After weathering a lackluster
grinding summer, commodities stocks are poised for a big rally. Thanks
to an anomalous divergence between commodities prices and the general stock
markets, commodities stocks are relatively cheap today. This has
created an excellent buying opportunity for investors.
Commodities stocks, of course, are
in the business of exploring for and producing raw materials. These
resources are exceedingly important, indeed utterly indispensable for life
and commerce. Even in this young Information Age, our entire
physical world is built out of commodities. All physical
movement is fueled by commodities. And despite new resource finds
getting scarcer, world demand continues to grow relentlessly.
Commodities stocks’ profits
are directly driven by commodities prices. The higher these
resources’ prices travel, the greater the raw profits and margins for
producing these products. And in the stock markets, the larger any
company’s long-term profits the higher its stock price will be
bid. So as the ironclad links of this causal chain show, it is
commodities prices that ultimately drive commodities-stock prices.
But over the short term, sentiment
heavily affects commodities-stock price levels. Even today a decade
into these secular commodities bulls, Wall Street still considers these
top-performing stocks exceptionally risky for some strange reason. So
when general-stock-market psychology is happily bullish, commodities stocks
surge higher much faster than the broader markets. And conversely when
Wall Street waxes bearish, the commodities-stock sectors readily leverage
In light of this background, a
very bullish anomaly has developed in today’s markets.
Commodities prices have been rallying strongly, guaranteeing higher future
profits (and hence stock prices) for commodities producers. Yet at the
same time, the general stock markets have been grinding sideways while
fighting intense mainstream anxiety. And commodities stocks have
latched on to this stock-market malaise, ignoring the rallying prices of the
products they produce.
This situation is easy to see on a
chart. Commodities prices are best represented by the Continuous
Commodity Index, the new name for the old-school equally-weighted geometrically-averaged
CRB index. The CCI is much more representative than today’s
so-called “CRB”, which is now dominated by crude oil. And
of course the general stock markets are best represented by the flagship
S&P 500 stock index (SPX).
On this chart the SPX, which
dominates short-term commodities-stock sentiment, is slaved to the left axis
in red. Superimposed over that is the CCI, which ultimately drives
commodities-stock profits, in blue. While commodities prices have been
rallying sharply and have returned to pre-stock-panic levels,
commodities stocks have been ignoring them to languish in the broader
SPX’s sideways grind.
Late 2008’s epic
once-in-a-century stock panic was not kind to commodities. Technically
that brutal period ran from when the classic VXO fear gauge first exceeded 50
on September 29th to when it finally fell back under that panic-defining
level on December 19th. Over that unbelievably-wild 58-trading-day
span, the markets weathered a raging fear storm like no one alive today had
ever seen before.
But to streamline today’s
analysis, I broadened this panic span to include all of September, October,
November, and December 2008. That year prior to those fateful panic
months, the CCI and SPX were completely uncorrelated. Their correlation
r-square ran a paltry 11% based on a negative underlying correlation.
Commodities did their own thing regardless of what the general stock markets
This changed radically during the
panic months, where the CCI/SPX r-square soared to a staggering 92% on a
positive correlation. Investors worldwide were so terrified that they
dumped everything regardless of fundamentals. As the stock
markets plummeted, futures traders feared a new global depression so
they jettisoned commodities at a frightening pace. Exacerbating this
already-mighty commodities selloff, flight capital deluged into the US
dollar. The resulting rallying dollar farther weighed on commodities
While the SPX ultimately plunged
53% in 10 months as a result of that panic, commodities didn’t fare
much better. The CCI plummeted 47% in just 5 months! With
both their sentiment driver (SPX) and fundamental driver (CCI) in free falls,
elite commodities stocks including the world’s biggest and best
producers lost between 60% to 90% of their stock prices! Such carnage
was utterly unprecedented.
Since that panic period, both
general stocks and commodities prices have rallied tremendously. The
post-panic CCI and SPX rallies were very similar and intertwined, a testament
to how ridiculously oversold both commodities and stocks became during the
panic. But despite this powerful CCI rally, still today most
commodities-stock traders remain so skittish that they look to the SPX for
guidance instead of the CCI.
This year’s first half
wasn’t great for the CCI. Earlier in 2010, commodities prices
were consolidating sideways while the stock markets were still
rallying. And then when the SPX corrected sharply in May and early
June, the CCI followed it down to new 2010 lows. But ever since that
early-June CCI bottom, commodities have been rallying strongly. In
normal times, commodities stocks would have followed them higher and
leveraged their gains. But lately they’ve mirrored the grinding
Interestingly, by early last month
the CCI had actually fully recovered all its panic losses.
Meanwhile the SPX had recovered most of its own, but still remained well
behind the CCI’s recovery. It is this development that drove
today’s commodities-stock price anomaly. Since commodities stocks
ignored the CCI’s entire recent 17% rally over 3 months, they are now
very undervalued relative to today’s commodities prices.
In order to better understand the
relative performances of the CCI and SPX since the panic, I indexed
each. This renders them in perfectly-comparable percentage terms and
eliminates visual distortion. They are both set at 100 at their closes
on the last trading day of August 2008, the eve of those 4 panic
months. As each fell 10% it hit an index level of 90, 20% equals 80,
and so on. This comparison is fascinating.
In those panic months, the
percentage decay curve of the CCI was nearly identical to that of the
SPX! This is startling and remarkable. Because of the CCI’s
geometric averaging across commodities and between individual contract months
within commodities, it is usually slow to move. So to see this
particular heavily-smoothed index match the SPX’s first true panic
plunge since 1907 is really extraordinary.
The SPX panic reached its nadir in
late November 2008, and the CCI bottomed just 2 weeks later in early
December. Ever since then commodities have been rallying on balance
despite the secondary SPX low in early 2009. Just after the Obama
Administration took office in January 2009, the SPX plunged sharply.
Why? Remember the arrogant
Democrats attacking hard-working American investors, saying our huge tax
burden was too low and they were hellbent on raising it? They were also
advancing scary Marxist class-warfare doctrine, an abhorrent anti-American
philosophy Obama continues to poisonously spew today. Thankfully the
Democrats are about to pay a heavy price at the voting booths for their
endless demonization of American small businessmen who have earned
success and created most jobs.
Amazingly the stock markets were
so ridiculous oversold by early March 2009 that not even the Democrat Despair
could hold them down. As they started recovering in a
fantastically-profitable new cyclical bull, commodities prices followed them
higher. There is a super-important psychological link between
stock prices and commodities prices that all investors must understand in
order to succeed.
The fortunes of the stock markets
affect sentiment universally. When they are rising, everyone
feels better even if they aren’t investors themselves. When they
are falling, everyone feels worse. Rising stock markets also make
traders assume the global economic outlook must be improving. And the
better the world economy looks, the faster global commodities demand will
grow. So a rising stock market leads futures traders to bid up
commodities prices, and vice versa. The SPX heavily influences the CCI.
But provocatively, the SPX often
falls behind and lags commodities before surging rapidly to catch up
again. We first saw this in early 2009 when Obama threatened the most
massive federal-government growth and attacks on Americans’ financial
freedom that we’ve seen in decades. Nevertheless, by mid-2009 the
SPX had caught up with the CCI in perfectly-comparable indexed terms.
This disconnect happened again in
late 2009, when the CCI surged higher decisively while the SPX reluctantly
consolidated higher. But in early 2010 the SPX once again caught up
with the CCI to match its post-panic performance perfectly. Though the
CCI corrected a bit in early 2010, at the point where the SPX caught up to it
general stocks were trading at their best levels since the stock panic and
commodities weren’t too far behind.
Once again for the third
time in mid-2010, the SPX fell behind the CCI. While the CCI started
rallying strongly in early June, the SPX just ground sideways in its
anxiety-laden summer spawned by the healthy spring correction. The
result, as you can see on this chart, is the biggest gap between absolute CCI
and SPX performance that we’ve seen since early 2009. This gap is
the anomaly that is so darned bullish for commodities stocks today.
In this entire post-panic
recovery, every time commodities advanced ahead of the stock markets,
stocks soon surged to catch up and match commodities’ progress. I
really doubt this pattern will suddenly break today. The SPX’s
cyclical bull is alive and well, and coming out of the low summer base there
is a great technical and sentimental setup for a big rally in the coming
months. Heck, just the prospect of throwing out some of the Democratic
Marxists who have so damaged American economic confidence is super-bullish!
And if the SPX once again surges
to catch up with the CCI’s absolute performance, it is very bullish for
commodities stocks on multiple fronts. First, commodities stocks are very
undervalued relative to today’s commodities prices since
they have been following the consolidating SPX instead of the rallying
CCI. So they are starting from an oversold and unloved base, which
means any investor buying will have a disproportionately-large impact.
Second, a rallying SPX will
improve economic confidence. This means futures traders will likely bid
the commodities prices even higher, effectively slowing the progress of
closing this gap. Of course higher commodities prices make commodities
stocks look much more attractive to investors, intensifying any new
investment demand. An improving economic outlook, rising stock markets,
rising commodities, and improving sentiment all feed on themselves and form
Third, as the SPX rallies the fear
trade including the US dollar is sold. A falling dollar leads to higher
dollar-denominated commodities prices, encouraging commodities-stock demand
among investors. This indirect dollar-negative impact of the
SPX-rally-driven reversal of the fear trade will add fuel to the fire under
commodities prices. Futures traders get excited about commodities when
the US dollar is trending lower.
Fourth, commodities stocks usually
leverage SPX gains. So as the SPX rallies to rejoin the
CCI’s progress, commodities stocks should surge much faster than the
general stock markets. Of course nothing gets mainstream investors more
excited than rapidly-rising stock prices, so this phenomenon too will feed on
itself once it gets underway. This week we are already seeing this
start in smaller commodities stocks.
Each of the past times the SPX
rallied to catch up with the leading CCI, commodities stocks rallied
sharply. This time ought to be even better due to overarching sentiment
trends. The majority of American investors have been hiding out in
zero-yielding cash and near-record-low-yielding Treasuries since the
panic. They are tired of watching the Federal Reserve inflate their
capital away. As they start to return to the markets, they will chase
performance. And commodities stocks will likely be the best-performing
At Zeal, we’ve been
preparing for the end of this anomaly since it first started developing in
May. Since then we’ve gradually layered into dozens of
high-potential smaller-commodities-stocks trades with great odds of soaring
in this coming rally. Today the trading books in our acclaimed monthly
Zeal Intelligence and weekly Zeal Speculator newsletters are full of
fantastic commodities stocks ready to rocket. While we’ve already
seen nice gains in most of these positions, it isn’t too late for you
Despite the countless
opportunities in recent months, most investors have been hypnotized by the
anxious drumbeat of fear, paralyzed into inaction. As these ostrich
investors wake up and return, their trillions of idle cash have the
potential to drive huge rallies. We’ve been specializing in
commodities stocks for over a decade, earning awesome returns for our
subscribers. You too can share in our knowledge, wisdom, and experience
as we continue to uncover new opportunities. Join us today!
The bottom line is commodities
stocks are very undervalued relative to commodities prices today. While
the latter have enjoyed a strong rally since June, commodities stocks have
languished in the stock markets’ sideways consolidation. This
anomalous disconnect cannot persist, as it is commodities prices that drive
commodities-producers’ profits, and ultimately any company’s
profits drive its stock price.
So even if the stock markets
continue to do nothing, commodities stocks are overdue for a big rally.
But every other time since the panic when the stock markets have fallen
behind commodities’ recovery, the stock markets soon surged to catch
up. This time probably won’t be any different. As
commodities stocks usually leverage stock-market gains, another catch-up
rally amplifies commodities stocks’ potential.
Adam Hamilton, CPA
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