Don’t Buy Commodities Now

Miami Beach, Florida

Commodities and common stocks continue to show a strong correlation to each other since 2007. And that might be bad news for commodity bulls if stocks head sharply lower in January as virtually every sentiment indicator I track flashes “overbought.”

Since the advent of the credit crisis in mid-2007, the “risk on” and “risk off” trading relationship has forced these two asset classes into the same bed. That means more often than not that their performance is intertwined.

Diversification has failed most portfolios over the past three years with only a few commodities breaking ranks; gold and natural gas have tended to break free from the broader stock market but just about everything else has managed to plunge when equities head south.

With the exception of bombed-out natural gas and most oil services stocks, the commodities complex remains heavily overbought and poised for a severe correction in January. I would not buy most resource stocks or commodity ETFs heading into the New Year. The odds favor a much better entry point lies ahead.

This would be consistent with my view on stocks, which have shown to be positively correlated to commodities since 2009; if stocks and commodities are running the gamut together in this recovery off the March 2009 lows, then shrewd investors would be better off waiting for marked decline in both risk assets before committing new funds.

For commodities investors, understanding stock market indicators might allow for less pain come January 2011.

Major sentiment indicators I’m tracking show dangerously bullish levels. These include the CBOE puts-to-calls ratio, Investors Intelligence surveys and the number of shorts at both the NYSE and NASDAQ. These indicators are now trading at their highest levels since 2007 and point to a big market decline.

Another indicator is the level of closed-end fund discount trading to big discounts to their net asset values; that figure has significantly compressed since November. Finally, the worst market-timers of all, the individual investor, is now a net buyer of stock funds since last month for the first time since 2007.

The Investors Intelligence survey is most telling of all. This indicator is calculated weekly and now shows bulls at their highest levels since before October 2007 at just under 56%. That’s a bearish number. Back in August, the number of bulls was just 29%, suggesting stocks were about to stage a big rally. Indeed, they did, courtesy of Bubble Ben and the Feds announcement of QE II.

Stocks and commodities have shown a strong correlation since the emergence of the credit crisis and especially since the March 2009 lows. Too much complacency is a bad thing and warrants caution for most risk assets heading into January. Commodities are no exception.

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