Commodity Correction Part II

Montreal, Canada

From its high this year the benchmark Reuters-CRB Index is down 9%. That’s the good news. The bad news is commodities are likely to suffer another hit this summer as the Fed exits QE II and global markets test longer term moving averages.

Oil, the single largest constituent in all commodity benchmarks, is losing support as the $90 level approaches for WTI crude. In “risk-off” sell-off, oil will head lower.

Historically, the summer is a bad time of the year for natural resources. Markets are often thinly traded as we approach August and most buyers in the commodities complex are away on holidays. That leaves room for the heavy-hitting speculators to attack volatile markets with a bias towards the downside; most commodities remain vulnerable.

The odds are pretty good that the U.S. dollar has started a short-term bear market rally. That’s not because things are looking pretty in the United States – they’re not. But the macro outlook has deteriorated markedly not only in the U.S. but in Europe and China as well. Some sort of massive dislocation across Europe seems probable this summer as the markets force a Greek restructuring or soft default. That’s a dollar-bullish event.

The markets must work their way through this uncertainty and the first thing investors will throw out is high risk like commodities and small-cap stocks. That trend has already begun.

From now until late summer or early fall, a reverse-index on commodities or a long position in the Dollar Index should produce attractive gains or, at the very least, give investors a suitable hedge in an otherwise difficult environment for risk. The Fed’s big dose of liquidity is nearing an end. That spells trouble for the markets.

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