Commodity Correction - Coming Into an Important Bottom?
By Frank Barbera CMT. August 12, 2008
For the last 4 weeks, commodity markets have been shredded with prices moving steadily lower across the board. From the July highs, spot Copper is down 17.72%, nearby Gold down 17.03%, Spot Silver down 24.62% and spot Platinum down 26.54%. Within Energy, the damage is even more considerable with Heating Oil down 25.55%, Unleaded Gasoline down 20.93%, Crude Oil down 22.94% and worst of all, Natural Gas down an incredible 38.60%. In Crude Oil, the decline has lasted 21 days dating back to the high seen at $146.65 on July 11th. That means Crude Oil has been declining more then 1% per day for 21 days. In the table below, we have gone back and assessed what could be considered all of the other ‘substantial' double digit corrections which have taken place in Crude Oil since the bull market began in 2002. Not surprisingly, at just over 20% the current decline in Crude is on par ‘as reasonable' for a potential correction low given what has been this market's high level of historical volatility.
|Date of High||Date of Low||Total Duration||Total %|
|All 14||Prior Declines||Averages:||27.9||-20.7|
In addition to the fact that the amplitude of the decline is generally within the ball park of other strong corrective declines, we would also point out that a number of technical gauges for Crude Oil are now fully oversold. In our work, we highlight Crude Oil as it has been the indisputable leader within the commodity complex. In the chart below, we show the 14 day RSI for Crude, a very medium term momentum indicator which is now down to a reading of +32.24. For the 14 day RSI, readings above +68 and at or below +32 qualify as important extremes. In the case of Crude Oil, the current reading is the single most oversold value seen since January 22nd, 2007.
Above: Crude Oil with 14 day RSI now fully oversold in the area of prior important lows.
In addition to the daily chart of Crude, we use USO, an ETF, to track the price action of Crude Oil on an even shorter term hourly chart. In this case, our chart dates back to late February 2008 and shows that USO is now down to very important support at the lower Bollinger Band. Both the Commodity Channel Index and the elongated RSI are also deeply oversold. In the case of USO, the price action over the last number of hours has formed a declining wedge formation, which is actually a potentially bullish basing pattern that would break out topside with any move above the $93.00 level on USO. Were USO to manage a break out, and there are never any guarantees, a snap back recovery rally could lift the Oil ETF back up toward the $100 to $105 area in my opinion. For spot Crude Oil, the equivalent rally would likely lift prices from readings near $113 to readings closer to the $125 to $130 range. This would effectively retrace about a half to two thirds of the recent decline. If USO is unable to hold nearby support at $90-$91 and Crude Oil unable to hold support at $110-$113, that would argue for further downside pressure in the Oil patch with the next important support for Crude Oil at $100, the March – April lows, and the low $80's on USO.
Above: the Hourly Chart for Crude Oil implies a bottom could be nearby.
Above: The CRB Index with the 14 day RSI and 100 day or 20 week Bollinger Bands.
Elsewhere, we cast an eye toward the widely watched CRB Index, which is presently also deeply, deeply oversold. As of Monday evening, the CRB Index registered a 14 day RSI value of +22.17, down from the prior day reading of +23.02. As it happens, this reading is among the 30 most oversold single day RSI values going back over the last 20 years, a period of 5,160 trading days.
That means that the CRB is presently in the .0058% most oversold, or put another way, is less oversold than this 99.41% of the time. ADD to this another fact that the CRB Index is also now right on major support at its rising 20 week lower band, and you have all the ingredients necessary for a very sharp counter-trend rally.
Above: the CRB Commodity Index
In fact, even if the CRB and the commodity complex in general are making a more important cyclical peak, the rally that should be directly ahead for commodities should lift the index from current levels near 507.86 to levels closer to the zone of the March 5th, 2008 peak at 575.96.
Over the years, this index has become complicated to track as there are now two very similar sounding CRB type indices. We use this one in our work, and at present the 100 day lower band resides as major support at 503.78 with the index at 507.86. The rally in commodities, once underway should be good until at least the beginning of October, at which point we will have to reassess the intermediate term outlook. In our view, the odds are at present, very high that the U.S. is heading into (1) a deepening recession which could easily evolve into a full scale depression, and (2) a full blown banking system crisis. On this later point, our confidence resides at all time highs. Just take a gander at today's price action in AIG and JPM. More of this yet to come.
So what does a deep economic contraction that will that likely be felt worldwide imply? It could have several major implications. Among these could be a renewed Dollar Crisis, which we fully expect. In our view, the US Dollar is recording a very major peak in this zone and over the next few weeks. Once that high is fully in place, we expect the Dollar Index to begin an even larger collapse to below 50 over the next 12 months. A falling dollar is generally a bullish support for commodities. However, within the commodity complex, a falling Dollar is super bullish for Precious Metals. Other commodities, like Base Metals and Energy, will likely not fair as well and since they have a higher weight in the commodity indices, they may end up treading water for some time, or perhaps even moving lower. The global recession will likely impact the demand for energy and base metals and to that end, some caution will likely be warranted at the next medium term peak. In our view, it is very likely that Precious Metals will all together decouple from everything else and begin their own private super bull leg climbing to new all time highs in what promises to be a stunning advance.
In our view, a substantive rally in physical commodities should also be a good harbinger for a recovery in badly oversold natural resource stocks. In the case of the Energy patch, we often keep a sharp eye on the Amex Oil Index, the XOI. Simply put, this index is now down to a major support area between 1250 and 1300 with a last quote in the neighborhood of 1288. Over the last few days, lower lows in the price of the index have not been confirmed by new lows in RSI, CCI, Stochastics and MACD. In other words, across a broad spectrum of momentum indicators we see developing evidence that an important bottom is nearly complete. For the XOI, a recovery rally should lift the index back up to above 1400 going into early October. This bounce in Energy and Resource names should also be of some assistance to the broad stock market, which likely manage to hold up in the current range for a few additional weeks.
Supporting the argument for a strong recovery rally in Energy type shares, we examine the Medium Term ARMS Index for Energy stocks using our GST Oil and Gas Index. Based on 40 large cap names, the ARMS Index closed at 1.40 on Monday, up from 1.396 last Friday. Over the last two decades, readings above 1.25 have been infrequent, usually one or two per year, and have always signaled the approach of a major low. For those not familiar with the ARMS Index, the indicator is plotted on an inverse scale, wherein high readings above 1.25 are oversold values and low readings below .75 are overbought signals. The last set of readings above 1.25 was all the way back on October 4th, 2006 and that signaled the completion of a bottom from which Oil and Gas stocks re-emerged as market leaders.
Above: the GST Oil and Gas Index (40 stocks) and the Medium Term ARMS Index or TRIN.
Above: GST Up to Down Volume Detrend Oscillator for Oil and Gas Stocks.
In addition to the ARMS Index, several other gauges are also highlighting a potentially important low. In our work, we also maintain a medium term Up to Down Volume indicator which is normally oversold at readings of –20% or less. On Friday of last week, this gauge closed at –26.68% with a close of –25.57 on Monday. Again, we are looking at what is easily the single most oversold cluster of readings on this indicator since the –29.92% seen way back on July 26th, 2002. For those without a clear memory, that low represented the deep oversold value from which the mega bull market in energy stocks sprang forth. Can you hear the bell ringing for another potentially important low? In our view, it is ringing loudly.
Above: the GST Oil and Gas Index with the longer range McClellan Summation Index.
Adding yet another stout voice to the case for an impending low is the Summation Index for Oil and Gas Stocks. Historically, on this gauge readings in the upper +2,500 to +3,000 zone have been high momentum (not necessarily bearish) signals. Typically, the Summation Index peaks months before an important high and will show an extended pattern of bearish divergence (lower highs) going into a major peak. However, at bottoms, the Summation Index has a marked tendency to be quite coincidental and in this vain, values below zero to –500 usually signal that an important low is at hand. As of Monday night, the Summation Index closed at +5.74, down from +22.19 the prior day and is now freefalling into negative territory. For an energy stock bull, this is the cavalry riding over the hill as the Summation Index, (which is based on Advancing and Declining Issues) now within a few days of matching the major oversold values seen in 2001 and 2002.
Elsewhere within the Energy patch, Oil Service stocks have actually had a smaller than expected decline. Historically, the OSX which tracks Oil Service issues, is far more volatile than the XOI, which is the Amex Oil and Gas Index, usually on an order of magnitude of two to three times more volatile. To that end, the XOI is presently down 24.76% from its May 21st peak of 1663.95, to the recent low at 1251.88 on August 5th. At the same time, the OIH which is an ETF that tracks Oil Service issues, is only down 23.29%, actually falling less than the XOI. On most occasions, we would expect the OIH to be down considerably harder on the order of 35 to 40% given the decline in XOI. However, this cycle has had a huge emphasis on finding new reserves, while at the same time, majors have been not replacing existing reserves. It is therefore understandable as to why, (with day rates for rigs a stratospheric levels) Oil Service stocks have held up so well. By the way, if Crude Oil cannot hold nearby support, Oil Service stocks would be likely more vulnerable to a further decline in Oil. That said, in our work on Oil Service stocks we note that the medium term ARMS Index is at 1.362 and is in the 1.35 to 1.40 upper boundary zone that normally delineates important bottoms. This means that the level of fear is quite high amid a sector that has arguably been THE market leader these last few years.
Above: GST Oil Service Index with Medium Term ARMS.
Above: Detrend A/D Ratio relative to lower medium term trading band.
In addition to the ARMS Index, we also maintain a medium term advance-decline gauge for our universe of 30 Oil Service issues, which at the present time is also substantially oversold. For the Amex Oil Index, a rally above 1310 would be bullish, while for the OIH, any move above 183.00 would likely signal the completion of an important low. For the OIH, major support resides just below current levels at 175.00, the 100 day lower band, and if a bullish break out should develop, a recovery back up toward the 200 to 210 zone would appear within the realm of the possible.
Finally, Smaller Cap E&P Companies have been especially hard hit, experiencing the largest percentage declines from the 12 month highs. Here again, as a sector, small cap Energy names are deeply oversold with the 14 day RSI back under +32 for the first time since August 2007. In our view, while there are never any guarantees about what markets will do in the future, for now, the technical readings throughout the Energy patch would seem to be suggesting that a rather strong rally could be just ahead.
That's all for now,
© 2008 Frank Barbera