The Participant 7/22/15: Commodities

by Jason Kelly

Wednesday, July 22, 2015

Good morning,



The commodity rout remains top financial news this week, for good reason. Look at this year-to-date performance summary of 18 commodity ETFs and ETNs as of yesterday’s close:

-11.8% Aluminum (FOIL $24.17)
-5.3% Coal (TONS $38.32) [since 2/20/15 inception]
+16.1% Cocoa (CHOC $49.17)
-30.5% Coffee (JO $21.20)
-6.1% Corn (CORN $25.02)
-12.4% Copper (CPER $16.66)
+2.6% Cotton (CTNN $27.81)
-7.2% Gold (GLD $105.37)
-12.0% Industrial Metals (HEVY $26.98)
-5.8% Lead (LEDD $30.69)
-15.1% Livestock (COW $25.82)
-6.1% Natural Gas (UNG $13.87)
-23.9% Nickel (NINI $20.08)
-16.9% Oil (USO $16.91)
-6.1% Silver (SLV $14.14)
-3.8% Soy Beans (SOYB $19.97)
-24.7% Sugar (SGAR $19.85)
-17.5% Wheat (WEAT $10.51)

Except for cocoa and cotton, the whole complex has been heading south. That it was led by coffee may come as a surprise, given the recently publicized price increase at Starbucks (SBUX $56.20), but that was the company leveraging its brand’s pricing power rather than reacting to the cost of beans. The price of coffee is fluctuating around 14-year lows, copper around 10-year lows, oil around 7-year lows, and livestock around 6-year lows.

What’s going on? Analysts point to a number of factors. The recent slowdown in world trade, as indicated by China’s weakening economy, is reducing demand. A glut of oil production has created abundant supply in that market. An expected rise in American interest rates at the end of this year has pressured the price of gold and silver, and strengthened the dollar. The stronger dollar has caused the price of commodities to fall because they are priced in dollars, so as the currency grows more valuable it takes less of it to buy the same quantity of a commodity. Finally, it could be that commodities as an asset class is losing its appeal after having been hot for about a decade from 2001 to 2011. The so-called supercycle has come to an end.

Shouldn’t the world’s growing population and the lifting of impoverished areas to developed-economy lifestyles sustain demand for commodities? In theory, yes, but the population has been trending higher and demanding more materials for centuries, during which time the price of goods has fluctuated. It could be that after surging from the tech bubble and Chinese growth in the 1990s and 2000s, a consolidation and catching of the economic breath is underway.

What it means for stock markets is anyone’s guess, but the popular view is that it’s an omen of falling prices to come. If the global economy is so weak it can’t provide a bid for raw materials, how much demand for business activity will it be able to muster? Not much, say the pessimists, hence earnings will fall and take share prices down with them.

Opportunists say the commodity wipeout is the place to focus now, because tides will shift. Jared Dillian, in yesterday’s Daily Dirtnap ($600/yr,, noted the market is currently suggesting coal has no value. “If the market is pricing it in as nothing, then I will pay nothing, and hope that it is worth something,” he wrote. He advised saving up cash and making strategic purchases “when things get stupid. Things are already stupid, but likely to get stupider. … This stuff is not going to go to zero. Almost by definition, it cannot. I am going to buy, and hold, and wait.”



From this year’s Note 25 sent to subscribers last Sunday morning, with data as of Friday, July 17:

Last week, our portfolio balance rose $5,998 (0.3%) to $1,853,552 from $1,847,554. Year-to-date by total return, we are up 1.3% (from $1,830,505) compared with 4.3% for the S&P 500 (from 2059, plus dividends). Over the past three years, we are up 25.6% (from $1,476,079) compared with 18.7% for the S&P 500.

West Texas Intermediate closed Friday at $50.89 per barrel, down 3.5% for the week. Our oil-price hedge, PowerShares Oil -2x (DTO $84.67), rose 5.7%.

Gold as represented by SPDR Gold (GLD $108.65) is now under the key $110 level from which it bounced higher in November and March. Its point-and-figure (P&F) bearish target is $91. The bearish case is centered on this: Rising interest rates and the improving US economy suggest that supposed “currency killing” policies of the Fed instituted since the 2008 financial crisis are no longer needed. Higher rates make gold unappealing since it pays no interest or dividends. Lower interest in gold means a lower price for the metal, and a lower price for the metal means lower stock prices for gold miners. The bullish case is just the evergreen one: Central banks will devalue currencies and only gold will retain worth — please ignore the past five years.

On the general stock market front, bullishness reigns, much to our disappointment as capital allocators eager to move money from bonds to stocks on a decent pullback. All the bears can muster these days is a yellow flag on the fact that momentum stocks are leading the market higher, and that this happening when the market is at an already high valuation tends to mark the end of a bull run. Sure, just like it was supposedly doing in every year since 2010. This is just another bit of oft-repeated meaninglessness that doesn’t matter until coincidental correlation is confused with causation, at which point it’s said to have mattered.

A bearish observation more worthy of your time is that the S&P 500 exhibited a multi-year rising wedge pattern to its bull market peaks in 2000 and 2007, which were followed by crashes. Since the bottom of the last crash in 2009, the market has exhibited another multi-year rising wedge pattern, suggesting that a top is imminent. The problem here is that chartists have been drawing the rising wedge for a few years now. It’s still rising in a narrowing wedge pattern. When an indicator appears so many years ahead of an eventual and inevitable top in a bull market, can it be considered useful in any way? I don’t think so. Too bad because we’d sure like the bears to be right one of these quarters. Somehow, they just never are.


Tired of indecision in the financial markets? Read The Kelly Letter every Sunday morning to put The 3% Signal and other price-based rationality on your side. You’ll run circles around people following conjecture-based speculation. The letter costs $19.97 per month or $236.97 per year. Please subscribe now at:



On April 22, Dana Lyons wrote in “Smart Money Options Indicator Now ‘Off The Charts’ Bearish”:

Since 1998, the put/call ratio on open interest in OEX options has been considered extremely elevated when it has risen above 2.00. From 1998 to 2011, there were just 6 days when the ratio got as high as 2.00. Each of those days either came in the vicinity of a significant market top or at least presented extremely limited upside in the intermediate-term. In the second half of 2014 alone, there were 8 readings. And 2015 has ratcheted up the frequency of such readings to a whole other level. There have now been no less than 34 readings above 2.00, all coming in the past 2 months.

And it hasn’t just been the frequency of the readings, but the magnitude as well. Before a week ago, the highest level of the OEX open interest put/call ratio since 1998 was 2.31 in November 1999. The past 2 days have seen readings of 2.77 and 2.79!

I characterized the disposition of this call as “Short-Term Bearish” to be judged on July 22. The S&P 500 traded at 2108 on April 22 and closed yesterday at 2119, a change of +0.5%. Therefore, in my judgment, this call was wrong.

To see this call in The Z-val Zone, please visit:


Background: The term “z-val” is a shorthand introduced in The 3% Signal for “zero-validity forecasters” and “zero-validity environment.” The latter phrase was coined by Nobel Prize winner Daniel Kahneman in his book Thinking, Fast and Slow, where he wrote that “stock pickers and political scientists who make long-term forecasts operate in a zero-validity environment. Their failures reflect the basic unpredictability of the events that they try to forecast.” This is why stock market forecasters are proven to sport an accuracy rate of about 50%, same as a coin toss, yet they continue forecasting.

You can peruse the growing collection of judged forecasts in The Z-val Zone at:



How about some perspective? See why the book Where is Everybody? by Stephen Webb is one of my favorites by reading the article “The Fermi Paradox” by Tim Urban at “Wait But Why,” from which:

“…given that my normal outlook is that humanity is a lonely orphan on a tiny rock in the middle of a desolate universe, the humbling fact that we’re probably not as smart as we think we are, and the possibility that a lot of what we’re sure about might be wrong, sounds wonderful. It opens the door just a crack that maybe, just maybe, there might be more to the story than we realize.”

Full article at:

Be well and enjoy the rest of the week. Kelly Letter subscribers, see you Sunday!

Yours very truly,
Jason Kelly

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