term. It can be seen that this index currently rests near the top of its own trading band.

Weekly Distribution. The is the numerical value indicator telling how far above or below the medium point on the trading band a stock lies. The TSE now resides 43% above that point and is thus overbought by 43% on a weekly basis.

With these shorter-term indicators in mind, one would be wise to exercise patience and try to wait for pullbacks before making new purchases of stocks that would be representative of companies in the TSE Index. I prefer to have a risk reward ratio much more in my favor, and a pause in the latest advance back to the 550 range would tilt the odds back toward investors.

Australia (XAO-AU)

The All Ordinaries index represents 500 companies listed on the Australian Stock Exchange and accounts for approximately 99% of the total market capitalization of the Australian market.

The Ordinaries participated in the spring commodity sell-off (the tail end just barely visible on the bottom left hand of the accompany chart) before seeing numerous upside breakouts since. I certainly have been looking for signs of a trend reversal in many of the commodity plays, only to watch them float ever higher. The Ordinaries index has consistently traded on the higher side of its trading band, just as strong stocks will tend to do. Still, as with the TSE I would prefer a pullback to the low 4,000's to increase the risk reward opportunity before making any heavy commitments to this market in the near-term.

Brazil Fund ETF (BZF)

The Brazil Fund is a close proxy to the Sao Paulo Bovespa, which is how I will use it here. Among other components, this ETF's major weightings include 32% in materials and a 12% exposure to energy. Since many of the material and mining (in addition to precious metals) stocks experienced strong rallies of late, this Brazilian ETF is benefiting since one of its biggest components, for example, is Companhia Vale do Rio Doce, a stock whose chart looks excellent.

Throughout the rebound in global equities seen in the last couple of years, Latin American stock markets have consistently shown up as some of the strongest on the radar screen, and BZF has been right at the top. Indeed, from its $8.5 October 2002 low, BZF is up nine-fold, which poses a dilemma: although it currently is below the very top of its trading band, it is 68% overbought... like the markets highlighted above, it would seem wise to exercise patience before entering stocks or funds on the Brazilian market. However, investors need to keep in mind that the strongest s tocks and stock markets tend not to become terribly oversold on retracements, that they tend to pull back only to the middle of their trading bands, which is what investors might look for from stocks on this exchange.

While I'm using this ETF as a proxy for the Brazilian market for the purposes of this article, it must be said that the Point and Figure bullish price objective on BZF is $67 which implies that though a pause may be in order, the Brazilian market may have a lot further to run on the upside.

Finally, investors would be wise to keep in mind that the stock markets of "commodity economies" have seen the biggest runs over the last couple of years, another reason to exercise patience with regard to initiating new equity positions in commodity-related markets. While interesting from a fundamental standpoint and still healthy, if short-term overbought, on a technical basis, the world's commodity-related stock markets must be monitored closely by those participating in them.


Bruce Zaro

Author: Bruce Zaro

Bruce Zaro
Chief Technical Strategist
Delta Global Advisors, Inc.

Over his 20-year investment career, Mr. Zaro has become a highly-regarded technical analyst who runs private client portfolios at Delta Global. For the last 3 years, he served as Managing Director of Granite Wealth Management outside of Boston and spent nearly 15 years prior as a Vice President at Gage Wiley & Co. His current firm is full-service, but specializes in providing international market access as well as alternative investment strategies.

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