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Don’t shun commodities!

March 27, 2007

CRB Spot Index overlaid on Dow Jones Industrial Index

>>Commodities are in a secular uptrend likely to last another 10-15 years. The DowGold Ratio chart affirms this fact as does the chart above showing the long term historical performance of the CRB Spot Index* plotted against the Dow Jones Industrial Index.

>>Viewed down the diagonal line in the chart above, the performance of the CRB Spot Index and the Dow Jones Industrial Index has been antithetical to an uncanny degree.

 >> Given that western equities are in secular downtrend, there is every reason to believe, based on this unique historical relationship, that commodities are likely to continue trending upwards for a number of years yet.

>> The unique relationship between US equities and commodities makes them a great asset class for diversification purposes and lends themselves to a buy and hold ideology using a suitable commodity fund or well diversified portfolios of commodities.

>>The economic growth stories of India, China, Russia, etc all add credence to this view. Given that commodity infrastructure takes time to build, demand is likely to outstrip supply in the short term leading to higher prices.

 >>But don’t go in blindly: remember, there will be cyclical vacillations within this secular uptrend that will test your nerves  – as we are currently enduring. We never go up in a straight line.

Commodities undergoing a cyclical correction

CRB Index is currently in the cyclical bear phase of the secular uptrend – don’t lose faith!

>>Trading the cycles by participating in the bull phases of the cycle and avoiding the bear part increases the chance of profitability. Within the class of commodities some will be more appealing than others – especially the more liquid commodities (Copper, Oil, Gold, etc). Choose those commodities that appeal to you – both on a risk and return level.

>>Certain commodities(especially the more liquid ones traded by hedge funds) are more prone to unsustainable parabolic rises – owing to speculative activity as more and more traders and speculators catch onto the “hype”. Parabolic rises, while fun on the ride up often end in tears on the way down. This is only normal, as prices fall to more “fundamental values” to readjust to the long term story.

Copper has also exhibited parabolic rises

 Copper has exhibited bouts of parabolic price** rises fueled by speculative price action

Gold prices parabolic indicating speculative activity

Gold has also exhibited parbolic price rises** over the period 2005-2006, explaining why it has been very volatile since, attempting to adjust to more normal levels.

>>Investors needs to be cautious of such activity which, unfortunately, results in high volatility especially if adopting a “buying and hold” strategy for commodities.


*The CRB Spot Index is a bellweather for Commodities and more information on this can be found from the creators

** Parabolic rises are easily identifiable by their charcteristic rocket-like rises. They can also be identified by calculating the deviation of the price action from some mean value – in the chart of gold and copper above, the deviation from the 200D MA has been calculated and the results compared to the long run history. It is observable that during parabolic rises, the deviation of price from its 200D MA surpases two standard deviaitons – a truly rare event(statistically!)


Will the US housing market cause a recession?

March 7, 2007

US NAHB Traffic of Prospective buyers - a precursor for the S&P500 market?

>>A very interesting chart that illustrates an overlay of the US NAHB Traffic index*and the S&P 500 index, with the former lagged 15 months.

>>Historically, real estate downturns have had the tendency to lead the US economy into recessions and stock market slumps: In 1994, the bull market in stocks was portended by the NAHB index and in 1999, its decline starting in 1999 adumbrated the equity market wipeout the following year. Unsurprisingly, this index rebounded in November 2001 – approximately a year in advance of the stock market upswing that commenced in October 2002.

>>More worringly, in recent times – since July 2005, to be precise – the index has wiped out from a high of 55 in July 2005 to a low of 22 in September 2006; an incredible drop of 60%! According to the New York Times,  “The slump in home prices from the end of 2005 to the end of 2006 was the biggest year over year drop since the National Association of Realtors started keeping track in 1982.”

>>If historical correlations hold (the index has had an 84% correlation with the direction of the S&P 500 with a lag of 15 months from 1996-2006), then the US equity market could waterfall on the back of a weakened US economy. The fear is that this could occur this year!

>>Surprisingly, so far the US economy has remained resilient to a recession notwithstanding the slump in the housing sector. Normally, a weak housing market has meant a slowdown in the construction sector and a fall in construction materials. It is also not unexpected that construction-related employment should take a hit – especially considering that 30% of all jobs created since the end of the last recession in 2001(1.4 millin) have been in sectors related to the US housing market boom (according to an estimate by Capital Economics).

>> The ripple effect of the housing crash is often reduced consumer spending and increased unemployment. Over the past several years, the rising price of properties in the US has allowed consumers to support their consumption with cash flow derived from borrowing against their homes – an activity dubbed Mortgage Equity withdrawal . With house prices rising, this has been a key contributor to consumer wealth(U.S. homeowners pulled more than $450 billion in equity out of their homes in 2005), allowing consumers to treat their homes like ATM machines. With house prices falling now, consumption is likely to take a hit as the ATM machines go bust – or so goes the theory! Given that consumption constitutes 70% of GDP in the US, it’s only reasonable that a slowdown in consumption would precede a slowdown in GDP growth.

>> For now, there’s little hard evidence that the housing slowdown is dragging the US economy into a recession.  The economy grew at a sluggish 2.2 percent pace in the final quarter of last year, much slower than initially reported, battled by the weak housing market. With mounting concerns that mortgage lenders might be hurt by the increasing level of defaults and delinquencies especially in the sub-prime area , the fear is that each negative development is likely to fuels additional deterioration putting further pressure on the banks and sending the economy into a tailspin. We just hope it doesn’t get too ugly!


*NAHB Traffic Index – Derived from a monthly survey that NAHB has been conducting for 20 years, the NAHB/Wells Fargo Housing Market Index (HMI) gauges builder perceptions of current single-family home sales and sales expectations for the next six months as either good, fair or poor. The survey also asks builders to rate traffic of prospective buyers as either high to very high, average or low to very low. Scores for each component are then used to calculate a seasonally adjusted index where any number over 50 indicates that more builders view sales conditions as good than poor.


UK Equities Relative Strength Performance comparitive to UK Government Bonds

February 26, 2007

UK Equities relative to UK Government Bonds


Investing using chart ideas

February 23, 2007

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The idea of this blog is to give you simple charts to compliment your investment ideas. Please feel free to comment on these charts and give useful feedback.

Good luck!