Friday, May 25, 2012

Think Commodity Fundamentals Look Grim? Check Out the Charts

May the games continue. Aivars Lode

By Reuters
Friday, May 25, 2012

NEW YORK (Reuters)—To a growing list of fundamental reasons to be worried about commodity markets, add one more: prices are threatening to crash below key chart levels that may unleash a new deluge of selling.

A host of external factors has fueled the 8 percent selloff in raw material markets this month — the deepening crisis in the euro zone, a U.S. economy struggling for traction, signs that China's once-explosive growth may be cooling.

But for chart-watchers all that is largely irrelevant. Far more worrying are the moving averages, Fibonacci retracements and congestion zones that foretell the next big move. And even after May's selloff, one of the worst of the past two years, they say most indicators are pointing lower still.

"Our sentiment indicator has fallen like a stone to almost zero," said Julien Turc, head of Société Générale's Cross Asset Quantitative Strategy group in Paris. He said the speed of the decline was a very bearish technical indicator, and noted that credit spreads are near levels last seen at the peak of the financial crisis in October 2008. "You don't need to have a PhD to know that's a bad signal for the economy and risk assets."

Three key price points stand out for technical analysts: $1.25 for the euro; $88 for U.S. crude oil futures; and around $1,520 an ounce for gold.

As three of the largest and most active markets for commodity traders, these can set the trends that smaller markets like coffee and grains follow — and all three markets are within a hair's breadth of those pivots.

"The reason these levels are important is they have acted as key supports in earlier selloffs," said Dominick Chirichella at the Energy Management Institute in New York, adding he thought the "commodities up-cycle" is due for a pause. "As a result, traders will have a lot of automatic buy- or sell-stops just above or below them. Commodity markets don't tend to move in ‘V' patterns, they move into a new range and then consolidate."

Growing Influence

While technical analysis has been part of commodity trading even since Japanese grain merchants started studying patterns in price movements in the 18th Century, quantitative traders and funds have come to exert even greater influence over markets in recent years.

The growth of multibillion dollar algorithmic trend-following funds like Winton Capital, and the rise of lightning-speed high frequency traders, makes technical support and resistance levels more important than ever.

It was apparent at least twice this week in soft commodity markets.

New York sugar prices dived abruptly after breaking below the psychological 20-cent level on Tuesday [May 22], while coffee followed a day later after crashing below the $1.74 level that had held firm for the previous six weeks.

Other warning signs have flashed elsewhere.

The Thomson Reuters-Jefferies commodities index .CRB has gapped lower three times in two weeks. U.S. crude oil prices dropped below their 200-day moving average in early May.

Copper, which some analysts view as an early indicator of global economic expansion or contraction due its use in construction, has retraced almost 60 percent of its near $2,000 a metric ton (1.1023 tons) rally to $8,765 between October and February.

Gold, one of the assets most susceptible to technical trading since is it viewed by many as an alternative currency, has been hit hard of late, threatening to collapse below the $1,522 low of last December. It is down 19 percent from a record high of more than $1,920 an ounce last September, flirting with a technical bear market.

Kris Kaufman at Parallax Financial Research in Washington state said he expects gold to fall by more than $200 an ounce in the coming months toward $1,300, despite it often being viewed as a safe haven in times of financial stress.

"We had an enormous extension top in gold last year and since then we've been telling clients that gold's untouchable on the long side for the next three to four years," Mr. Kaufman said. "We're similarly bearish on the euro — and as a result other risk assets. We now see it falling to $1.10 by the end of the year. It's hard to see dollar-priced commodities performing well in that environment."

As the dollar strengthens it generally weighs on assets priced in the greenback, as they become more expensive for holders of other currencies.

Darkest Before the Dawn?

Technical trading is, however, more of an art than a science, and some analysts expressed a contrarian view.

Brian LaRose, technical analyst at United-Icap in New Jersey, said that while he does not see the market embarking on a prolonged rally, the recent selling may be overdone.

"While I'm very bearish in the medium to long term, there are signs across the broad markets that we could be in for a multi-week corrective bounce in the short-term," Mr. LaRose said, adding that he had been telling clients to "sell in May" since April, when U.S. crude was about $20 above where it is now. "The euro will be key — its domination of other markets was dormant for a short time earlier this year, but now it's back with a vengeance. The must-hold levels are $1.255 to $1.235 — if that holds I think we'll see something of a rally."

The correlation between the euro and U.S. crude oil futures has risen to above 95 percent since the middle of May, from less than 50 percent at the beginning of the month. That means moves in the euro are currently matched almost 1-for-1 with crude.

U.S. crude oil's "relative strength index," which rises and falls based on the speed of rallies and selloffs, has been below 30 since the middle of May, a sign for technical traders that it could be oversold.

In the last 17 trading sessions, U.S. crude oil has finished lower 14 times, though it rose 1.2 percent on Thursday. The euro weakened slightly, but held above $1.25 against the dollar. Gold was almost unchanged at $1,560 an ounce.

Mr. LaRose said that while he still has a 'conservative' medium-term target for U.S. crude of $75 a barrel, "I'd rather be taking off shorts than adding to them here."

By David Sheppard