Equity-driven Commodities Correction

By: Donald_W_Dony

Commodities

Best Financial Markets Analysis ArticleKEY POINTS
• Resistance in stocks drives commodity correction
• Risk aversion in equities underpins US$
• Gold low expect in September/October
• Range-bound oil prices under resistance
• Copper prices stall at $2.50
• Natural gas looks to seasonal strength in September

In the July issue, I mentioned that commodities, stocks and the U.S. dollar are all moving to the beat of risk aversion.

If the S&P 500 pulls back in July, money will likely flow out of equities and into the ‘safe haven’ of the big dollar. This in turn, props up the fundamentally weak currency and should send raw materials downward. This intermarket dance is normally in reverse. Usually, the US$ sets the mood first, followed by the action of commodities, and then, finally, stocks. However, because of the severe bear market conditions, the opposite is happening. Basically, the caboose is driving the engine.

Risk aversion is key

In Chart 1, the comparison between the three markets is fairly clear. Throughout the bear market bounce (March to June), capital shifted out of the dollar and into stocks. This had a negative affect on the greenback. But what is bad for the dollar is usually good for commodities; the Commodities Research Bureau (CRB) Index soared.

The picture began to change in June. Weakness in the S&P 500 spelled risk aversion loud and clear for traders. Capital shifted back to U.S. treasury bills, and materials were under pressure.

What about the expected movements of commodities in the coming months, especially with an expected major low for stocks in October?
Market psychology will likely play a bigger role until October than will the fundamentals.

For example, should the S&P 500 start to slide downward in August and September, traders are expected to follow a similar path to what they have for many months – protecting their assets and running for safety (safety equals U.S. dollar strength). This action is, of course, negative for commodities.If the movement to October is gentle for the S&P 500, capital is less likely to shift out of equities and transfer to the US$. This outlook is more favourable for the CRB.

By Donald W. Dony, FCSI, MFTA