China and Commodities Collapsing Together?

Last week, in an unsurprising move, the S&P500 bounced back a little over one percent. It was unsurprising because the bounce happened just as the S&P touched the 200 day moving average. In other words, the 200 day did exactly as what most market technicians would expect it to do—provide support.  On the other hand, volume was very light and that means that this support was only technical, not some sign of new money rushing into US stocks. And volatility dropped back down to the lows of the calendar year.

So while one technical interpretation was bullish (the 200 day successfully provided price support), another interpretation is still bearish: the 5o day moving average is converging down towards the 200 day, and the slope of the 200 day moving average is flattening out. Now this doesn’t mean that the “Death Cross” (which typically marks the beginning of a bear market phase) is imminent, but it bears closer watching with these two hugely important moving averages start to pinch together.

On Main Street, the bad news returned. While durable goods orders and the Chicago PMI beat expectations, almost every other economic report last week as a disappointment. The Dallas Fed manufacturing survey missed. Consumer confidence collapsed. Pending home sales missed. GDP came in lower than expected. Consumer sentiment missed, and the employment cost index missed very badly. This report sent shock waves throughout the Treasury markets because investors had been bracing for higher wages (employment costs) which would make it more likely the Fed would begin to raise rates. But when the report showed negligible wage growth, Treasury bears had to run for cover and interest rates plunged back down to levels more consistent with weak wage growth.

Finally, it’s becoming clear that as China’s financial markets continue to crumble (and they are) and as its real economy continues to stumble (and it is…..even the positively manipulated numbers are coming in very weak), the collapse of the commodity complex—which began over a year ago—is related and will probably continue to collapse as long as China keeps failing to re-ignite strong growth.

What’s worse is that when one backs up and looks at broad commodity indices over the last 15-20 years, one sees a massive commodities bubble that coincided almost perfectly with China’s investment bubble. And since China’s retreat has only recently gotten underway, it’s realistic to assume that the downside to commodity prices may still be huge….even after the already massive pullback in prices.

Copper for example is down almost 50% from its 2011 highs, but it may fall an additional 40% just to return to the 2008 lows. To reach it 2002 lows—which is very possible if China’s bubble completely unwinds—then copper may fall an additional 75%….from where it already is today!

And similar outcomes may apply in oil, and other base metals, and all the currencies that benefited from the Chinese bubble (for example the Australian dollar).

So does this mean that commodities and energy are NOW good assets to buy?  Yes and no.  Yes, because many are already down well over 50% and if the holding period is long enough, then the upside should be high. No, because one of the major indicators of bear and bull markets—the 200 day moving average—is still solidly in bear more. So to improve the timing of the investment, it would be advisable to sit tight and wait for the 200 day moving average to first stop descending and even better to begin to turn up before putting a lot of money to work in these sectors.

The good news is that after 50% losses, the turn up in the 200 day moving average is that much closer, given that it first turned down in late 2011.  It could be another six months, or a year or even longer, but when it happens, you’ll be less likely to suffer subsequent, even if only temporary, drawdowns in your investment.

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