Commodities: A picture's worth a thousand soundbites...

Time to sell oil and buy wheat? I remain a bear of the speculative commodity bubble that has inflated to dangerous proportions in the last few months as a flood of new money has squeezed into these relatively illiquid and poorly regulated markets (see previous post), but as the old saw goes, the market can stay irrational a lot longer than you can stay solvent. So how can an investor minimise risk in taking a contrary view to the market consensus? One proven way of predicting the extent to which a sector, stock or commodity is overbought/sold and thus likely to revert to the mean is to chart against a 2 standard deviation band above and below the 50 day moving average. This is very useful from my experience in investment timing; if a trade is very crowded, as reflected in the energy charts below, the probability of a contrary trade becoming profitable rises dramatically.

The charts show clearly the extreme overbought conditions in energy right now (a chart of the crude oil or natural gas RSI versus the CRB index is similarly overextended). Gold, which I shorted at $1000 in March and close at $870 two weeks ago, partly on the technically oversold condition evident in the chart, has bounced since, with a move back to the $950 range quite likely in coming weeks.

Agricultural commodities have been hard hit by a sharp reversal, as speculative money has moved into the crowded energy trade in recent weeks. This was eminently predictable given the 'food crisis' hysteria in the media back in March and April, another great contrary indicator (do a Google count on 'Peak Oil' news stories and start loading those put options). I'm a big long term bull of soft commodities, and grain stocks globally remain at 30 year lows despite hopes of a better Australian harvest this year (see post); wheat has retraced all the 2008 run-up, and at these levels will prove a steal on a 12 month view, although rice and corn are still in a corrective phase.

Sphere: Related Content