The inevitable periodic selloffs in the general
stock markets indiscriminately hammer all stocks lower. But they pose a
special magnified risk to commodities stocks. In addition to weighing
on this sector directly, stock selloffs ignite fast US dollar rallies.
This rapidly drives dollar-denominated commodities prices lower, amplifying
the selling pressure faced by commodities stocks.
The threat of a stock-market selloff is particularly
relevant today. The flagship S&P 500 stock index (SPX) is extremely
overbought technically, and sentiment is wildly complacent and bullish.
Key indicators reflecting traders’ collective psychology are pegged
near dangerous levels from where past major SPX selloffs started. Right
now the stock markets are as ripe for a major correction as they’ve
ever been.
Meanwhile the Continuous Commodity Index (CCI)
continues to achieve new all-time record highs, reflecting similar exuberance
in the commodities realm. And the benchmark US Dollar Index (USDX, the
best proxy for this currency) is relatively low with lots of room to
soar. I can’t imagine a more-perfect scenario for an SPX selloff
igniting a USDX rally that temporarily crushes commodities prices!
This effective double jeopardy that SPX selloffs
exert on commodities stocks offers great opportunity to speculators and
investors who understand it. When the risks of an SPX selloff wax high,
speculators can realize profits and raise cash to ride out the coming
carnage. Then once the SPX selloff passes, both speculators and
investors can snatch up the resulting commodities-stock bargains.
The inverse relationship between the US stock
markets and US dollar, at least at its present potency, flared up during
2008’s once-in-a-century stock panic. That epic event, far more
than anything else in our lifetimes, galvanized traders’ sentiment
during stock-market selloffs. Its echoes have been strongly felt in the
last couple years, and will continue to reverberate for years to come (with
decreasing intensity).
In order to understand how SPX selloffs ignite USDX
rallies today, we have to start during that crazy panic episode. This
first chart superimposes the USDX (blue) over the SPX (red) for
comparison. The inverse correlation between these two datasets is
visually-astounding. Major SPX selling episodes are highlighted in red
so we can easily see what the US dollar did over these particular spans.
![](http://www.24hgold.com/24hpmdata/articles/2011/02/img/20110218ELS160.jpg)
Before the panic, the US Dollar Index hit an all-time
closing low back in April 2008. It had fallen a mind-blowing 41% since
its secular bear started in July 2001! It is crucial to realize that
the dollar started off a very low base before that autumn’s stock panic
erupted. By mid-July 2008, the USDX was scraping along just 0.5% above
its all-time low. You could hardly even give US dollars away, global investors rightfully spurned them after their
long bear.
That month though, a bond panic started
brewing. After their stocks plummeted 72% and 78% in a single month, US
mortgage giants Fannie Mae and Freddie Mac teetered on the edge of
bankruptcy. Large investors around the world who owned trillions
of dollars worth of these GSEs’ bonds watched nervously. Would
they get their principal back if the GSEs failed? Rather than holding
and hoping, they rushed to sell GSE bonds. Some of this capital flooded
into US dollars (cash), and some parked in US Treasuries.
As these fears accelerated into a full-blown bond
panic, the USDX shot up rapidly. Then just when the dollar peaked and
started to roll over in August, the stock panic ignited. This is shaded
in red above. Between late August and late November 2008, just 3
months, the flagship S&P 500 stock index plummeted 42.2%! It was an
utter bloodbath, unlike anything seen since the Panic of 1907.
As terrified traders worldwide rushed to dump their
stocks, they moved their capital into cash. There is nothing better to
own in a rapidly-falling market, it preserves purchasing power to buy the
resulting bargains after the intense selling burns itself out.
Countless foreign traders, seeing their local currencies plunging with stocks,
sold their own money to buy US dollars. Thus the US dollar skyrocketed,
as you can see above.
The USDX itself, a measure of the US dollar versus
six other major currencies (mostly the euro at 57.6% of its weight), blasted
22.6% higher in just 4 months! Realize that currencies usually
move with all the sound and fury of a glacier, so this was a breathtaking
extreme for the world’s reserve currency. This particular USDX
rally was actually its biggest and fastest ever witnessed over such a short
span!
The SPX and USDX inverse correlation over that red
panic span is readily evident visually in this chart. This relationship
holds up statistically too, sporting a very high 81.7% r-square. Nearly
82% of the daily USDX price action over that stock-panic span was directly
explainable mathematically by the SPX’s own. The USDX even hit
new highs on the same days the SPX hit new lows, both at the original October
panic low and the secondary deeper November one. The dollar was slaved
to the stock markets’ fortunes.
And then when the SPX finally started stabilizing in
December, the USDX plummeted. There was no need for the safe-haven
refuge of US-dollar-denominated cash with the stock markets clawing higher
again. But then in January 2009, the stock markets inexorably started
sliding lower again. This trend accelerated in February as the new
Obama Administration haughtily asserted that American investors were undertaxed and the federal government was too small.
The SPX spiraled lower in despair.
Once again the USDX soared as the SPX plunged, even
exceeding its earlier panic highs. But as soon as the stock markets
finally managed to bottom in March 2009 (I called this in real-time), the
USDX started selling off again. The Fed’s announcement that it was
starting to monetize US debt, its original gigantic quantitative easing,
accelerated this plunge. Once again rallying stock markets negated the
need for a safe-haven refuge in the US dollar, capital left to return to
stocks.
Note that during that wildly-crazy stock-panic span,
the only time the USDX rallied materially was when the stock markets were
selling off. Then as soon as the SPX started rallying again, the dollar
sold off. At the time, Wall Street argued that this USDX strength was
due to the fundamental superiority of the dollar to other fiat
currencies. Nonsense! The dollar only rallied when stocks sold
off, it was a pure safe-haven play. There was nowhere else
to go so traders nervously parked capital in zero-yielding cash.
Even though holding cash is very wise when stock
markets are falling, that doesn’t mean the US dollar is either
fundamentally-sound or a worthy long-term investment. It was a
convenient shelter in an epic storm, nothing more. This surging dollar
behavior during the panic conditioned traders to flee into the USDX whenever
the SPX started selling off in the couple of years since.
A month ago I wrote an essay examining the extreme
complacency and apathy in the stock markets today that guarantees a major SPX
correction looms. In it I highlighted the pullbacks and corrections the
SPX has weathered so far in its cyclical bull to date. These same seven
SPX selloffs are highlighted below in red. Note what the US dollar did
during each one. The panic-spawned phenomenon of rushing into this currency
whenever stocks are weak is very much alive and well.
![](http://www.24hgold.com/24hpmdata/articles/2011/02/img/20110218ELS161.jpg)
The initial several pullbacks in this stock bull
were fairly small and short, and they happened early in the post-panic
recovery when the stock markets were rebounding rapidly. So their
resulting impact on the US dollar was minor. Yet note that this
currency still rallied sharply in each of those initial SPX pullbacks.
Then this SPX-driven dollar-rally model appeared to break in December 2009
when the dollar surged on its own accord.
Even though the dollar has been heavily influenced
by the stock markets in recent years, it still has its own
inherent technicals and sentiment.
Occasionally they get extreme enough to overpower the stock markets’
dominating influence. And in late November 2009, the dollar was simply
getting too oversold. Traders were too bearish on it and one of its
periodic bear-market rallies was due. So one indeed erupted, but it
soon petered out. Again the stock markets surged in early January 2010
and pushed dollar demand lower.
But then in mid-January last year, what would
eventually grow into the largest pullback (less than 10% selloff) in this entire
cyclical bull emerged. The USDX shot up sharply, topping the exact day
the SPX bottomed just like we had seen during the stock panic. Traders
were once again flooding into this currency for a safe-haven refuge during
fast stock-market selloffs. Due to the irrational euro panic the dollar
kept grinding higher in the subsequent months despite a stronger SPX, but its
rally was very anemic.
Then late last April, the SPX started on what would
prove to be its only full-blown correction (greater than 10% selloff) of this
bull. What did the dollar do as capital fled overbought and complacent
stock markets? It rocketed higher so vigorously that it actually neared
its old panic highs despite a vastly higher SPX! And then literally the very day
the SPX initially bounced in early June, the USDX topped. It started
plunging until the next SPX pullback in August, when it again surged sharply.
Beginning in early September when the stock markets
recommenced rallying, global traders again pulled their capital out of this
safe-haven-currency parking spot and the USDX collapsed. It
couldn’t manage another rally until the most recent SPX pullback
erupted in November. Then of course right on cue, the US Dollar Index
rocketed higher until the stock markets stabilized again. See the
crystal-clear pattern here?
Nearly without exception, the only times the US
dollar has rallied materially in the past few years was exactly
during stock-market selloffs. With the Fed relentlessly
creating new fiat dollars out of thin air like there is no tomorrow, and
interest rates at zero, and Washington spending like drunken sailors, there
is literally no fundamental reason to own the US dollar today. Traders
only want it in one specific situation, when stock markets are falling fast
so cash temporarily becomes king.
The entire dollar gains during the stock panic,
which sparked its biggest and fastest rally ever, happened only when the SPX
was plunging. At all other times, the USDX was generally sold
off. And over the couple of years since that panic ended, the only
times we’ve seen large and sharp USDX rallies (with the single
exception of that dollar-oversold episode) was when the SPX was pulling back
or correcting.
There is no reason why this behavior shouldn’t
continue. Since stock-market selloffs drag all sectors lower, none escape, the best trade to own during these events is cash.
It preserves your capital while your effective stock purchasing power grows
as share prices decline. Demand for cash will always surge during a
major stock-market selloff, and this will continue to drive major dollar
rallies. I have no doubt that the US Dollar Index will again surge when
this next overdue SPX correction finally arrives.
Now if you own stocks in most sectors, the
dollar’s action is largely irrelevant. Apple is going to keep
selling iPhones and iPads
like hotcakes regardless of which way the dollar meanders. But if you
own commodities stocks, these SPX-driven dollar surges are huge deals.
Your commodities producers’ profits are driven by the prices of their
underlying commodities, and these prices take a hit
whenever the dollar rallies. When traders bid the USDX higher, it takes
fewer dollars to buy any given unit of commodities.
So commodities stocks are hammered from multiple
fronts during stock-market selloffs. Like all sectors, they are sold
off simply because the general stock markets are falling. And since
professional traders still consider commodities stocks riskier than many
other sectors, they tend to leverage the declines in the stock markets.
Larger commodities stocks often double whatever the SPX decline
happens to be.
And a stock-market selloff’s parallel impact
on the dollar compounds this selling pressure on commodities stocks. As
traders see the commodities prices critical to producers’ profits
drifting lower, they start to fear for this sector’s core
fundamentals. So they accelerate their selling even beyond what the
stock markets would suggest is reasonable. A rising dollar alone weighs
on commodities prices and hence commodities stocks, but coupled with an SPX
selloff the resulting impact is freight-train hard.
The natural reaction of traders to any stock-market
selloff is to assume the economy must be deteriorating if stocks are
down. Usually this is incorrect, as periodic selloffs within ongoing
bulls are usually simply driven by technicals
(prices rallied too far too fast) and sentiment (consensus is too
bullish). They have nothing to do with fundamentals at all. But
when a fast dollar rally drives falling commodities prices in concert with an
SPX selloff, this bearish economic psychology metastasizes into fundamental
concerns.
So when the stock markets are falling, the dollar is
surging, and commodities prices are weakening, Wall Street endlessly declares
that commodities stocks are falling for fundamental reasons. With lower
commodities prices, their profits will deteriorate. Provocatively, you
usually hear bold declarations that the secular commodities bulls (or
“bubbles”) are finished during these SPX-selloff
events. This naturally leads to a really-negative environment for
commodities stocks. They are often beaten to a pulp.
This probably sounds depressing at this point, but
it really isn’t at all. Our goal as speculators and investors is
simple, to buy low and sell high. In order to buy low, we need
selloffs periodically to drive commodities-stock prices low enough to be
relatively-cheap bargains. SPX selloffs, which are inevitable, healthy,
and necessary to keep sentiment balanced, drive the best buying opportunities
ever seen in this entire commodities-stock bull. These selling events
should be gleefully anticipated!
They certainly are here at Zeal. As lifelong
speculators ourselves, we zealously study the markets to uncover
high-probability-for-success trading opportunities for our own capital.
By selling commodities-stock trading positions just before stock-market
corrections and buying back in just after they’ve run their courses,
we’ve amassed an amazing record of success over this past decade.
Our subscribers have made fortunes by heeding our famous contrarian research
and mirroring our trades.
All 235 stock trades made in our flagship Zeal Intelligence monthly newsletter since 2001 have averaged annualized realized gains
of +52.4%! Lately with the stock markets so overbought, we’ve
been realizing our many large gains from the autumn rally and amassing
cash. Then once this overdue stock-market correction arrives and
hammers commodities stocks, we’ll be ready to buy the resulting
oversold bargains which will subsequently multiply our capital again. Subscribe today to our acclaimed monthly or weekly newsletters and be ready to seize
the fantastic buying opportunities that are approaching!
The bottom line is stock-market selloffs ignite
major US dollar rallies. And these are almost the only times the dollar
surges, as the vast majority of its rallies in the last few years coincided
perfectly with stock selloffs. Cash is the natural and prudent refuge
in times of falling stocks, as it preserves capital while its purchasing
power increases. But the resulting dollar surges weigh heavily on
commodities prices.
This is a problem for commodities stocks, especially
if they produce commodities with prices particularly sensitive to dollar
action. These weaker commodities prices combine with the general
bearishness of falling stocks to lead to outsized losses in this sector.
While tough on traders not expecting this behavior, it is a huge boon for
those who do. It leads to the best commodities-stock buying
opportunities ever seen in their ongoing bull markets.
Adam Hamilton,
CPA
Zealllc.com
So how can you profit
from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence,
that details exactly what we are doing in terms of actual stock and options
trading based on all the lessons we have learned in our market
research. Please consider joining us each month for tactical trading
details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm
Questions for
Adam? I would be more than happy to address them through my
private consulting business. Please visit www.zealllc.com/adam.htm for
more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that I
am not able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000
- 2006 Zeal Research (www.ZealLLC.com)
|