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Commodities Fire Warning Shot For Stocks and Economy

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    March 3, 2013

    It’s time for an update on commodity prices.

    As I have written before, consumers understandably like to see prices for commodities decline, the more the merrier, particularly gasoline and energy costs.

    Many fundamental analysts also take commodity price declines as a positive for the economy, on the theory that consumers will have more spending money in their pockets, and manufacturers will have lower costs, so hopefully greater earnings.

    Investors tend to also take declining commodity prices as a positive for the stock market on the same reasoning.

    Unfortunately, history doesn’t confirm the optimism.

    As a five-year chart of the CRB Index of Commodity Prices shows, declining commodity prices usually indicate demand for goods is dropping and the economy will soon be in trouble, which in turn is a problem for the stock market.


    For instance, the CRB Index of Commodity Prices plunged 57%, from 470 to 200 in 2008-2009. Good for the economy and stock market? Not hardly. The severe 2008-2009 ‘great recession’ and severe bear market in stocks accompanied the decline in commodity prices, and saw the S&P 500 also plunge 57%.

    Before the economy slowed in the summer of 2010, and the stock market experienced the double-digit decline that summer, commodity prices had rolled over to the downside again.

    And before the economy began to slow again in the summer of 2011, and the S&P 500 experienced a 19% decline that summer, commodity prices began to decline again.

    Now, after only a brief recovery last year, the CRB Index of Commodity Prices has been back to the downside since last fall in spite of the economic recovery being back on track after last summer’s stumble, and in spite of the stock market being in a significant ‘favorable season’ rally.

    So another reason to enjoy the favorable season rally while it lasts, but to remain alert to the technical indicators on commodities as well as the stock market.

    Here’s the thing about technical analysis.

    Columnists, stock brokers and retail investors love to analyze and discuss the fundamentals. It’s easy to understand the good and bad points regarding a company’s products, management, earnings, and so on.

    And it seems simple to form expectations for market or sector direction by judging whether some political situation, economic condition, unexpected event, or economic report, will be positive or negative for the market.

    The biggest attraction of fundamental analysis is not having to learn too much beyond what seems to be simple common sense. Government created record budget deficits and debt? Stock market can’t possibly move into a four-year bull market. Apple is coming out with a new product? Cars or houses are selling well, or not. That kind of thing.

    On the other hand, using technical analysis involves a lengthy knowledge, learning and experience process first. In the case of columnists and brokers it would also require being able to have readers and clients accept it, difficult given that few readers or retail investors understand it, many not even aware it exists.

    Therefore, it’s easier to write or talk about the easy to understand fundamentals. In the case of brokers and other Wall Street folks who come in contact with retail investors, it’s easier to blow off technical analysis as voodoo and worse, than to have to learn anything about it or how it is utilized. It’s even easier to recommend that investors simply buy what they are sold and hold on through whatever comes along.

    But the fact is that behind the scenes professional money-management firms, mutual funds, hedge funds, giant pension plans, university endowment funds, and other institutions, employ almost as many market technicians as they do fundamental analysts.

    In feeding information to brokers as to which stocks they should be selling, brokerage firms employ market technicians and technical analysis as well as fundamental analysts. In fact some of the most famous Wall Street names, past and present, the likes of famed Bob Farrell (Merrill Lynch) are or were with brokerage firms. 

    It’s not a new phenomenon. In his 1920’s memoir, old time brokerage firm founder Richard D. Wyckoff wrote of his firm using charting and technical analysis to pick stocks that looked like they were about to make a move in one direction or the other, and then having to look up the company’s fundamentals and use only them when discussing the company’s stock with clients.

    Charts and technical indicators just don’t care what the surrounding conditions or situations are. They simply show what the market is actually doing, whether money is flowing in or out, whether momentum continues or is reversing, and so on, not caring why or who is buying or selling, or whether common sense says it should be doing something else because of this or that situation in the news.

    To read my weekend newspaper column click here:  Politicians Still Don’t Get It!

    Subscribers to Street Smart Report: In addition to the charts and analysis in the ‘premium section’ of this blog post, the  new issue of the newsletter will be out on Wednesday in your secure area of the Street Smart Report website.

    Images: Flickr (licence attribution)

    About The Author

    Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!