Has the commodity cycle turned?

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In the Switzer Super Report on 18 November last year I discussed the technical cases for and against the potential outcomes for the Continuous Commodity Index chart at that time and how those outcomes might affect Australian resource stocks.

Given the movement in the Continuous Commodity Index ($CCI) over the last month, it appears that the ‘for’ case has well and truly come to the fore.

Strong rise in commodity indices

The last four weeks has seen a sharp rise in the CCI. Being an equally weighted index across 17 different commodities, it takes more than the rise in a single commodity to cause such a pick up. The other commodities indices, the CRB Index and S&P GSCI, which use different compositions and weightings for their respective indices, have also risen sharply over the same period.

Source: Beyond Charts

The rise in the CCI can be attributed to the recent rises in natural gas, coffee, cocoa, gold, silver, sugar and light sweet crude oil to a lesser degree.

Rises in coffee and sugar prices are mostly attributed to the drought in Brazil and the rise in natural gas to the ongoing cold weather in the northern hemisphere, particularly the United States. Sure, these are fundamental reasons that can be attributed to affecting the supply and demand of these commodities at the moment. However, if these are the only reasons for the sharp rises, then why did natural gas prices fall sharply in February 2013 during similarly cold weather in the United States?

My point is that there are many more variables at play than just these one or two fundamental items. It is also amazing how often shifts in price trend to occur at critical technical zones that can be gleaned from charts. This is where shifts in sentiment can be discovered in a timely fashion without spending huge amounts of effort to determine why. And the ‘why’ that may be unearthed this time will be a different ‘why’ next time, and the next. When prices move, it is what it is.

What could the rise in the CCI mean for investors?

As I pointed out in November last year, there appeared to be a shift in sentiment brewing in the large resource stocks in Australia. BHP and RIO had already started moving higher from the middle of 2013, but it was only from around November that they started showing relative outperformance of other larger cap stocks, such as the Australian banks.

In the last month, BHP, Rio and many other resource companies, such as Alumina, Fortescue Metals Group, Arrium and Atlas Iron have shown even more relative outperformance compared to the rest of the market. The Mid Cap Resources Index (XMR) has started showing relative outperformance of the market but the Small Resources Index (XSR) has not yet done so.

Summary

A retracement in the CCI is to be expected, given its sharp rise over the last month. However, this could be the start of a shift to the energy and materials sectors of the market, which have displayed poor sentiment for nearly three years now.

At this stage, copper is a notable omission from the list of performing commodities. My view is that copper needs to join the party, as do the small cap resources stocks. Some are showing signs of positive movement but not enough to move the XSR.

These are still early days in the commodities move, but if the large, mid and small cap resource (energy and materials) stocks get going, the All Ordinaries will take on the 6,000 level. Without them participating in any positive market move, the Australian market will have difficulty getting to 6,000 and keeping up with international equities indices.

Keep an eye on the CCI for an inside running on how this commodities run plays out.

Gary Stone is the founder and managing director of Share Wealth Systems.

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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