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Commodity Caution

  • After a historic two years, we're pivoting from bullish to bearish on commodities.

  • Weakening technicals, crowded positioning, and the overwhelming bullish consensus make for a treacherous tactical outlook.

  • Stretched valuations, strong dollar, and a weakening macro backdrop also present fundamental headwinds across commodities.

It has been an incredible run for commodities in the last two years. From late April 2020, the overall commodities tracking ETF (DBC) is up 167% while the popular oil fund (USO) has surged a whopping 377%. After initiating a bullish outlook on the space in March 2020, it’s time to close this long idea.

Tough Slogging Ahead

Why the change? Technicals are turning bearish, sentiment indicators are frothy, the macro backdrop is weaker, and frankly, the value narrative is questionable right now. All these factors skew risks to the downside for the balance of the year through 2023.

Telltale Industrial Metals?

A key indicator recently has been the swift pullback in economically sensitive base metals. The industrial metals complex came under attack in April. Meanwhile, the US Dollar index staged a huge rally this year – continued strength could turn into a headwind for the commodity complex as fears shift from inflationary risks to a global growth scare.

Big Changes

Our Weekly Macro Themes report digs into equity and bond market risks, an piqued interest on peak inflation, and a reassessment of commodities, including the agriculture space. We have a few major idea changes investors should heed.

A Bevy of Bearish Factors for Commodities

Homing in on commodities, the technicals have taken a decidedly bearish tone of late. The GSCI light energy index snuck a peak above its all-time highs, but then fell back below previous resistance. That’s a clear bearish false breakdown risk right now. Meanwhile, 200dma breadth rolled over from overbought levels.

Moreover, as Topdown Charts founder and Head of Research, Callum Thomas, highlights in the chart below -- the proportion of commodities positive on a YoY basis is tracking lower. We’ve seen this pattern before (technicians refer to this as bearish divergence, and it is a key tool in detecting turning points). Commodity bulls must concede this is not March 2020.

Featured Chart: Commodity Prices Struggle at Resistance, Breadth Dips

chart showing deteriorating technical outlook for commodities

The Long-Term Valuation Perspective

When in doubt, zoom out. As they say. The longer-term value indicators we track across 46 commodities reached similar levels back during the mid-2008 commodity climax. While always hard to truly gauge valuation among commodities, our assessment underscores the stretched prices within the group.

Dollar Hollar

And we cannot ignore what’s going on with the Greenback. The US Dollar Index surged to 20-year highs. It’s breaking out. Even novice intermarket analysts know that a bullish USD is bearish for dollar-denominated commodities. A rising dollar portends tightening global financial conditions in the months ahead, leading to demand destruction (another bearish factor).

PMI Pulse

We’ve commented quite a bit this year on the imminent rollover of global PMIs. Commodities bull markets eventually succumb to dips in economic activity. Our report outlines why that’s the case this time around. Already in 2022, the consensus full-year global GDP forecast has dropped from near 4.0% in January to about 2.7% at last check.

Bottom Line: We initiate a bearish view on commodities looking ahead through next year. As such, we close our bullish idea on the asset class. It had a good two-year run, but the times they are a changin. Fundamentals, technicals, and macro headwinds are just too great.

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