by Tom Aspray
Commodities have taken a hit recently, but the overall trend remains positive. Consider this multi-week correction your opportunity to build positions in select commodity funds.
The news about global food shortages and stockpiling of scarce commodities by emerging economies like China has been the focus for many over the past year, and the Reuters CRB Index had risen 55% from the May 2010 lows at 450 to last week’s high at 691.
The selling across many of the commodity markets has now turned into a stampede for the exits this week, as the Reuters CRB Index, as well as the commodity ETFs and ETNs are now clearly in a correction phase.
The dollar is also trying to turn higher, and a further rally will add additional downward pressure on commodity prices. The major technical trend for the majority of the commodity markets is still positive, as is the global demand outlook for commodities. Of course, this demand flattens out at various periods when the emerging market economies cool, but this does not alter the major trend.
Therefore, it is my view that a deeper correction and a significant retracement of the recent gains should be an opportunity to establish either 1) long positions in a broad-based commodity vehicle, or 2) targeted positions in a specific commodity market. In fact, one of the markets I am focusing on appears to be in the process of completing a significant bottom formation. Let’s first look at the Reuters CRB Index.
Figure 1
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This weekly chart of the Reuters CRB Index goes back to the peak in 2008, when the weekly relative strength index (RSI) formed a 16-week bearish divergence (line c) in July 2008 as crude oil was peaking.
During this plunge, the CRB lost over 47% of its value. In late 2008, the RSI formed a short-term positive divergence (line d), which was confirmed by the move through its downtrend in March 2009 (line 1). This completed the bottom formation in the CRB.
During early 2010, the CRB Index corrected for five months, losing 10% before bottoming in May. This week’s drop in the index will signal at least a test of the March lows at 635, and a decline to test the upper boundary of the trading channel (line a), currently at 620, would not be surprising. The 38.2% support from last summer’s low is at 600 with the 50% level just under 570.
The weekly RSI failed to confirm the CRB’s recent highs (point 3), as it was not able to move back above its weighted moving average (WMA) while the CRB was making a new weekly closing high. The break of the short-term uptrend, line e, warned that a divergence may be forming. Typically, this length of divergence is consistent with a correction, and not a major top. The most likely downside target is at 600-615, which would amount to a 12% correction from the highs.
Figure 2
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The Elements Rogers Total Return ETN (RJI) was designed to track the global consumption of a basket of 36 commodities. It has 35% in agricultural commodities, 21% in both precious and base metals, and the remaining 44% in energy.
RJI peaked in early April at $10.51 and formed a lower secondary peak last week. The weak close on May 4 violated short-term support (line a) with the daily uptrend, line b, at $9.70.
The correction may be able to hold the March lows at $9.33, but if not, there is stronger support in the $9.00-$9.10 area. This corresponds to the 38.2% support level as well as the November 2010 highs.
How to Profit: Go 50% long RJI at $9.24 and 50% long at $9.08 with a stop at $8.57 (risk of approx. 6.4%).
Figure 3
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The PowerShares DB Commodity Index ETF (DBC) is more narrowly focused than RJI, as it includes the commodities like light sweet crude oil (West Texas Intermediate, or WTI), heating oil, RBOB gasoline*, natural gas, Brent crude, gold, silver, aluminum, zinc, copper grade A, corn, wheat, soybeans, and sugar.
*RBOB: Reformulated Blendstock for Oxygenate Blending. This is the benchmark gasoline product traded on the major commodity exchanges.
DBC has declined steadily from the highs made at the end of April, and next chart support (line a) and the daily uptrend, line b, is in the $29.70 area. The March lows ($28.20) are a key level to watch with the 38.2% support at $27.80. The daily on-balance volume (OBV) has dropped below its weighted moving average (WMA), but is still well above its uptrend from the September 2010 lows, line c.
How to Profit: Go 50% long DBC at $27.88 and 50% long at $27.44 with a stop at $26.77 (risk of approx. 5.4%).
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