Buy U.S., Short Commodities

The following commentary was sent out to Money Matters subscribers on 19 April 2013.

According to our methodology, Wall Street is currently in ‘correction mode’ and additional near-term selling pressure cannot be ruled out. At this stage, nobody can predict the duration or depth of the ongoing stock market correction. However, until a new uptrend emerges, caution is warranted and investors should not allocate fresh capital to common stocks.

It is notable that after an impressive advance during the first quarter, Wall Street has recently experienced some distribution days (declines on rising volume) and a couple of days ago, our trend following system gave us the correction signal. Thus, as long as the stock market remains in ‘correction mode’, we plan to stay defensive and will refrain from initiating new positions.

Looking at the bigger picture, it is notable that Wall Street is outperforming the majority of the global stock markets and we expect this trend to continue for several years. You will recall that between 2000 and 2011, the correct trade was to go short the US and buy commodities and the emerging markets. However, we suspect that trade has now reversed and for the next few years, investors should buy American assets and go short commodities and the stock markets of the developing world. After all, America’s housing market is now on the mend and the world’s largest economy is still home to some of the most successful corporations on the planet. Furthermore, sentiment towards America is still very negative and we believe that the stage is now set for a secular bull market on Wall Street.

Given the fact that the stock market is currently in ‘correction mode’, investors should monitor the strongest sectors carefully and identify leading stocks which should be purchased after the end of the ongoing pullback. As we stated last week, biotechnology, consumer staples and healthcare are amongst the strongest industry groups and investors should focus on these areas for new opportunities. In terms of the laggards, commodity producers, chemical companies, oil & gas royalty trusts and precious metals miners are some of the weakest sectors and they must be avoided at all costs!

Turning to commodities, the picture is deteriorating and the Reuters-CRB (CCI) Index has now slipped to a multi-month low. Furthermore, the CCI is now trading well below the key moving averages and this implies that commodities are in a downtrend. Looking at specifics, the price of copper has now declined to a 52-week low and further weakness may bring about a waterfall decline. In our view, major support lies in the $2.80-3.00 per pound area and a close below that level may trigger a dramatic plunge! Thus, experienced traders can consider going ‘short’ copper and the associated miners. Elsewhere, the price of crude is also exhibiting weakness and a close below the $84 per barrel level will probably unleash a wave of selling. Thus, investors should avoid investing in the energy complex and nimble traders can consider going short crude oil.

Over in the precious metals patch, the prices of gold and silver plummeted last week and this disaster show was in line with our expectation. As you will recall, we sold out of precious metals in September 2011 and were continuously warning our readers about the possibility of a major plunge beneath the key support levels. As things stand today, precious metals are trading below the major consolidation zone and prior support will now act as overhead resistance. Given the magnitude of the decline, a brief bounce towards overhead resistance (US$1,440-1,500 per ounce for gold and US$25-26 per ounce for silver) cannot be ruled out but we suspect that any rally will fail and prices will probably fall below the recent lows. Thus, if we get a relief rally, nimble traders can consider going short gold and silver. In our view, the secular bull market in precious metals is now over and this is not the time to have any exposure to gold, silver or the associated miners. Remember, opinions are often wrong and the price never lies. Therefore, we urge our readers to ignore the bull market hype and follow the price action, which is now decidedly bearish.

In the world of currencies, it appears as though the US Dollar is gathering momentum and it is conceivable that we may be in the early stages of a multi-year uptrend. After all, the US Dollar is currently trading above the key moving averages and a close above the 84.1 level will probably usher in the next rally. Thus, as long as the US Dollar Index remains in an uptrend, investors should keep their cash in the world’s reserve currency. Conversely, nimble traders can consider going short the Australian Dollar, British Pound, Canadian Dollar and the Euro.

Finally, over in the bond market, it appears as though German Bunds and US Treasuries bottomed out in March and they may appreciate over the following weeks. Thus, nimble traders can consider establishing long positions in these safe haven assets. Elsewhere, due to the loose monetary policy, high yield corporate bonds are holding steady and in our view, income-seeking investors should maintain their existing positions.