The Dow Report: Commodity Boom or Bust
By Tim W Wood CPA, May 13, 2005
It's been a while since I talked about commodities, and given the price action seen this week, I thought that we would revisit this subject today. In early December 2004 it looked as if the commodity boom was over. At that time many of the technical pieces had fallen in place indicating a major top had occurred. But, there happened to have been one last gasp into the parabolic advance that ended in March.
But what about now? Is the commodity boom really over? Has the recent decline really been another buying opportunity? Why have gold stocks been hit so hard? Why is the dollar rallying? Why is oil falling? Isn't this an inflationary environment? Why did Warren Buffet loose $300 million shorting the dollar? What is going on here?
On April 15, 2005 I introduced to you my Trend and Cycle Turn Indicators. In that wrap up I explained the rules and how I used these indicators as an aid in my cycles work. I also explained that these indicators were designed to help simplify the cycles work. The really neat thing about these indicators is that they can be used on a long, intermediate and short term horizon. This helps to define the Primary, Secondary and shorter-term trends. These indicators can also be used on relative strength charts in order to tell me when one index or commodity will out- or under-perform another on a particular time horizon. In an effort to answer a few of the questions I presented above, I will show you a few of these charts along with these indicators, and explain their meaning. We will not look at all of the time horizons because that is outside of the scope of this commentary and would require far too many charts and complicate the matter.
The first chart below is a weekly chart of the CRB Index. There is a long-term cycle in the commodities market that I have traced back for the better part of a century. This cycle is a 3-year cycle. There are numerous pieces of technical DNA that are common with the formation of these 3-year cycle tops. Today, I am only showing you one of the pieces of DNA that is centered around these tops. I have found that at most 3-year cycle tops price will diverge with the Trend Indicator. You can see an example of this at the last 3-year cycle top in 2000 and the divergence between price and the indicator is marked in red.
If you look at the current top you will see that at the December 2004 high we also had a divergence between price and the Trend Indicator. This divergence is marked in blue. From that diverging top, the CRB began to move down and it appeared that the 3-year cycle had once again topped. But, commodity prices were able to muster up an additional push in spite of this divergence. I believe that this was a direct result of the Fed's re-inflation efforts, which did indeed make this cycle run a bit long, but still within the historical norms. However, in spite of the parabolic move into March, the Trend Indicator was not able to better its early 2004 peak. Therefore, the divergence at the March high still exists, but at a different level. Since the divergent high seen in March, the CRB has once again begun moving down and that down move has been confirmed by a down turn of the Trend Indicator. Yes, there are a few other technical tea leaves that I need to see line up, but all indications based on this indicator are suggesting that there is a very good chance the 3-year top in the CRB is in. If so, the next meaningful buying opportunity in commodities will not occur until this indicator turns back up confirming the next cycle low. We also have the monthly and daily charts that we monitor in order better fine tune the trend at two other levels. The divergence between the Trend Indicator and the CRB at the recent price high clearly warned of this top. It is the fact that this cycle has topped and the CRB is now declining out of this 3-year cycle top that explains the recent price action seen in commodities and the Trend Indicator did provide advance warning.
The next chart shown below is a monthly relative strength chart between the XAU and gold. I have also plotted the Trend Indicator on this chart. When the Trend Indicator is moving up it is telling us that gold stocks are out performing the physical metal, and conversely when the Trend Indicator is moving down the gold stocks are under performing the metal. As you can see in the chart below, the monthly Trend Indicator turned down last year telling me that the gold stocks were going to be under performing the metal, and this is exactly what has occurred. Since this down turn in early 2004, the XAU has declined 25%.
I have also found that when the Trend Indicator turns down at this level and the gold stocks begin to under perform gold, this serves as one of the many DNA markers which tend to appear at the 9-year cycle tops in gold. For example, the double top seen by the Trend Indicator in 1994 and 1996 occurred at the previous 9-year cycle top in gold. The price swing that occurred in gold between the 1994 high and the final high in 1996 was approximately 5%, and the final down turn of the Trend Indicator in 1996 marked the previous 9-year cycle top in gold.
The next chart below is a monthly chart of the XAU along with my Trend Indicator. Notice that this indicator turned up at the 2000 price low and out of a diverging bottom. From that low the gold stocks performed very well into their January 2004 9-year cycle top. This was confirmed by a down turn of the Trend Indictor. Then, in mid 2004 the XAU attempted another advance, but failed creating a double top right at the downward sloping trend line. This failed advance temporarily turned the Trend Indicator positive, but from that failed top, price broke down once again, which was confirmed by the Trend indicator. Now the XAU has dropped below the upward sloping trend line that served as support for the bullish move out of the 2000 9-year cycle low. So, not only did the Trend Indicator on the XAU chart below tell us that gold stocks had topped out in early 2004, this was also confirmed by the relative strength chart above.
It is for these reasons along with my cycles work and the other technical DNA markers that I have remained bearish on gold, the gold stocks, and commodities for the last year. Understand that there will be rallies along the way in both gold and the gold stocks. The key is to know if such rallies are being confirmed at the daily, weekly or monthly level by the Trend Indicator. If such rallies are not confirmed by a monthly and weekly upturn of the Trend Indicator, then any such bounce is a counter trend bounce and not the beginning of another sustainable move up. Trading against the direction of the indicators is not advised.
I will tell you that odds greatly support the notion that the commodity boom is over, at least for now. If the commodity boom is still on, then these indicators will turn up. This indicator and the ratio charts do not care what popular sentiment is saying. They do not care that Warren Buffet has been short the dollar. These indicators do not care what the price estimates on oil, copper, silver, gold or gold stocks have been. They do not care what the fundamentals are in China, the US or with GM and Exxon. No, these indicators have no emotion because they are based on price, and price is ultimately all that counts. I know that when I talk cycles many people find the concept hard to grasp. Therefore, I have been working with this and a variety of other indicators that are all tied to the various cycles in an effort to make my cycles work much easier to understand. All one has to do is look at the direction of the indicator. It's either up or down at each of the various levels and when following these indicators on the different time intervals, (daily, weekly and monthly) we will not find ourselves on the wrong side of the market.
As an example, in December 2004 I told subscribers that the dollar was making a major low. In December 2004 I also explained why gold had likely made its top. In February 2005 I told them that a bounce in gold was coming and gave my buy signal for the bounce. Then, in March 2005 I told everyone to bail once again on gold and specifically that gold stocks were about to get hit. These calls were based in part on the Trend and Cycle Turn Indicators, which were obviously correct. So, my point here is that these indicators do work and knowing their direction and interrelationships with other charts, cycles and the various relative strength charts are key to staying on the right side of the market and to keeping your emotions out of the picture.
Tim W. Wood
© 2005 Tim Wood