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Chart of the week – focus on resources

Posted By Gary Stone On In Shares | No Comments

When conducting analysis to determine where resource stocks may be heading in the near to intermediate future, one of the main charts, amongst others, that I consult is the Continuous Commodity Index ($CCI). The $CCI is a benchmark of performance for commodities prices. It is an equally weighted index using 17 commodity futures prices. Each commodity represents 5.88% of the index.

Chart reproduced with permission from Beyond Charts www.beyondcharts.com [1].

The above weekly chart of the CCI provides three important insights into commodities price action over the last three to four years:

  1. There is a very strong support zone between 498 and 508, as shown by the blue rectangle on the CCI chart.
  2. A potential projection zone exists between 595 and 605.
  3. A long term descending triangle has formed since September 2010.

The support zone is substantiated by two strong technical analyses. Firstly, the support zone was a resistance zone back in 2009/2010 (and earlier) and a support zone on three occasions since June 2012, as shown by the blue rectangle.

Secondly, the support zone coincides with the 50% retracement level of the commodities bull market that ran from December 2008 to April 2011, as indicated on the above CCI chart by the magenta ellipse on the lower left.

This makes a case that support for commodity prices will once again hold at these levels, meaning that commodities prices could potentially have another attempt at rising from these current levels.

The risks and opportunities

Of course, there are no guarantees. If this support zone doesn’t hold, then expect commodity prices to fall further, thereby greatly reducing the chances of rising resources stock prices in Australia and around the world.

Technically, to support a bearish case for commodity prices, a 14-month descending triangle has formed and is nearing its apex. This means that a breakout one way or the other is nearing, probably in the next three to four weeks.

If a breakout occurs on the upside, then the first target would be around the 550 level in the CCI and then the 595 – 605 zone. The index would only rise if commodity prices rose, which would undoubtedly lead to rising resource stock prices.

If a breakout to the downside occurs, then expect a fall in the CCI down to the 450 – 465 zone and a corresponding fall in resource stock prices.

The big guns

The second chart below shows the relationship between both BHP (blue) and RIO (green) to the Continuous Commodities Index (red). All three charts are ‘based’ at 12 January 2007, showing the relative relationship between BHP, RIO and the CCI. Note the high correlation in direction.

Since July this year, both BHP and RIO have rallied, despite commodity prices not rising. This is clearly seen on the extreme right of the chart below.

The story, two and a half years in the making, is building to a climax that I believe will be resolved this side of Christmas. Either commodity prices will rally from the CCI support zone, thereby justifying the early runs by BHP and RIO over the last four months and leading to a rally in resource stocks. This might be the impetus needed by the small to mid cap resource stocks in Australia to also rally. Or the descending triangle will hold sway and commodity prices will fall taking BHP, RIO and many other resource stocks to lower prices. Let’s watch with interest as this climax approaches…

Chart reproduced with permission from Beyond Charts www.beyondcharts.com [1].

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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