Are Commodities Ready To Plummet?

| June 1, 2012 | 0 Comments

No doubt about it, last month was rough for commodities.  Lean hogs, cattle, and natural gas were the only hard assets eeking out gains in May.

The others?  Well, they weren’t so lucky.

Take a look…

Oil Chart

As you can see, commodities encountered hefty losses over the past few weeks.  Gold and silver fell 6% and 10% respectively.  Coffee slumped 11%.  Oil plunged a whopping 17.5%.  And not be outdone, cotton fell a staggering 20% last month alone!

But that’s not all…

The entire commodities complex as measured by the Reuters/Jefferies CRB index, dropped 11% in May.  That’s a remarkable drop for an index comprised of 19 different hard assets.  As you may know, the CRB index is a leading benchmark for the overall commodity performance.

Why are hard assets having such a rough time?

It’s simple really.  European debt crisis fears have investors trading in risk assets like stocks and commodities for the safety of US treasuries.  When investors make the switch, they simultaneously drive up the value of the dollar.

And let’s not forget the currency markets.  Once a trend is established, traders can push a currency farther than most investors realize.  In this case it’s the US dollar.

Remember, commodities are inversely correlated with the dollar.  In other words, when the dollar is exhibiting strength, commodities generally weaken-and vice versa.

Take a look at this chart and you’ll see the dollar is definitely ruling the roost…

US Dollar Chart

As measured against its global currency peers, last month’s phenomenal dollar rally has it trading at levels not seen since August 2010.   This sudden and strong dollar move is the primary reason commodities have fallen so dramatically in recent weeks.

Of course, the question now is how much longer can the dollar rally last?

Many traders believe the dollar will keep rising and cause a total blowout for the commodities sector- worse than what’s already happened.

I disagree…

I believe the commodity markets are very close to a ‘risk on’ moment.  As you may know, risk on is a term used to describe the movement of capital into risk assets like commodities.

The CRB index I spoke of earlier is now drastically oversold while the US dollar is remarkably overbought.  We only need a hint of good news out of Europe and money will flow straight out of treasuries and right back into stocks and commodities.

Why am I so sure Europe won’t drag the entire global financial system down the toilet?

Because investors are convinced it’s going to happen… 

And when the crowd is convinced something’s going to happen, the markets almost always do the exact opposite.  It’s funny, but the market applies the most pain to the most popular viewpoint.  And right now the bears are the most popular kids on the playground.

Bottom line…

The recent dollar rally will likely run out of steam in the very near future.  And when it does, capital will return to the commodity complex.

Until next time,

Justin Bennett

 

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Category: Commodities

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.

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