Commodities vs Bonds comparison for mapping future interest rateCommodities vs Bonds futures comparison for mapping future interest rates projections ....
AW1! trade ideas
AW1 bull gartley near trendline breakoutaw1 3d bull gartley harmonic, coming off support, just broke downtrend line before rejection back to just above prev support. watching for another breakout higher with gartley pt at B level. This is also a large bull pennant on daily/weekly tf
Myth-busting: top 6 misconceptions about commoditiesWisdomTree has long-standing expertise in commodities, and this asset class constitutes a core part of our business. We aim to debunk several myths that surround commodity investing1.
Myth 1: Commodities are only a tactical instrument
Some believe that commodities trade in a range and do not outperform over the long term. Furthermore, they think commodities only outperform in an ‘up’ phase of a commodity ‘super-cycle’.
Physical commodities are the fundamental building blocks of our society. Therefore, it is no surprise that their price movements largely explain inflation and tend to at least match inflation over the long term.
Furthermore, commodity investors most often invest in futures contracts, not physical commodities. Futures contracts have been designed as hedging tools to allow commodity producers and miners to hedge their production forward, making their businesses sustainable and allowing them to invest because they are insulated from the commodity prices’ short-term volatility.
Producers are willing to pay for this hedge, just as they would pay for insurance. Therefore, investors who provide this hedge by buying futures contracts receive an insurance premium that allows them to beat inflation over the long term. This ‘insurance’ is a permanent feature of commodity futures and doesn’t fall away through economic cycles. Thus, commodity futures are suitable for consideration as a strategic investment, not just tactical investments.
Commodities futures provide a positive risk premium, driven by their intrinsic link to inflation and embedded ‘insurance premium’. While upward phases of commodities’ super-cycle are historically advantageous for commodity investors, future-based broad commodity investments can deliver a risk premium in any part of a super-cycle.
Myth 2: Losses are guaranteed when commodities are in contango
Contango (negative roll yield) and backwardation (positive roll yield)2 are used to describe the state of the futures curve. It describes the relative position of the current spot price and the futures contract price. Drivers of roll yield include storage costs, financing costs, and convenience yield. Backwardation is often associated with demand strength when people are willing to pay more for immediate delivery than lock into a contract for later delivery at a cheaper price. Some believe that, because contango is the opposite state of backwardation, losses are guaranteed as a corollary.
The fact that Keynes’ theory is called ‘normal backwardation’ has caused some terminology confusion. However, what is described by Keynes is that futures contracts are generally priced at a discount to the expected spot price at expiry. It has nothing to do with the current spot price. In other words, the curve can be in contango, and the future price can still be at a discount to the expected spot price at maturity, that is, be in normal backwardation as well.
Using a numerical example, let’s say that WTI Crude Oil is worth $50 today. The market expects WTI Oil to trade at $55 in a month (expected spot price) because of storage and other costs. Keynes’ theory hypothesis is that the 1-month futures contract will be priced at a discount to $55, let’s say $54, to incentivise speculators to provide the hedge to producers. In this situation, the curve is in contango ($54>$50), and the expected risk premium is still positive at $1.
So, a curve in contango and a positive risk premium can coexist.
While the shape of the curve has an impact on the performance, it is not a good predictor of future performance.
Myth 3: Commodities are riskier and more volatile than equities.
There is a common perception that commodities are riskier than equities.
Equities and commodities are similar asset classes statistically. Their historic returns and volatility are quite close. Historically, commodities have exhibited higher volatility than equities in 42% of the 3Y periods since 1960. However, in a larger number of periods (58%) equities have shown higher volatility.
More importantly, the two assets’ distributions differ from a normal distribution with a significantly higher skew. But commodities have the advantage. They exhibit a positive skew (a tendency for higher-than-expected positive returns), when equities are known for their negative skew (their tendency to surprise on the downside).
Commodities have exhibited lower volatility than equities in 58% of the time rolling 3-year periods we studied and benefit from positive skew.
Myth 4: Commodities stopped being an effective diversifier after the 2008 Global Financial Crisis presented a structural break in commodity price relationships
Markets are becoming more and more efficient. With those changes, assets have become more correlated. It is clear that commodities have been more correlated to equities in the last 10-20 years than before. However, this is true of most asset pairs as well. US equities are more correlated to global equities. Equities are more correlated to high yield bonds. In a globalised world where correlations are more elevated, commodities still stand out for their lower level of correlation.
Note, commodities have continued to provide a cushion against equity and other asset crises in recent periods. For example, in 2022, commodities rose 16%, while US equities3 fell 18% and bonds4 fell 16%.
While 2008 marked an all-time high for the correlation between equities and commodities, their correlation has always oscillated. There have been earlier spikes of similar magnitude in the 1960s and 1980s. In 2020, we saw a similar spike in correlation, but correlations have more than halved since in 2023.
Commodity vs equity correlation tends to oscillate and has remained within normal historical ranges.
Myth 5: Inflation linked bonds are better than commodities at inflation-hedging
Some assets are often considered good inflation hedges, such as inflation-linked bonds (TIPS) or real estate. However, it is surprising that more people don’t recognise the superior inflation-hedging properties of commodities.
The beta to inflation (US Consumer Price Index (CPI)) of inflation-linked bonds and real estate, historically, is significantly lower than that of commodities (2.45): US TIPS (0), US Equity Real Estate Sector (1), House Prices (0.4). Furthermore, while broad commodities’ average monthly performance tends to increase when the CPI increases, this is not the case for other assets. The performance of TIPS appears to be relatively unrelated to the level of CPI. The performance of real estate, being equities or real assets, seems to worsen when the CPI increases.
Real estate suffers from the fact that, while rental incomes are linked to inflation (rents are part of the CPI basket, for example), the capital values themselves are not, and yet have a larger impact on the asset's price. Similarly, inflation-linked bonds are linked to inflation, but their price is also tied to real yields changes (through a duration multiplier) which tends to dilute the relationship to inflation itself.
Historically, commodities have been a better hedge to inflation than TIPS or real estate assets.
Myth 6: Futures are the best way to access gold for institutional investors
Futures markets tend to be extremely liquid and offer very low transaction costs. Therefore, investors assume that, if they can, it is always the most efficient way to implement a trade.
However, futures markets respond to their own constraints where banks tend to provide most of the hedging. Recently, banks have suffered from increasing regulation and operating costs that they have translated into their pricing of futures contracts, leading to significant tracking differences with the physical asset. Sometimes futures contracts are the only way to access a commodity, but for precious metals this is not the case.
For gold, this cost has, historically, represented 0.9%6 per year on average compared to owning gold bullion. Physically backed exchange-traded commodities (ETCs) have many advantages: limited operational burden, reduced tracking difference, cheap and liquid.
It is clear that commodities are a frequently misunderstood asset class, and many misconceptions remain today. For a fuller description of the fundamentals of commodity investing, please see The Case for Investing in Broad Commodities.
Sources
1 These myths were all addressed in The Case for Investing in Broad Commodities, November 2021, which takes a deep dive into commodity investing. This blog summarises and updates data addressing several of the ‘misconceptions’ listed in the piece.
2 For more information on contango and backwardation, see our educational ETPedia hub (specifically the ‘Costs and Performance’ tab).
3 S&P 500 TR.
4 Bloomberg GlobalAgg Index (government, corporate and securitised bonds, multicurrency across developed and emerging markets).
5 Source: WisdomTree, Bloomberg, S&P, Kenneth French Data Library. From January 1960 to July 2023. Calculations are based on monthly returns in USD. Broad commodities (Bloomberg commodity total return index) data started in Jan 1960. US TIPS (Bloomberg US Treasury Inflation-linked total return bond index – Series L index) data started in March 1997. US Equity Real Estate (S&P 500 Real Estate sector total return index) data started in October 2001. US House Price (S&P Corelogic Case-Schiller US National Home Price seasonally adjusted index) data started in January 1987. Historical performance is not an indication of future performance and any investments may go down in value
6 Source: WisdomTree, Bloomberg. From 4 June 2007 to 31 July 2023. The Performance of the physical Gold was observed at 1.30 PM Eastern Time to match the BCOM sub-index calculation time. You cannot invest in an Index. Historical performance is not an indication of future performance and any investments may go down in value.
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Commodities Are Waking Up From The SupportCommodities are waking up from the support with the help of China stocks and there's room for more upside.
Bloomberg commodity index with ticker AW made a nice three-wave (A)-(B)-(C) correction with the wedge pattern into wave (C). Unless it has alternatively unfolded a leading diagonal from the highs. Anyway, in both cases we can expect a recovery, at least for a temporary period of time.
Currently we can see it nicely breaking out of projected wedge pattern, which indicates for a bigger recovery, at least back to the starting point of the that wedge pattern near 120 area, or maybe even higher if correction is completed.
Commodity Outlook: Cyclical pressures vs structural strengthsCommodities have been enjoying a strong revival in recent years, with broad commodities returning 27% in 2021 and 15% in 2022. A combination of fiscal and monetary support in the early phases of the COVID-19 pandemic helped to soften the damage to demand from one of the deepest economic shocks in modern times. As COVID-19 restrictions lifted, commodity demand bounced back strongly.
In 2022, the Ukrainian invasion presented a supply shock, restricting energy and agricultural product supplies and further supporting commodity prices. Whilst many developed world central banks tightened monetary policy in the first half of 2022, inflationary pressures became the most extreme since 1981.
Commodities proved again to be one of the best asset classes to hedge this extreme inflation. After arguably falling behind the curve, developed world central banks sought to get ahead and became the most hawkish since the early 1980s. Commodities emerged as a refuge in the storm.
Cyclical headwinds have emerged
Commodities, often seen as a late-cycle asset performer, struggled in late-2022. Energy prices, which had been propelling the asset class, declined by Q3 2022, joining metals, which had been weak since Q1 2022. Economic deceleration resulting from monetary tightening in developed nations weighed on the asset class. Composite lead indicators (CLIs)—designed to provide early signals of turning points in business cycles—turned decisively even before 2022 started. Commodity performance peaked later in 2022. CLIs are still declining, indicating the cyclical headwinds faced by commodities are still present.
China reopening to counter economic headwinds elsewhere
The global economic rebound experienced in 2021 and 2022, and the accompanying commodity rally, occurred largely without China’s contribution. Chinese policy makers pursuing a zero-COVID policy up until November 2022 hamstrung their economy, and growth was disappointing. Although Chinese exports remained relatively strong due to international demand for Chinese goods, constant supply disruptions restrained export volumes during the zero-COVID period.
Now that China has abandoned its zero-COVID policies, domestic economic activity is picking up strongly. In fact, the January and February prints of Purchasing Manager Indices (PMIs) in 2023 look encouraging. Both manufacturing and non-manufacturing PMIs rose clearly above 50 (the demarcation between growth and contraction). The February figure (released on 01/03/2023) showed manufacturing PMIs hitting levels not seen since 2012, underscoring that the domestically driven recovery is reaching industry as well as services (manufacturing is more commodity-intense than services, so that is arguably the most important of two indicators).
What about the commodity supercycle?
We believe commodities should see long-term structural support from an energy transition and an infrastructure spending rebound. Furthermore, these catalysts could drive another supercycle in commodities. Supercycles coincide with periods of industrialisation and urbanisation when the supply of commodities failed to keep up with the growth in demand. The last supercycle occurred after China joined the World Trade Organization in 2001, which turbocharged development as barriers to commerce were removed. After two strong years of commodity market performance (2021 and 2022), could we be on the cusp of another supercycle? We believe there are some strong structural underpinnings but, for now, business cycle dynamics (including a rising risk of recession) could dominate price behaviour in the short term.
Energy transition
In a scenario where net zero emissions are targeted by 2050 in order to limit temperature increases to 1.5 degrees Celsius above pre-industrial levels, we should see a significant rise in demand for metals. Metals are critical for the manufacture of batteries, electrification of power energy consumption, electrolysers, heat pumps, and other technologies needed for the energy transition. International Energy Agency data indicates that, in a net zero emissions scenario, supplies of critical materials are going to be woefully short of demand, both in terms of mining and material production.
Infrastructure rebound
In the US, three Acts with partially overlapping priorities - the Bipartisan Infrastructure Bill (2021), the CHIPS and Science Act (August 2022), and the Inflation Reduction Act of 2022 (IRA, August 2022) – have a combined budget of close to US$2 trillion in federal spending and the infrastructure intensive projects are only just starting.
Just looking at the energy funding from the Bipartisan Infrastructure Bill and the Inflation Reduction Act, a total of US$370 billion is earmarked to be spent over the next 5 to 10 years, primarily to facilitate the clean energy transition. The IRA encourages the procurement of critical supplies domestically. In order to meet the supply chain requirements, we expect large infrastructure spending on mineral extraction, processing and manufacturing.
The European Union’s REPowerEU plan—designed to wean the economic bloc off Russian hydrocarbon dependency—will also require a large spend on energy infrastructure. The EU is already building liquified natural gas capacity at breakneck speed, aiming to expand capacity by one-third by 2024.1 The EU estimates that delivering the REPowerEU objectives will require an additional investment of €210 billion between 2022 and 2027.
The green industrial ‘arms race’ takes off
After decades of underspending for the climate policy goals governments have signed up to, we may be witnessing a tipping point. Some of the protective features of IRA (regional sourcing requirements) may propel tit-for-tat policies that drive local sourcing elsewhere. Many nations recognising China’s dominance in critical materials had already been designing policies to mitigate the risk of overreliance on the country. This process is likely to drive an upsurge in ex-China green infrastructure spending globally.
Conclusions
After several years of commodity market outperformance, the asset class is already experiencing cyclical headwinds. However, a China reopening is likely to mitigate some of these pressures, and we are seeing tentative evidence of China’s economy rebounding. Commodities are likely to be underpinned by global policy support for an energy transition. Whilst general infrastructure spending may also face cyclical headwinds this year, green infrastructure spending is likely to lead to a new ‘arms race’ as countries compete to support their industries and maintain energy/resource security.
Commodities are more than just an inflation hedgeIn 2022, we saw some of the highest levels of inflation in the US and Europe since the 1980s (Figure 1). Not only had central banks left the punch bowl at the party for too long, but many supply shocks had sent prices rising sharply. The Ukrainian war, for example, sent energy and food prices higher. Adjusting complex supply chains that showed their weaknesses in the COVID-19 pandemic has also contributed to pricing pressure. In 2021, when prices were rising on the back of monetary and fiscal stimulus, cyclical assets like equities performed very well. But as the punch bowl was belatedly removed in 2022, with a monetary tightening cycle that was the most aggressive since the 1980s, and input costs rose (think higher energy and labour costs compressing corporate profit margins), there was very little place for refuge. US equities were down 18%1, global equities were down 20%2, bonds were down 16%3, Bitcoin Index was down 64%4 and real estate was down 24%5. The one standout asset class was commodities6, which was up 16%.
Commodities and gold as an inflation hedge
European professional investors believe broad commodities (48%), gold (41%) and industrial metals (40%) are the best instruments for hedging against inflation according to a recent survey we commissioned7.
We agree that commodities are one of the best hedges for inflation. Looking back at long-term historic data, we can see that commodities are one of the most inflation-sensitive assets classes. We separate inflation into ‘expected’ and ‘unexpected’ components. We proxy ‘expected’ inflation using the T-Bill interest rate. ‘Unexpected inflation’ is the 'realised inflation rate' minus the T-Bill rate. Very few assets rise with unexpected inflation. Commodities and gold are clearly in a category of their own here, with industrial metals excelling as an unexpected inflation hedge. To stress, the inflation we have been living with in the past 2 years has been largely of the unexpected nature8.
Broad commodities also do well in hedging against expected inflation. Only US Treasuries have a sensitivity to expected inflation as high as broad commodities. So, as inflation surprises temper, we could find commodities remain an important hedging instrument.
Moving to the next phase of the business cycle
In 2021, when monetary and fiscal conditions were loose, we saw very strong economic growth and high inflation. That was the goldilocks scenario for commodities. Looking back at data since 1961 (Figure 3), we can see that commodities have returned on average 43% in high inflation and strong growth environments. Gold has returned 37% over the same period. In 2021, commodities returned 27%. In 2022, when developed world central banks started to tighten monetary policy, growth faltered while inflation remained high. Looking back at data since 1961, we can see that in high inflation/low growth environments, commodities do not do so badly, with an average 11% growth, which is on a par with Treasuries. In 2022 we know that commodities outperformed Treasuries by a long stretch (+18% vs. -10%). Historically, in high inflation/low growth environments gold also performs positively. In 2022, gold was about flat, after facing extraordinary headwinds from a strong US dollar and rising bond yields.
Looking to 2023, we believe that inflation will remain stubbornly high (at least above 3.5%, the threshold we use for ‘high’ in this analysis). That means we could be stuck in this phase of high inflation/low growth period for longer. We stress that is not bad for commodities. In fact, with the US dollar no longer appreciating, broad commodities and gold have one headwind removed. With US bond yields appearing to have peaked, gold also has another headwind removed.
Commodities are not just an inflation hedge
While inflation has been a key concern for investors over the past 2 years, and will continue to be an important consideration for the coming year, we believe that there are more reasons to consider allocations to commodities than just inflation.
Commodities generally have a low correlation with most other assets. That makes it a nice asset to diversify with.
In fact as we argue in The Case for Investing in Broad Commodities, these low correlations hold even in times of crisis (that is, when US equities are falling more than 5%). On average, in all the months since the 1960s where US equities have lost more than -5%, commodities have lost -0.65%. In all the months where US equities gained more than 5%, commodities gained 1.13%. This compares to -7.8% and 7.5%, respectively, for US equities themselves. So, while commodities are cyclical (that is, they tend to lose and gain broadly at the same time as equities), the amplitude of such gains is significantly more muted. So, any investors fearing further downside to equities, could hedge with commodity exposure.
Positioning for the future
We believe we are in a time of profound change. The energy crisis of 2022 laid bare the need for Europe to wean itself off Russian energy sources. REPowerEU, the European Union’s plan to reduce reliance on Russia, accelerates an energy transition to renewable energy sources. We believe that will be metal demand positive. An electrification of energy production (that comes with a move to renewables instead of combusting hydrocarbons) will require more distribution and transmission cables, more energy infrastructure, and more batteries. This trend will be industrial metal positive. With most nations across the world behind in their climate change targets, we believe there will be an acceleration in the adoption of decarbonising technology as they play catch-up. At the same time, an underinvestment in traditional energy sources has left oil and gas markets (which the world is still highly reliant on) very tight. Commodities provide the essential materials to manage this transition and are likely to benefit.
Conclusions
As many professional investors have identified, commodities, gold, and industrial metals are typically excellent tools for inflation hedging. Commodities are a valuable asset for portfolio diversification in general. Commodities may play an increasingly important role in hedging against climate risk and industrial metals demand, in particular, is likely to benefit from the energy transition megatrend.
Sources
1 S&P 500 equity total return index (31/12/2021 to 30/12/2022)
2 MSCI ACWI total return (31/12/2021 to 30/12/2022)
3 Bloomberg global aggregate credit total return (31/12/2021 to 30/12/2022)
4 Bloomberg Galaxy Bitcoin total return (31/12/2021 to 30/12/2022)
5 FTSE EPRA Nareit Global REITS (31/12/2021 to 30/12/2022)
6 Bloomberg Commodity Index Total Return (31/12/2021 to 30/12/2022)
7 Pan European Professional Investor Survey, September 2022, 600 respondents, conducted by Core Data Research.
8 For example, the Citi Inflation Surprise Indicator, which measures whether inflation readings have been coming in above or below consensus expectations (calculated in a 3-month rolling window), has been positive for 28 consecutive months to November 2022 (i.e. inflation has surprised to the upside) for the US and UK and 24 consecutive months for the Euro Area.
Commodity Index AnalysisBear case: There is a descending triangle and a time cycle of peaks suggesting downside.
Bull case: There is a trendline suggesting upside
General: If the green trendline is broken to the downside, there is no moving average support* until the 20-month SMA and below that there is only the 100-week and 200-week which is well below near the implied target of the descending triangle at 87. The descending triangle should break down by December 7th to satisfy the textbook 2/3-3/4 triangle breakout zone (results may vary). If the trendline is bounced off of and holds through December 7th the bullish target would become the area marked by the green targets which are derived from the trendline and it’s upper channel which is defined by previous rallies off of the trendline. A head fake is always a possibility to watch out for.
*going by the standard 9/20/50/100/200 simple moving averages that I watch
Commodity OutlookRecession may be a red herring for a market fuelled by a supercycle
While broad commodities have outperformed most major asset classes year-to-date1, the pressure of rising interest rates, a strong US dollar and fears of several large economies tipping into recession has led to a pull-back since the summer of 2022. In our Market Outlook, we argued that the current negative business cycle pressures on commodities are likely to be temporary and give way to the larger forces pushing the demand for commodities higher and constraining supply of those commodities.
Historically, commodities have been a cyclical asset class, generally declining when the business cycle turns negative. But even history illustrates that commodity prices can continue to rise long after a business cycle has turned if fundamentals are supportive. Oil price shocks in the 1970s and 80s are a case in point. Admittedly they are unusual cycles but, today, we are likely to be living in another energy price shock.
Energy price shocks continue
Since we published our Market Outlook, the Organization of the Petroleum Exporting Countries and partner countries (OPEC+) has announced a large cut to oil production from November 2022, amounting to 2 million barrels per day. As we expected in our Outlook, OPEC+ reacted to the price weakness in oil after the summer and sought to raise prices of Brent oil to over US$90/barrel (prices had fallen to US$84/barrel on 26 September 2022, just over a week before the OPEC decision). They have been successful in keeping prices above US$90/barrel since that decision but have laid the groundwork for further cuts by painting a pessimistic picture on demand forecasts (giving the group an excuse to intervene in the market again). Meanwhile, the Ukraine war shows no sign of improving and natural gas supplies into Europe from Russia have fallen to a trickle. The European Union has taken various measures to try to soften the shock. However, we view several of the proposals with scepticism. For example, introducing price caps on natural gas imports could simply divert natural gas to other countries and worsen the energy shortage for the EU. Interfering with price benchmarks, such as the Title Transfer Facility (TTF), could send incorrect pricing signals and lead to overconsumption of energy resulting in additional shortages2.
Supply shortages of commodities extend beyond energy
A combination of rising energy prices and interest rates have driven many metal smelters to shutter production. High fertiliser prices (petrochemical product) are also constraining crop yields.
Looking across the commodity spectrum, all commodities have lower-than-normal levels of inventory.
Base metal supply is especially low
The inventory of base metals is considerably lower than their respective 5-year averages, yet base metals have seen the largest price declines of all the commodity sub-sectors. The markets are pricing in demand weakness from an economic deceleration. However, demand has not weakened yet. On the other hand, supply is declining fast.
Let’s take the example of copper. The International Copper Study Group (ICSG)’s first forecast for 2022 copper balances (demand less supply), cast on October 2021, was for a sizeable surplus of 328 thousand tonnes. Its latest forecast (cast on 19 October 2022) is for a deficit of 328 thousand tonnes in 2022. Judging by historical revisions, their 2023 forecast of a surplus is likely to be revised down.
Their initial forecasts tended to assume no production disruptions. Yet, as we have observed this year, production disruptions can be very large.
China’s economic deceleration is countered by policy support
China’s zero-COVID polices have slowed economic growth and, thus, its demand for commodities. That matters because China is the largest commodity consumer in the world. However, its central bank has been loosening policy and President Xi has called for an ‘all-out effort’ to increase infrastructure spending (and given local governments free rein to raise debt financing to fund these projects).
However, the future course of China’s policy will become clearer after we write this blog. At the time of writing (21 October 2022), China's 20th Communist Party Congress is still in process and will wrap up in the coming days. Xi Jinping is poised to clinch his third five-year term in charge of the nation. We expect national security to take a greater role in policy priority than the economy.
Commodity supercycle
An energy transition and a revitalised global infrastructure spend are likely to drive the demand for commodities significantly higher over the coming years. However, today, we are living in the down-phase of a business cycle. Even though many commodity markets are visibly tight, commodities are not sufficiently pricing the tightness. The Inflation Reduction Act in the US and the Infrastructure Bill are both strong tailwinds for commodity demand. In Europe, the sharp focus on weaning off Russian energy dependency is adding a new urgency to the energy transition, and we expect to see accelerated energy infrastructure plans take place.
Conclusion
As a headline, economies going into recession doesn’t inspire huge confidence in a commodity rebound. However, history does suggest that an economic slowdown combined with high inflation has been associated with positive commodity and gold performance. The energy price shock has set off a vicious circle of supply contraction from metals, fertilisers, and other energy intensive commodities. The energy transition and infrastructure led supercycle remains in play even if short-term business cycle phenomena dictate headlines today. As we emerge from this phase of the business cycle, we may find commodity markets extraordinarily tight.
Trendline and Channel Tutorial: Part 2In part 2 we discuss how to construct and utilize sloped trendlines (TL) and Channels in order to better understand the ebb and flow of supply and demand. Like most other charting techniques understanding supply and demand and its relationship to trends and channels depends on you staring at hundreds and thousands of bar charts. Unfortunately, there just isn't a shortcut. It's hard work.
Uptrends represent the "stride of demand." They are a graphic representation of the willingness of the composite investor to enter new longs at consistently higher prices. The parallel channel top is the overbought or supply line. A point in the trend where the composite investor might be reliably expected to reduce their long positions. The median line represents (roughly) the center of the channel. At times (as in the commodities example) the median line may have a basis in the chart pattern, but more generally is simply scribed roughly in the center of the channel. The median line is useful in gauging supply and demand relative to the channel boundaries.
TLs need to be constantly adjusted and often are messy. Most of the time these adjustments occur with a significant lag, but even with the delay the channel helps to define and visualize the aggresiveness or lack thereof of the supply or demand. In the markets that I am most interested in, I constantly adjust the channel elements to best reflect the latest pivots and chart elements.
In my analysis I also use volume, Wyckoff principles and other techncial methods to build the viewpoint. TLs and channels are like any other technical pattern in that they are much stronger and more understandable when combined with multiple methods and tactics.
These patterns are fractal. They occur in all time perspectives from 1 minute to decades and are generally analyzed in the same manner.
Generally Speaking:
-The relationship of the market to the demand line and the supply line relate to the aggresiveness of the demand.
-Ideally a reaction higher from a demand line should cover the entire distance to the supply line. A failure to push to the overbought line (the channel top) is often a sign that the trend is weakening.
-A modest overthrow of a supply line is generally a sign of demand, but if the overthrow occurs late in the trend and represents a significant acceleration, there is potential that it is terminal (see the commodities chart).
-A failure to decline completely back to the supply line is a sign of relative strength.
-How markets relieve overbought conditions within the channel is important. A move to the supply line with an overbought RSI (or momentum oscillator of your choice) that subsequently moves laterally is a bullish show of demand or strength.
-A modest violation of an uptrend would suggest a weakening in the underlying trend while an inability to fully decline to the uptrend would suggest a trend gaining strength.
Bloomberg Commodity Index Daily:
The channel in commodities that has defined trading for most of the last two years displays many of the concepts. Note that like most other TLs and channels the process can be messy. Adjusting demand, supply and median lines as the market evolves takes practice.
-From the pandemic low in late March 2020 commodities began an extended daily/weekly perspective bull market. At the end of September (B) the market formed a pivot that allowed the projection of an initial demand line. It also allowed the projection of an initial supply line from point A.
-As the channel progressed, the markets behavior made it clear that demand was strengthening. Highs were overthrowing the initial projected supply line, reactions from the initial supply line were finding support ABOVE the demand line and when momentum (RSI) became overbought, it was being relieved through mostly lateral to higher prices. All represented strong underlying demand.
-While the initial supply line proved inadequate it did provide a median line to the eventual channel. The median line offered important support or resistance on multiple occasions.
-Soon after point C, a new supply line could be projected.
-From March through September 2021 the market held solidly above the midpoint of the channel. This is clearly a sign of strong demand and bodes well for additional gains.
-After testing the demand line in late 2021, the market once again moved back to the supply line. The easy move higher (no notable counter trend reactions) suggested a lack of sellers. Combined with the prior long lateral move above the midline, it was obvious that buyers were in complete control.
-In February 2022 price exploded above the top of the supply line as the demand that had been evident for months completely overwhelmed the available supply.
-Often a significant overthrow of the supply line is terminal. In this case the market produced a three drives pattern before beginning a steep decline. The break below the pattern trendline is a good example of a type 3 trendline.
In Part 3 we will look at another example (Ten year Treasury yields) and explore using demand and supply lines as a trading vehicle.
And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.
Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Taylor Financial Communications
Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.
Trading Seasonal Market Patterns RecapTrading Seasonal Market Patterns
Hey traders today I wanted to do a recap of all the Seasonal Market Patterns covered in the series. Also putting it all together for yearly trading opportunities. These Seasonal Market Patterns can be very rewarding l to all of us in our trading if we know when to look for them.
Enjoy!
Trade Well,
Clifford
Bloomberg's commodity index looks toppyThe weekly chart shows a bearish divergence of the RSI and MACD's bearish cross below zero.
To me, this says the hawkish Fed trade driven by inflation concerns may be over and the focus could soon shift to the impending economic slowdown/recession.
BLOOMBERG COMMODITY INDEX II PRICE ACTION IS BEAUTIFULAmazing how THE PRICE JUST REFUSES TO FORGET ... not matter the asset class ... and by the way, this is an index.
It´s been over 8 years since this resistance level was laid out.
Not saying it will hold, just saying it is being respected for now.
Price action is beatiful!
Lower commodity prices before higher $96 first, $80s nextEveryone's bullish commodities and calling for a supercycle and a breakout here. However, every commodity chart looks like it's in the process of topping or has already topped.
Then if you look at this chart, it just hit resistance again and hasn't been able to break through.
The highest probability scenario to me here is that we reject and fall lower to $96, then rally over summer, and fall lower in the fall/early 2023 to find a bottom in the $80 region.
After that, I can see the case for commodities to rally, but don't think commodities are going to go up here like everyone thinks.
Inflation prices based on oil and general commodities ...Inflation prices based on oil and general commodities analysis ... vs long term bonds
Decline of the US Dollar Means Commodities Will Continue To RoarThe pound sterling, the United Kingdom’s foreign currency instrument, was the global reserve currency in the 19th century and the first half of the 20th century. For decades, the US dollar has been the world’s reserve currency, which became official in 1944 after a delegation from forty-four allied countries decided that the world’s currencies would no longer be linked to gold but pegged to the US dollar, which was linked to gold. The Bretton Woods Agreement established the authority of central banks to maintain fixed exchange rates between their foreign exchange instruments and the US dollar. In turn, the US would redeem US dollars for gold on demand. The redemption option ended in 1971 when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value.
The dollar’s link to commodities
Three factors that will continue to weigh on the dollar’s global role
Expect higher base prices for commodities
Long-term trends are very bullish
Buying dips is likely to be the optimal approach
For seventy-eight years, since the end of World War II, the US dollar has been the king of the currencies. On December 27, 1945, the participating countries signed the Bretton Woods Agreement. On August 15, 1971, President Nixon abandoned the gold standard. On February 4, 2022, a handshake on a “no-limits” support agreement between Chinese President Xi and Russian President Putin may go down in history as the beginning of the end of the US dollar as the leading world reserve currency. The watershed event could have far-reaching consequences for markets across all asset classes. Commodities are global assets. The end of the dollar’s reign as the monarch of money will likely lift raw material prices in dollar terms in the coming years.
The dollar’s link to commodities
As the world’s reserve currency, the dollar has been the leading global pricing mechanism for most commodities. Over the past decades, a rising dollar often weighed on commodity prices as the essentials became more expensive in other currency terms. A weak dollar encouraged buying as prices fell in different foreign exchange instruments.
While the US is the world’s leading economy, the population at around 333 million is only 4.2% of the total number of people on our planet. Therefore, the dollar’s link to commodities is financially based on the US position in the global financial markets and not on the supply and demand equations for the raw materials.
If the dollar’s role in the world declines, its link to commodity prices will diminish.
Three factors that will continue to weigh on the dollar’s global role
King dollar is facing a challenge in 2022 as world economic and political events threaten its dominance. The US dollar faces at least three issues that continue to erode its purchasing power and role in the global economy:
Inflation - The February US CPI and PPI data pointed to the highest inflation in over four decades. The March data will be even worse. The Fed began increasing short-term interest rates but remains far behind the inflationary curve. Rising inflation erodes the US dollar’s purchasing power.
Geopolitical tensions - The war in Ukraine and China’s support for Russia has dramatically changed the geopolitical landscape. In the leadup to the expansionary move, Russia reduced its US dollar reserves, increasing holdings in euros and gold. Sanctions on Russia will likely cause China to follow the same course. China is the world’s second-leading economy, and Russia is a leading commodity-producing country. As China and Russia move away from using the US currency as a reserve currency, the dollar’s global role will decline. Geopolitical tensions have accelerated the descent.
The decline of fiat currencies - The rise of cryptocurrencies is a sign of the fall of fiat currencies. Cryptos derive value from bids and offers for the currencies in an open and transparent market that transcends borders. Fiat currencies derive value from the full faith and credit in the governments that issue the legal tender. Meanwhile, rising commodity prices signify the decline in the dollar’s purchasing power.
The dollar index measures the US currency against other world currencies, but it is a bit of a mirage as when all fiat currencies lose value, it is not apparent. The dollar index measures the US currency against other world reserve currencies, including the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc. The most significant weighting, at 57.6%, is against the euro currency. The dollar may be moving higher against the basket of currencies, but that does not mean that all of them, including the dollar, are losing value.
Expect higher base prices for commodities
The decline of the dollar and all fiat currencies makes purchasing power drop and commodity prices rise. Therefore, a strong dollar index has not weighed on many commodity prices over the past year.
The weekly chart shows that the dollar index has rallied, making higher lows and higher highs since early 2021. Over that period, most commodities have risen to multi-year and all-time highs. The strength of the dollar did nothing to restrain increasing raw material prices.
Meanwhile, higher US interest rates increase the cost of carrying commodity inventories and boost the US dollar’s value against other currencies.
The weekly chart of the US 30-Year Treasury bond futures shows the pattern of lower highs and lower lows, pushing long-term interest rates higher.
The bottom line is that a rising dollar and increasing US interest rates have not stopped commodity prices from rallying since early 2021.
Higher interest rates, rising inflation, geopolitical turmoil leading to supply chain issues, and sanctions that interfere with many raw materials supply and demand equations mean that production costs are rising. The base prices for raw materials are moving higher.
Long-term trends are very bullish
Bull markets rarely move in straight lines, and since commodities are highly volatile assets, corrections can be brutal. However, the long-term charts in four leading commodities, copper, crude oil, corn, and gold, display the same bullish patterns.
The quarterly chart of COMEX copper futures shows the bullish pattern over the past two decades.
The highly political crude oil market displays the path of least resistance of the price is higher. US energy policy and geopolitical turmoil have only exacerbated the upward trajectory of the energy commodity since April 2020.
Corn’s price path has been higher, making higher highs and higher lows for decades.
Gold’s bull market dates back over two decades. Gold may be the best example of the decline in fiat currency values as it is a hybrid between a commodity and a foreign exchange instrument.
Many other commodities display the same long-term trends. The recent strength in the US dollar means that commodity prices in other currencies have followed even more bullish price paths over the past year.
Buying dips is likely to be the optimal approach
The trend is always your best friend in markets. While short-term and medium-term traders follow technicals that depend on the market’s sentiment, long-term trends are a function of macro and microeconomic factors. The decline of fiat currency values continues to push commodity prices higher.
Over the past decades, price corrections have been long-term buying opportunities in the commodities asset class. The economic and geopolitical landscapes point to a continuation of the trend. Buying on price weakness has offered optimal results. Even if the US dollar index continues to rise, it will not mean the currency is strong. The foreign exchange market is a mirage that only measures one fiat currency’s value against another. Commodity prices are the actual value indicator, and the long-term trends reveal that currencies are all losing purchasing power.
We remain bullish on commodities. However, the higher the prices, the more vicious the corrections will become. Buying when they look the worse could be the best course of action over the coming months and years.
--
Trading advice given in this communication, if any, is based on information taken from trades and statistical services and other sources that we believe are reliable. The author does not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects the author’s good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice the author provides will result in profitable trades. There is risk of loss in all futures and options trading. Any investment involves substantial risks, including, but not limited to, pricing volatility , inadequate liquidity, and the potential complete loss of principal. This article does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein, or any security in any jurisdiction in which such an offer would be unlawful under the securities laws of such jurisdiction.
Commodities trending, good opportunities still on pullbacks. Bloomberg Commodity index is flagging, has shown a steady uptrend since 12/21. I am looking for opportunites in specific commodity categories on pullbacks, although with the flag setting up in the uptrend, it may not happen soon.
Broad Commodities, not just another cyclical asset- Pierre Debru, Head of Quantitative Research & Multi Asset Solutions, WisdomTree Europe
Since the beginning of the covid-19 pandemic, broad commodities have benefitted from a new lease of life. The Bloomberg commodity index is up almost 60%2 from its nadir, and investments, tactical or strategic in nature, are flowing once again to the asset class. However, unrelated to their recent performance, broad commodities can be an additive to a multi-asset portfolio. In our previous blog, we focused on commodities’ diversification superpowers. In this blog, we want to look at the behaviour of commodities across the business cycle.
Analyses show that broad commodities, while cyclical, complement other cyclical assets like equities very well across the business cycle:
- Broad commodities tend to resist pretty well in the early phase of a recession, a period where equities suffer the most.
- They also tend to do well in the late part of an economic expansion when equities usually fail to find their second wind.
Commodities benefit from economic expansions
Intuitively, it feels like commodities should benefit from a positive economic environment. When the economy grows, it needs base materials to do so. Metals are required to build new homes, new factories, new infrastructure, new cars etc. More energy is consumed to move goods and people around. So overall, there is a logic to commodities behaving like a cyclical asset.
To fully assess the relationship of commodities with the business cycle, we turn to the National Bureau of Economic Research (NBER) Business Cycle Dating Committee, which maintains a chronology of US business cycles. The chronology identifies the dates of peaks and troughs that frame economic recessions and expansions. By comparing the performance of different assets in those recession and expansion periods, it is possible to assess their cyclicality. Figure 1 shows that equities have gained on average 0.86% per month in periods of expansion. This is the largest performance among the asset classes tested. They are followed by commodities (+0.80%), high yield bonds (+0.56%) and then corporate bonds (+0.35%). In periods of recession, high yield bonds (+0.15%) and equities (+0.36%) have performed less strongly. On the other side of the spectrum, US Treasuries and corporate bonds performed strongly (0.88% and 0.87%, respectively). Equities, commodities and high yield bonds are cyclical assets, with equities and commodities being the strongest.
A surprisingly robust asset in early recessions
While logical, this cyclicality may seem difficult to reconcile with the low correlation between commodities and equities, as discussed in Broad Commodities, the portfolio’s super diversifier? Equities are also very cyclical, so how can two cyclical assets be so uncorrelated?
On average, in all the months since the 1960s where US equities have lost more than -5%, commodities have lost -0.65%3. In all the months where US equities gained more than 5%, commodities gained 1.13%1. So while commodities are cyclical, i.e. they tend to lose and gain broadly at the same time as equities, the amplitude of such gains is significantly more muted. This supports our decorrelation hypothesis. It appears that while commodities and equities tend to gain during the expansion phase of the business cycle, they may not gain at the same time, i.e. during the same part of the cycle.
- They suffer the most from the early recession part of the cycle but rebound the strongest in the later part of that recession.
- While they benefit from the expansion part of the cycle, they rise faster in the earlier part of that expansion.
On the contrary, commodities:
- Tend to hold up well in the early phase of a recession, posting on average a positive performance of 0.54% (vs -1.3% for equities).
- Suffer more in the later phase of a recession and trail both equities and high yield bonds.
- Perform better in the second half of the expansion period, contrary to equities that prefer the first half. Commodities are the strongest performers among all the asset classes in that late part of the expansion cycle.
So overall, while commodities are a cyclical asset, their behaviour is very decorrelated to equities or high yield bonds. They offer great diversification in early recession and late expansion phases when other cyclical assets (equities, high yield bonds) struggle.
Late recoveries are commodities’ best friend
Commodities tend to perform the best in late recoveries, with an average performance of 1.25% in this phase. Judging by recent Composite Lead Indicator (CLI) prints4, we are in the latter stages of the current economic expansion. The United States, Japan, Germany and the United Kingdom are nearing economic peak, and in the Euro area, there are signs of moderating growth5. If history is any guide, this could be an environment for commodity outperformance. We also take the view that there are some unique tailwinds behind certain segments of commodities that could propel them for years to come. For example, the energy transition to lower-carbon energy sources will likely be very metal positive (given their use in developing renewable and electrification infrastructure and battery technology). Also, a renewed interest in building infrastructure in the US and Europe could benefit commodity demand.
An excellent diversifier and a strong complement to equities across the business cycle are only two of the potential advantages broad commodities could bring to a portfolio. The next item to consider will be whether broad commodities could act as a powerful inflation hedge.
Sources
1 Bloomberg, WisdomTree, 27th April 2020 to 7 Dec 2021
2 Bloomberg, WisdomTree, 27th April 2020 to 7 Dec 2021
3 Source: WisdomTree, Bloomberg, S&P. From January 1960 to August 2021. Calculations are based on monthly returns in USD. Broad commodities (Bloomberg commodity total return index) and US Equities (S&P 500 gross total return index) data started in Jan 1960. Historical performance is not an indication of future performance and any investments may go down in value.
4 The OECD system of Composite Leading Indicators (CLIs) is designed to provide early signals of turning points in business cycles: www.oecd.org
5 www.oecd.org
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Commodities might breakoutStagflation. Everything is ATH, this commodity index isn't.
Commodities have been very strong this week and if the day rolls over at this high I think it will breakout.
We also just crossed green on MACD. ...
If we break out target maybe 105 before we see more pushback.
Bloomberg Bloomberg Commodity Index AWH CONTRACT UNIT $100 times the Bloomberg Commodity Index
PRICE QUOTATION Index points
TRADING HOURS CME Globex: MON-FRI 8:15am-1:30pm
CME ClearPort: Sunday - Friday 5:00 p.m. - 4:00 p.m. (6:00 p.m. - 5:00 p.m. ET) with a 60-minute break each day beginning at 4:00 p.m. (5:00 p.m. ET)
MINIMUM PRICE FLUCTUATION .10 Index point ($10.00 per contract)
BTIC: 0.01 index point ($1.00 per contract)
PRODUCT CODE CME Globex: AW
CME ClearPort: 70
Clearing: 70
BTIC: AWT
LISTED CONTRACTS Mar, Jun, Sep, Dec
SETTLEMENT METHOD Financially Settled
TERMINATION OF TRADING 3rd Wednesday of contract month/ 1:30pm
SETTLEMENT PROCEDURES Bloomberg CI Settlement Procedures
POSITION LIMITS CBOT Position Limits
EXCHANGE RULEBOOK CBOT 29
BLOCK MINIMUM Block Minimum Thresholds
PRICE LIMIT OR CIRCUIT None
VENDOR CODES Quote Vendor Symbols Listing
Bloomber Commodity Index - Monthly; Despite all the noise...... the song remains the same.
It is (still) all about the USD and Gold!
... because otherwise the world is swimming in over-supply!
EURUSD vs commodity indexThe positive correlation between EURUSD and commodity index (negative with dollar index ) can not be refuted. And as you see, often times Commodity index leads EURUSD. A lag of 1-2 days can be observed at extremums. Why so? Euro and gbp comprise 69.5 percent of Dollar index against which all commodities are measured (gold , silver , crude oil , copper etc). Any move in commodity prices is reflected in dollar index and eurusd. With globalized economy and heavy correlation, one may claim that oil and gold prices exercise more impact on euro than ECB, interest rates or eurusd's moving averages.
Now we got two 9s (TD sequential) on commodity index and the index is likely to turn up. Right now its at S4 Woodie yearly floor pivot .
Also MACD points to a reversal in commodity index.
