It's not just gold and silver that appear to be starting new cyclical bull trends, it's commodities across the board. Could this be the start of another 2009-2011 type run? The evidence is compelling.
And the one outlier (for now): Copper
Getting right to it, the S&P 500 posted another all-time high this past week while virtually every other market indicator crashed in exactly the opposite direction. Nothing makes any sense anymore. Traditional market correlations no longer exist. Fundamental analysis no longer matters. Technical analysis no longer matters. The market is no longer a forward-looking, discounting mechanism. The only thing that matters is that the Fed and its counterparts abroad are creating money out of thin air to buy stocks and bonds in order to give the appearance that "all is well."
First, here's a chart of our completely "un-rigged" (as Zero Hedge likes to point out) market making yet another new high.
As you've probably read by now, crude oil was absolutely massacred after OPEC decided not to cut oil production at its Thanksgiving Day meeting. The last time crude was this low, the S&P 500 was in the low 900s, or 50% lower than the current price. Looks to me like we have lots of extra oil sloshing around with no economic activity to soak it up. But just look at the S&P, all is well!
Or how about the DBC Commodities Tracking Fund that I've posted about previously? As a refresher, the fund's own prospectus states that the index is "composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world." The last time DBC was this low, we were in the depths of the 2008-2009 financial crisis. Wouldn't you think that an all-time high in the S&P 500 might be accompanied by higher commodity prices?
The credit markets, supposedly the "smart money," are flashing HUGE red flags. The yield on 10 year and 30 year bonds crashed over the past week back to levels last seen in mid-October when the S&P actually sorta-kinda was allowed to fall just a little bit. Specifically, the 30 year yield is back down to where it was when the S&P was down 600 points intraday on October 15 before it was rescued by Mr. Bullard of the Federal Reserve. Remember, that was the day that the bond market broke and treasuries yields saw 10-12 sigma daily moves and traders were literally turning off their machines because the market was getting out of hand too quickly. If the market and the economy are so strong, why are billions of dollars pouring into supposed safe haven investments such as US Treasuries?
Lastly, I'll point out that housing, one of the cornerstones of our economy, have not even made it back to 50% of their all-time high set back in 2005. How in the world is the S&P able to print new all-time highs every week if housing isn't participating? Dave Kranzler posts some excellent housing analysis over at Investment Research Dynamics if you're interested in his take on where things are headed. Spoiler alert - it's not bullish.
I'll stop the rant here, but I think you get my point. The market is a train wreck waiting to happen. The Fed has too many balls in the air at one time - something has got to give and it looks like that time will come soon.
Commodities have been just awful the last couple of years as evidenced by the PowerShares DB Commodity Index Fund (Ticker: DBC). According to the fund's prospectus, "The Index is a rules-based index composed of futures contracts on 14 of the most heavily traded and important physical commodities in the world." Those 14 commodities are held with the following portfolio weightings:
By it's own definition, these commodities are the most "important physical commodities in the world." So, one would think, that a worldwide economic recovery might put upward pressure on this index. Let's take a look...
Here's a two year weekly chart of the DBC that shows nothing but weakness and it certainly isn't an inspiring chart if you're in the economic recovery camp. Just last week, the index broke intermediate support (green line) and fell hard to a fresh two year-low. Its RSI and MACD are terrible, themselves sitting at multi-year lows. So if the DBC reflects the "most important physical commodities in the world," then the "world" has got some serious problems. That must be reflected in the stock market, right? (where's that sarcastic font again...?)
I wanted to see how well the DBC correlated to the broader stock market so I did a long-term, side-by-side comparison of the S&P 500 (top graph) and the DBC (bottom graph). For the first 6 years of DBC's existence, it looks like it correlated very strongly with the S&P 500 - and that makes sense. Generally speaking, if the world economies are growing, then the world would demand more of these physical commodities thus putting upward pressure on prices. The opposite, of course, is true as well. If the world economies are collectively shrinking, then demand for these commodities should fall, along with prices.
The green-shaded boxes show periods of time when the S&P 500 and the DBC are rising together and the blue-shaded boxes show periods of time where they were falling together. The only time that the two were inversely correlated was during the initial market breakdown that lead to the financial meltdown of 2008-2009. Aside from these 6 months, however, there was a strong positive correlation.
But then something happened in late 2011. The stock market took off (on a completely unnatural 45-degree angle I might add) while the DBC languished. The correlation that existed from 2006 to 2011 not only disappeared, it has completely reversed! So either the stock market is right, and commodities represent a screaming, undervalued buy, OR commodities are right and the stock market has whole lot of catching down to do.
So do the stock markets represent an economic recovery or an utter dependence on easy-money federal stimulus? I'll let you decide.
The DBC is a PowerShares ETF that seeks to capture the return of a basket of different commodities including Light Sweet Crude Oil (WTI), Heating Oil, RBOB Gasoline, Natural Gas, Brent Crude, Gold, Silver, Aluminum, Zinc, Copper Grade A, Corn, Wheat, Soybeans, and Sugar. I'm taking a look at this today to see what commodities look like relative to the economy as a whole.
Here we have a 5-year weekly chart showing DBC to be in three year downtrend - much like gold and silver. After topping in mid-2011, it has obeyed the declining line of resistance shown above. After tagging the line just a couple months ago, it has fallen, on heavy volume no less, back down to intermediate support (shown by the solid green horizontal line). Short term indicators (not shown here) are suggesting a short-term bounce, but if you look at the weekly MACD, RSI, and moving averages, it appears that further downside is in the making. Look for the 50 dma to provide resistance if we do get a brief rally.
Longer-term, you can see the falling wedge pattern continuing to play out. The dashed horizontal line, marking the low from 2012, will be the next area of support. If this fails, expect a swift drop back to the low 20s where you can see the congestion from 2010.
The action in the DBC should be a bit surprising if you subscribe to the notion that we are in a booming economy as evidenced by yet another all-time high in the S&P today. If a strong stock market reflects a strong economy, then one would think commodities, and industrial commodities in particular (silver, aluminum, copper, oil, etc) would be in high demand and therefore rising in price assuming no readily available supply glut. Since the DBC is falling, it suggests either falling demand or increased supply (all else being equal) for the underlying commodities.
Based on the factors noted above, my bet is that the DBC will break down from here, falling 20% or so back to 2010 levels. In my opinion, this runs contrary to a strengthening economy, which should require more of these commodities to support increased industrial activity. So what's going on? As I've stated in previous posts (such as here and here), this bull market is getting very long in the tooth. We're starting to see evidence that a longer term trend change is starting to take place. While it hasn't happened yet, there are numerous indicators out there starting to flash cautionary warnings. In addition, it seems undeniable that the Fed, through unnatural market policies such as QE, has entirely decoupled the stock market from economic activity. Take a look at the graph below which shows Federal Reserve's total assets overlaid with the S&P 500 (from the Fed's own website). The green circle denotes when the first QE program went into effect.
What do you think? Does the S&P 500 reflect economic activity or does it reflect the Fed's balance sheet? That looks like an almost perfect correlation. As the balance sheet grows, so does the S&P. This would explain why the DBC shown above can fall for years while the stock market continues to make new highs. There is no longer any correlation between economic output and the broader stock indices. What happens when the Fed ends QE in October and starts reducing its balance sheet?