A Look at Commodities

I'm always searching for where the strength and value is in the market. Currently those characteristics  are showing up in the Commodity space. A big part of my investing philosophy is identifying strength and rotation as money flows from one area of the market to another. For the better part of the past two years there was no need to look beyond stocks as they have been exhibiting exceptional strength over that period. However I have been seeing action that suggests stocks may be at least slowing and there are better risk/reward investments heading to the top of my watch lists.

Russell 2000 - Small Cap Stocks

GCC Continuous Commodity ETF (Equal Weight)

Here is the comparison between the Small Cap stocks and an Equal Weight Commodity fund. Small cap stocks represent investors higher risk allocations and tend to outperform during market rallies; one can see both the Relative and absolute uptrends the small cap stocks have been in since late 2012. Small caps have been the place to be for capturing market upside, but their current look suggests at least some sideways corrective action for the coming future. During that same period, commodities as a whole have been sliding steadily in a very defined downtrend. However it appears that the commodity space has the look of  transitioning out of that prior trend.

*Note: I'm not suggesting that stocks crash from here and commodities duplicate what the stock market has done over the past couple years, but in terms of favorable risk/reward, commodities look cheap relative to stocks. I am seeing strong money flows as investors take profits from stocks and look for other market neutral areas to put that cash to work.

Let's take a look under the surface of the commodity sector and see if there are any favorable opportunities to be had in light of this potential long term trend shift.

Just as it's important to follow price and money flows with stocks, commodities should be treated no differently. When we own stocks we simply don't care what the pundits and media are opining about regarding our holdings, that's just noise and nobody ever made money reacting to noise. Price pays, it's as simple as that. We treat all asset classes the same, as it's the same irrational humans trading any particular market. While stocks carry risks with earnings reports and news events, commodities carry risks associated with weather related issues (drought, storms, heat/cold) and supply/demand inventory imbalances. As with stocks we cannot control how these events play out, neither can we determine how the weather will effect the next crop report. All we can do it assess which groups have the best relative price performance and offer the most attractive risk/reward setups. As with any asset class we invest in, there are some that are better than others. The primary commodity groups we follow are a mix of metals, energy, grains, live stock, and soft commodities. For the sake of simplicity and ease of trading we will be limited to commodity ETFs that represent most of these classes. Since we have recently discussed the metals (link to prior post here), today we are going to focus on energy, grains, softs, and live stock:

ETF Name--Commodity

OIL--Crude Oil
UNG--Natural Gas

CORN--Corn
SOYB--Soy Beans
WEAT--Wheat

NIB--Cocoa
JO--Coffee
BAL--Cotton
CANE--Sugar

COW--Live Stock

It is important to note that commodities should not be bought and held in the traditional investing sense. Commodities are highly cyclical and while trends can persist for extended periods of time, these should be treated as trading vehicles only.

ENERGY

Crude Oil (OIL)

Crude Oil has been forming a multi-year basing wedge since the 2009 stock market crash. Currently price is narrowing in trading range, but a break above or below these converging trend lines should create a very large, multi-year move in oil prices. Up or down is not decided yet, so we will just have to keep this one our radar going forward. It will take a move above $25 (roughly $110/barrel in the futures market) or below $21 ($90/barrel) for the next move to begin in motion.

Natural Gas (UNG)

Natural Gas prices have been declining for years. I am of the opinion that we may be seeing a generational buying opportunity in Nat Gas right here. Prices have been so depressed from their highs that this fund could double in value without batting an eye. Currently we are seeing price stabilize ABOVE multi-year resistance levels and I believe this move is just getting started. Do understand that this is a very volatile investment space, so you need to be sizing your positions in accordance to higher than typical risk parameters. Honestly though, right here, a stop below the prior couple week's lows at about $24 presents a phenomenal risk/reward opportunity.  I am currently Long UNG.


GRAINS

Corn (CORN)

Corn prices have swung wildly over the course of the last few years, but I believe we could be seeing the start of a new uptrend just getting underway. Both Relative and absolute downtrend lines have been broken to the upside over the past couple weeks as well as a nice rounded base formation over the past 6 months. Every signal for trend strength I follow suggests further upside from here; as long as prices stay above $33 (roughly $470 futures price) this is Long and strong all day. I am currently an owner of CORN.

Soy Beans (SOYB)

Soy Bean prices have been quite stable for the better part of the last few years and currently are testing a very important supply level. I would want to see prices breakout above this resistance at $25.50 to suggest a new uptrend and not more of this sideways, choppy action. Prices are above a newly rising 20 WMA and RS vs the SP500 has broken its multi-year downtrend, so an uptrend resumption could be in the works.

Wheat (WEAT)

Wheat has been steadily declining since mid 2012 and still has work to do. Relative to stocks, we are seeing some firming out of the downtrend, but there still is a large resistance level just above current prices. The 20 WMA has started to flatten out over the past few weeks which can often suggest that the downside from here is minimal as the downward momentum is waning. Still we would want to wait for a little more out of the Wheat space.

SOFTS

Cocoa (NIB)

Cocoa prices have been pivoting around a key inflection level for a few years now. The $37.50 level in NIB has been both key support and resistance on multiple tests, yet now prices remain above the line. This presents a very clean exit level should this trade fail. As of now it appears that a bullish Double Bottom pattern is in play with a target $47.50 and over 30% upside from current levels. I do not hold a position in NIB but may initiate one within the next couple weeks.

Coffee (JO)

Coffee prices have exploded, doubling in the last two months. Currently prices are still too extended for a comfortable entry and we may just have to let this one go. But with the last couple weeks' trading, prices have been able to break through a strong supply/demand level and look like they want to push higher. Just know you can't trade them all, and while this may continue to outperform, sometimes the risk is simply too high to justify a new position. Keep this on your radar to see what happens.


Cotton (BAL)

Cotton prices have formed a large, multi-year base. While prices remain depressed from the previous high levels, it seems that a trend resolution will occur soon. Prices are forming a wedging pattern and will eventually break to the upside or down. This is what we will focus on going forward.

Sugar (CANE)

Sugar prices are in a down trend but could be forming a potential basing pattern. Only time will tell if this comes to pass, but what we can say for certain is that CANE needs more time to bottom.

Live Stock

Lean Hogs and Live Cattle (COW)

COW tracks the prices of Lean Hogs and Live Cattle futures. As we can see prices have run into a supply area and have rejected that level. It will be very interesting to see how traders position themselves going forward at this significant resistance. We would need to see a breakout to get more excited about this space, especially after the strong rally it has had to start 2014.

---That's my take on Commodities at current levels. While an Equal Weight Commodity fund would look fine here, there are still notable pockets of strength and weakness within the group. Ideally we would enter the better risk/reward setups and avoid the weaker ones. Currently I like UNG, CORN, and NIB for actionable entries. While JO could get interesting once it cools off a bit. The rest should be avoided as new trades at current levels, but if continued strength comes into the group many may signal entries as well.

***read a basic overview on commodities trading here