Best of the Week
Most Popular
1. Next Financial Crisis Is Already Here! John Lewis 99% Profits CRASH - Retail Sector Collapse - Nadeem_Walayat
2.Why Is Apple Giving This Tiny Stock A $900 Million Opportunity? - James Burgess
3.Gold Price Trend Analysis - - Nadeem_Walayatt
4.The Beginning of the End of the Dollar - Richard_Mills
5.Stock Market Trend Forecast Update - - Nadeem_Walayat
6.Hindenburg Omen & Consumer Confidence: More Signs of Stock Market Trouble in 2019 - Troy_Bombardia
7.Precious Metals Sector: It’s 2013 All Over Again - P_Radomski_CFA
8.Central Banks Have Gone Rogue, Putting Us All at Risk - Ellen_Brown
9.Gold Stocks Forced Capitulation - Zeal_LLC
10.The Post Bubble Market Contraction Thesis Receives Validation - Plunger
Last 7 days
Is A Sharp Stock Market Crash Ahead? - 21st Nov 18
Have We Seen The Worst of the Gold Bubble Burst? - 21st Nov 18
The Real Price of LNG, Climate Change, Coming Fracking Environmental Disaster - 21st Nov 18
Powell and Gold between Inflation and Global Slowdown - 21st Nov 18
Why is the North American Wilderness Known for Spiritualism? - 21st Nov 18
Stock Market Buy the Dip is Dead - 20th Nov 18
Deep State Mad World - 20th Nov 18
Commodities - What Do You Need To Know? - 20th Nov 18
Precious Metals Moving In Unison For A Massive Price Advance - 20th Nov 18
Handicapping the Precious Metals Through Year-End - 20th Nov 18
Betting Markets Confirm Theresa May Safe From Tory Leadership Challenge this Week - 20th Nov 18
Rail Chaos Transpennine Express Cancels Services to Manchester Airport Whilst on the Train! - 20th Nov 18
The Giants Are Coming...Giants of The Internet! - 20th Nov 18
Gold & Silver Corrective Rally is Almost Over - 19th Nov 18
Stock Market Going Sideways - Which Direction is Next? - 19th Nov 18
Technical Analysis Points to DOW 30k Next Target - 19th Nov 18
Stock Market Consolidating in a Downtrend  - 19th Nov 18
Next Tory Leader, Prime Minister Forecast and Betting Market Odds - 18th Nov 18
The Fed's Misleading Money Supply Measures - 17th Nov 18
Stock Market Outlook: Why the Economy is Bullish for Stocks Going into 2019 - 17th Nov 18
NO DEAL HARD BrExit Tory Chaos, Theresa May Leadership Challenge - 17th Nov 18
Gold vs Several Key Investments - 17th Nov 18
GDX Gold Mining Stocks Q3 18 Fundamentals - 17th Nov 18
Is Gold Under or Overpriced? - 17th Nov 18
Active Managers are Bearish on Stocks. A Bullish Contrarian Sign - 16th Nov 18
Will The Fed Sacrifice Retirement Portfolio Values For The "Common Good"? - 16th Nov 18
BrExit War - Tory Party About to Replace Theresa May for NO DEAL BrExit - 16th Nov 18
Aspire Global Makes Significant Financial Strides - 16th Nov 18
Gold Oil and Commodities …Back to the Future ? - 16th Nov 18
Will Oil Price Crash Lead to “Contagion” for the U.S. Stock Market? - 15th Nov 18
How NOT to Be Among the MANY Stock Investors Fooled by This Market Myth - 15th Nov 18
Tory BrExit Chaos Cripples UK Economy, Wrecks Housing Market Confidence - 15th Nov 18
Stocks Could End 2018 With A Dramatic Rally - 15th Nov 18
What Could Be the Last Nail in This Stock Bull Markets Coffin - 15th Nov 18
Defensive Stock Sectors Outperforming, Just Like During the Dot-com Bubble - 15th Nov 18
Buying Your First Home? Here’s How to Save Money - 15th Nov 18
US Economy Ten Points or Ten Miles to ‘Bridge Out’? - 14th Nov 18
US Stocks: Whither from Here? - 14th Nov 18
Know exactly when to Enter&Exit trades using this... - 14th Nov 18
Understanding the Benefits of Keeping a Trading Journal - 14th Nov 18
S&P 500 Below 2,800 Again, New Downtrend or Just Correction? - 13th Nov 18
Warning: Precious Metals’ Gold and Silver Prices are about to Collapse! - 13th Nov 18
Why the End of the Longest Crude Oil Bull Market Since 2008? - 13th Nov 18
Stock Market Counter-trend Rally Reaches .618 Retracement - 13th Nov 18
How to Create the Best Website Content and Generate Organic Traffic - 13th Nov 18
Why the Stock Market Will Pullback, Rally, and Roll Into a Bear Market - 13th Nov 18
Stock Markets Around the World are Crashing. What Not to Worry About? - 12th Nov 18
Cyclical Commodities Continue to Weaken, Gold Moves in Relation - 12th Nov 18
Olympus Tough TG-5 Camera Stuck or Dead Pixels, Rubbish Video Auto Focus - 12th Nov 18
5 Things That Precede Gold Price Major Bottoms - 12th Nov 18
Big US Stocks Q3 Fundamentals - 12th Nov 18
How "Free Money" Helped Create Sizzling Housing Market & REIT Gains - 12th Nov 18
One Direction More Likely for Bitcoin Price - 12th Nov 18
The Place of HSE Software in Today's Business - 12th Nov 18

Market Oracle FREE Newsletter

How You Could Make £2,850 Per Month

SPX Stock Market Pullback to Drag Commodity Stocks Lower

Stock-Markets / Gold & Silver Stocks Nov 13, 2009 - 11:24 AM GMT

By: Zeal_LLC

Stock-Markets

Best Financial Markets Analysis ArticleWith the US stock markets very overextended technically, my recent research has focused on this development’s implications.  Several weeks ago I outlined the extremely overbought conditions in the flagship S&P 500 stock index (SPX).  Last week I explored how the overdue SPX pullback is even likely to spill over into the precious-metals stocks, dragging them down.


After reading that essay, many investors wrote in wondering how general commodities stocks would fare in a significant SPX pullback.  The short answer is not very well.  Commodities-stock investors and speculators alike have to realize that any meaningful SPX weakness will have a serious impact on commodities stocks, even if commodities prices themselves happen to be rising at the time.

Although commodities producers’ profits and hence stock prices ultimately follow commodities prices over the long term, over the short term sentiment is usually a far more important driver.  If traders are excited, they’ll eagerly buy commodities stocks.  But when they get scared, they are quick to sell these same stocks.  And nothing breeds fear and economic worries as rapidly as sharp retreats in the stock markets.

The precedent on this psychological spillover effect is very clear, even in the powerful cyclical bull market since the March 2009 post-panic lows.  I’ve written about this general-stock influence over near-term commodities-stock fortunes many times in our subscription newsletters.  With our subscribers’ capital already prepared, it’s probably about time to summarize this research in an essay.

In order to understand how commodities stocks are likely to perform in the next meaningful SPX pullback, we need to look at how they performed in past SPX pullbacks.  Since March’s despair-laden lows, the US stock markets have had 8 pullbacks.  But only one has been “meaningful” so far, big enough and long enough to really rebalance sentiment by injecting fear to bleed away complacency and greed.

To gain insights into how commodities stocks performed in these past pullbacks, we have to first find some way to measure them.  And unfortunately this isn’t easy.  I’ve been relentlessly studying and actively trading commodities stocks since this bull began in 2001.  In all the years since, I’ve yet to see an excellent commodities-stock index.  Plenty have been introduced, but all are seriously flawed.

They are often dominated by eccentric component stocks that don’t actually produce commodities, comprised of incomplete component lists excluding some of the best and most important producers, and/or illogically weighted internally.  Nevertheless, these flawed indexes are still the best way to measure commodities stocks’ progress.  So we must choose the least-poor index from this admittedly poor field.

These days my choice is XLB.  The 500 elite stocks of the S&P 500 are divided into 9 sectors.  Each of these sectors is independently tradable via a popular family of ETFs known as the Select Sector SPDRs (“spiders”).  XLB represents the materials stocks of the SPX.  Although unfortunately heavy with chemical producers, the XLB Materials SPDR also includes big weightings in Freeport McMoRan Copper & Gold, Newmont Mining, and Alcoa.

So while XLB is far from an ideal commodities-stock index, it does have enough big producers to act as a reasonable proxy for commodities stocks in general.  But despite containing some giant commodities companies, all the stocks in the XLB still account for merely 3.5% of the SPX’s total market capitalization!  This highlights just how contrarian commodities stocks remain today, which is very bullish.  Also be aware that the SPX energy stocks are a different case included in a separate ETF, the XLE Energy SPDR.

By seeing how XLB has behaved in the 8 SPX pullbacks since March, traders can get an excellent idea of how commodities stocks are likely to behave in the next SPX pullback.  This first chart overlays the XLB on top of the SPX, and they track nearly perfectly.  For each SPX pullback, three percentages are noted.  The red one is the SPX’s pullback loss and the blue one is the XLB’s loss over this exact same SPX-pullback span.  Finally the yellow one documents the CCI’s performance over these SPX-pullback spans.

The Continuous Commodity Index is the benchmark measure of general commodities price action.  Theoretically commodities stocks should follow commodities prices over the long term, since the latter dictate the former’s ultimate profits.  But as this chart reveals, over the short term a weak SPX overwhelms commodities-stock psychology and easily dominates whatever is happening in commodities.

Comparing the XLB to the SPX is really visually-striking.  These charts are essentially interchangeable, one could easily be passed off as the other.  And this relationship is stunning mathematically as well.  The correlation r-square between the XLB and the SPX since the latter’s March low is a staggering 97.2%!  Statistically, 97% of the XLB’s daily trading action was directly explainable by the SPX’s own.

Contrast this with the CCI, with which the XLB had a far weaker 80.9% r-square over this same span.  There is simply no arguing the fact that the general stock markets are a far greater influence over tactical commodities-stock price action than the commodities prices themselves.  Thus investors and speculators who first consider the state of the SPX before trading commodities stocks will have much greater success.

These specific SPX pullbacks rendered here were explained a few weeks ago in another essay, so we don’t need to rehash that analysis today.  This time our focus is on how commodities stocks, as represented by the XLB, did during these SPX-pullback spans.  And in addition to comparing the XLB’s loss to the SPX’s, the parallel performance of the CCI offers a kind of control to see how outsized the XLB’s reaction to the SPX proved.

During the first pullback in late March, the XLB’s 5.6% loss paced the SPX’s 5.4%.  Nevertheless, with the CCI falling by a more moderate 3.1% the commodities stocks still appeared unduly influenced by the SPX weakness.  This behavior continued in the second pullback in mid-April, with the XLB’s 4.6% loss being much closer to the SPX’s 4.3% than the CCI’s 2.5%.

In the third pullback in May, this SPX influence moderated a bit.  While the headline stock markets lost 5.0%, the XLB showed some relative strength with just a 3.6% loss of its own.  Interestingly the CCI only declined 2.2% over this span, so better commodities-price performance helped favorably influence commodities-stock psychology at the time.

The SPX’s fourth pullback in June and July has been its only significant and meaningful one so far in this cyclical-bull upleg.  The SPX lost 7.1% over 19 trading days, more than enough to stoke the fires of fear and burn away some of the excessive complacency and greed.  It was actually during this pullback that I first started considering the XLB’s behavior, as commodities stocks really didn’t fare well.  This ETF lost a brutal 13.2% over this span, leveraging the SPX’s retreat by 1.9x.

It is certainly true that commodities prices too were weak over this summer span, also negatively influenced by the SPX’s far-reaching sentiment splash damage.  The CCI fell 7.0% to the SPX’s 7.1%.  But still, the XLB’s decline was pretty excessive considering commodities prices remained at levels which were very profitable for the best producers.  With commodities stocks nearly doubling the SPX’s losses, today’s traders must remain wary of the next meaningful SPX pullback’s impact on commodities stocks.

During the fifth pullback in mid-August, the CCI’s 4.5% loss actually outpaced the SPX’s 3.3% for the only time in this entire upleg.  With both general stocks and commodities weak, the commodities stocks didn’t stand a chance and plunged 6.2% over just 2 trading days.

The SPX’s sixth pullback ending in early September was also revealing.  This elite stock index lost 3.5%, but over this same span commodities were actually surprisingly strong with the CCI gaining 0.7%.  If commodities prices were a bigger influence on tactical commodities-stock action than the SPX, here is where we would have seen it.  Yet the XLB still sunk 2.7%, somewhat splitting the difference between the SPX and CCI but mostly ignoring the commodities gains.

The seventh pullback running into early October probably would have become the first meaningful one since summer if the impressively-bullish Q3 earnings results hadn’t short-circuited it.  The SPX fell 4.3% over 8 trading days where the CCI was only off 1.7%.  Yet the XLB really took this poorly, falling 7.6% which leveraged the SPX’s decline by 1.8x.  Again we saw this 2-to-1 downside metric approached.

Highlighting just how absurdly overbought the SPX had become, its eighth pullback started right in the midst of incredibly bullish Q3 earnings results from many elite market-darling stocks.  The SPX gradually slid down 5.6% in 9 trading days, but once again commodities remained relatively resilient as evidenced by the CCI’s mild 2.8% decline.  Yet the XLB still plunged 9.8%, 1.8x downside leverage.

See the precedent here?  When the SPX is weak yet the CCI still rallies, commodities stocks sell off.  When the SPX is weak but the CCI is relatively resilient, commodities stocks sell off.  And when both the SPX and CCI are weak, commodities stocks really sell off.  General-stock-market weakness has been weighing on commodities stocks this year no matter what commodities prices happened to be doing.  These SPX pullbacks are the biggest short-term risks that commodities-stock traders face.

And this risk is really heightened today considering it has been so long since the SPX last saw a meaningful pullback.  The commodities stocks’ worst performance relative to the SPX happened during that larger June/July pullback.  Back then the SPX fell far enough, for long enough, to spawn serious and universal doubts about the prospects for the stock markets and economy.  And since commodities prices are heavily dependent on economic activity, these fears weighed disproportionately on their producers.

The SPX’s next pullback is likely to be meaningful as well, big enough and long enough to finally burn away some of today’s excessive complacency and greed.  In order to see sentiment rebalanced, which is the sole mission of any pullback or correction, some real fear will have to arise.  And of course this will manifest itself in economic worries, almost certainly leading to heavy selling in the commodities stocks.

This exceedingly important relationship between the SPX and commodities stocks can be considered from other perspectives too.  This next chart looks at the ratio between the XLB and the SPX.  This line (multiplied by 100 to eliminate the tiny decimals) deftly shows when commodities stocks have been outperforming the SPX and vice versa.  For comparison, this blue XLB/SPX Ratio is rendered over the CCI in red.  This chart offers many interesting insights, including some disturbing ones.

From March to early May the XLB/SPX Ratio (XSR) rocketed higher.  Commodities stocks were gaining ground much faster than the general stock markets, which was no mean feat since general stocks were soaring too.  But by early May, these outsized commodities-stock gains had run out of steam as the XSR x100 approached 3.0.  From here the SPX’s third pullback started an XSR trading range that has largely held to this day.

For the next 6 weeks or so this ratio oscillated within this nascent uptrend.  Commodities stocks were still rallying faster than the general stocks on balance, but only gradually.  But when the SPX’s last meaningful pullback hit hard in June, the XSR fell off a cliff and shattered its support.  You can see this fast and furious commodities-stock plunge driven by the fourth pullback above.  It really was stunning just how fast and far commodities stocks plunged compared to the general stock markets.

By the time the dust settled in the SPX in early July, the XSR was back down to mid-March levels!  Over nearly 4 months, commodities stocks had not gained any ground at all relative to the SPX.  This is really sobering to me, and it ought to be to you too.  The degree of XLB underperformance during the last meaningful SPX pullback was immense.  Commodities stocks are likely to exhibit similar outsized selling pressure in the next meaningful one as well, which is way overdue.

But after the carnage of the fourth pullback, buyers returned in droves and the XSR rapidly soared back up through support to revisit resistance.  Once again all was well in the world of commodities stocks.  When the stock markets are rising, these stocks really thrive.  And they should, because they suffered such epic losses in 2008’s stock panic that most of them remain nowhere close to rebounding far enough yet to reflect today’s prevailing commodities prices.

In mid-September, the XLB/SPX Ratio again fell sharply as the SPX’s seventh pullback heavily pressured commodities-stock sentiment.  But then some curious things started to happen.  I mentioned above that this September pullback was shaping up to be the first meaningful SPX pullback since summer until the Q3 earnings season short-circuited it.  But despite elite commodities stocks having big Q3 beats too (bigger than the elite tech stocks in some cases), the XLB did not recover with the SPX.

While the SPX clawed its way to marginal new highs in mid-October, the XLB lagged.  This drove the ratio to a much lower high in October than September.  Disturbingly, this episode was the first time since May that a new SPX high didn’t translate into the XSR climbing back up to resistance.  At the time I warned our Zeal Speculator subscribers that the unenthusiastic commodities-stock participation called the whole SPX rally’s legitimacy into question.  Something didn’t smell right.

And this disconnect looked even worse considering the CCI action.  Commodities prices were soaring in early October right along with the SPX.  The never-ending stream of high-profile corporate profits and sales exceeding expectations in Q3 sparked much economic hope.  Futures traders rushed to buy commodities anticipating higher demand, but commodities-stock buying was still tepid at best.

When both the stock markets and commodities prices are rallying sharply yet the commodities stocks refuse to respond as usual, it is a big warning sign.  The XSR’s divergence from the CCI suggests that the SPX rallies in the last 5 weeks or so were narrow and somewhat artificial, driven by mainstream-trader enthusiasm for their usual loves of tech stocks and financials instead of being broad-based.  The XLB/SPX Ratio suggests the broad-market SPX pullback actually started in mid-September!

This has all kinds of implications for commodities-stock traders.  In pure SPX terms, a meaningful pullback is still overdue.  And when the SPX falls fast enough and long enough to spawn some real fear, economic worries will multiply and commodities stocks will be sold aggressively.  Investors looking to add commodities stocks should wait until this pullback matures so they can attain much lower buying prices.  And speculators can play both this pullback’s initial downside as well as its subsequent sharp rebound.

In the financial markets, knowledge truly is power.  If you understand what is likely to happen (and why) before it actually happens, you gain a huge edge that nets big additional profits.  I founded Zeal to help private investors and speculators thrive, to learn what is going on and apply it to growing your own fortune through buying and selling stocks.  By studying the markets and learning what drives them, you can get smarter and radically increase the odds of achieving your financial dreams.

We’ve been specializing in commodities stocks since 2000 when only the hardest-core contrarians even knew they existed.  Over the 9 years since, we’ve launched 209 stock trades in our acclaimed Zeal Intelligence monthly newsletter with average annualized realized gains of 37%.  Subscribe today and start growing your practical understanding of the exciting commodities-stock realm!  First-time e-mail-PDF-edition subscribers will get a complimentary copy of our new November letter, detailing the SPX’s fascinating eighth pullback unfolding despite one of the most bullish earnings seasons in memory.

The bottom line is commodities stocks’ sentiment and prices are dominated by the fortunes of the general stock markets.  This is especially true when the stock markets are weak.  During such episodes the commodities stocks are usually sold much more aggressively than the general stocks.  And this is the case even if commodities prices themselves happen to be relatively strong or even rallying.

In order to thrive, commodities-stock investors and speculators cannot ignore the state of the general stock markets.  Not even commodities prices themselves are more important for near-term commodities-stock price action.  The best commodities-stock rallies are largely driven by general-stock strength, and their best buying opportunities are definitely driven by general-stock weakness.

By Adam Hamilton, CPA

So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence , that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month for tactical trading details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm

Questions for Adam? I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/adam.htm for more information.

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com . Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

Copyright 2000 - 2009 Zeal Research ( www.ZealLLC.com )

Zeal_LLC Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules