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Commodies Decline - Correction or Top?

Posted on July 9, 2006
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I’ve been on vacation for the past month or so. Just as I was leaving, most of the commodities markets that had been in tremendous bull markets were just starting their corrections. The declines were steep, but thus far the recoveries have also been robust. We are now at an interesting inflection point, as shown in the series of charts below:


August Gold (above) fell 25% from its high, and has since recovered about 50% of its decline.


Copper (above) also corrected about 25% from its high, then recovered almost 70% of its decline.


Same story for Sugar (above) , which is seeing its demand is being driven by its use in the production of ethanol.


The oddball here has been oil (above) , which didn’t fall as much, but also regained almost all of its decline. Almost, but not quite. It now appears to be falling away from these highs.


Finally, we see the CRB Commodities Index (above) . Its pattern is typical. While the 62% retracement level is a common failure point for countertrend rallies, it is also common for a true advance to simply pause at this level.

The exciting question we are faced with now is: Was the May-June decline in commodities just a healthy correction? Or was it the start of something bigger? And in the larger scheme of things, what are the implications?

Note that while commodities were falling from the middle of May until the middle of June, the US Dollar had a generally positive, if not choppy, uptrend:


Nearly everyone and his brother is expecting the dollar to plummet, and commodities (naturally) to resume their ascent. Everyone, that is, except Prechter, who writes in the June issue of his Elliott Wave Theorist:

A prominent deflationist throws in the towel. Another looks for “good deflation.” Bears on commodities expect the economy and stock market to boom. Bears on the stock market and the economy expect gold and silver to soar. A flood of articles insists that the stock market is being “spooked by inflation” even as silver crashes 30 percent, gold 20 percent and copper 25 percent. The Fed agrees and vows to “fight inflation” with higher interest rates…

…For a long time there have been signs of an impending deflation. Now there are signs that deflation has arrived. Japan is leading the way. Its monetary base has fallen dramatically since the beginning of the year (15 percent in the past two months according to USA Today). Stock markets around the world have suddenly fallen 10 to 50 percent. Commodities that were soaring have reversed violently. Real estate is now in a “buyers’ market,” when there are buyers. The investment binges of the past three years are not the story; they are the precursor to the story…

In 2004, Pete Kendall and I wrote an article for Barron’s in which we argued that all investment markets had begun moving together, not contra-cyclically as they had in the past. We theorized that late in the credit and economic cycle, liquidity is the motor of all investment markets. We showed a graph of the major markets, including stocks, junk bonds and precious metals, and called them “all the same market.” Of course, two years ago people thought that our claim was crazy because markets would have to be crazy to move all together. But markets are crazy, and predicting such events requires understanding that markets are impulsive and patterned, not rational, and that they go through similar expressions of the same cycle of psychology over and over. The extent and duration vary, but the essence is always the same.

The flip side of markets going up together is that when the reversal comes they all go down together. We have been predicting this event for way too long, but it finally seems to be upon us. The wild speculation supported by the expanding, inverted pyramid of credit is exhausted…

So there’s Prechter, bearish as ever. I’ll be going over his deflation argument, as I understand it, for the rest of this week, in concert with his own writings which will be made available by Elliott Wave International from Wednesday July 12, at 5 p.m. EST to Wednesday, July 19, at 5 p.m. EST. You can get access to all of Elliott Wave International’s US Market reports free for one week. No charge, no obligation, no credit card required.

In my experience, EWI offers these “Free Week” peeks when they think something big is brewing in the market. What is that “something big?” Here is a hint: The title of the June 16 Elliott Wave Theorist quoted above (which you’ll be able to read in it’s entirety between 7/12 and 7/19) is “We appear to be the only advocates of a deflation-depression scenario.” Deflation means falling asset prices and a rising dollar – something no one (except EWI) is expecting.

To get access to the free publications starting on Wednesday, sign up here: - Click -

Now, nobody has a monopoly on opinions, so I’d like to hear yours: On the direction of the stock market, commodities and dollar over the remainder of the year. No need to sign in to post your comments below.

To be notified when I update this site, sign up with my low volume e-mail announcement list here.

Doing my best to keep you informed,
Michael Nystrom

News updated daily on the Homepage


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25 Comments so far
  1. ronandreas July 9, 2006 8:32 pm

    I have the impression that the markets declining in unison is a leading indicator of recession in the 4th quarter. Commodities will fare poorly, real estate will crash, stocks will crash, even oil may sell at under $40/barrel. Precious metals offer no haven.

    Right now I see value in some real estate markets; Germany, Switzerland, Isla Margarita. Diversified currencies deployed at critical points will preserve capital.

  2. tommywad July 9, 2006 8:41 pm

    My humble opinion is that commodities are in a long term bull market.

    We may have a short term correction.

    We will come back in Sept. with a big rally in commodities.

  3. Marc Authier July 9, 2006 8:47 pm

    Diversified currencies will protect you of absolutely nothing. Personnally I prefer commodities. In this context, do you believe that countries like China or India have any intention of going backwards and stopping their industrialisation? This is a HUGE plus with commodities. The sector at large has been ignored for too long by stupid bankers and investors. A lack of investment over the last 30 years has resulted in chronic depletion. There are not enough oilfields, not enough mines and not enough coffee plantations etc…. across the world. And demand was there in 2006. The supply/demand equation will be very favourable to commodities producers, for at least the next 20 years.

    As for currencies? These are just pieces of papers printed in infinite quantity by crooks called central bankers. Buy the real stuff and never mind these fictitious assets called currencies. They ain’t worth even the paper they are printed on.

  4. Dirk Davies July 9, 2006 9:03 pm

    But Marc Authier, what you miss is that the commodities are valued in what you call the “ficticious assets” of currencies. Of course neither China nor India have any *intention* of going backwards - whether they will be forced to by the market is another story.

    The more “ficticious assets” - credit (not currency, mind you, but credit) - that governments create (create, mind you, not print), the higher these commodities will go.

    Inflation is a monetary phenomenon - the government prints money and it has to go somewhere. Ergo inflation. In the current situation, with credit, that credit can be destroyed, and the prices of commodities can collapse, and then the global economy can shift into reverse - not by choice, but by necessity. In such a situation, I imagine that demand for commodities will drop precipitously.

    Even now, I doubt that demand for copper and oil is as high as the prices indicate - most of the price is driven by leveraged speculators - i.e. the hedge funds. We’ve seen collapses before when the Fed decides to tighten too much that it chokes the economy. To within inches of its life. By cutting off the credit.

    - Dirk

  5. JDR July 9, 2006 9:08 pm

    “Deflation means falling asset prices and a rising dollar – something no one (except EWI) is expecting.”

    No. Deflation is a decrease in the money supply. Falling asset prices are just one symptom of deflation, not its root cause. Since all currencies now float (yes even the Swiss franc) relative to each other, there is nothing to limit the actions of central banks in manipulating the money supply in various economies. I’m sure Bernanke spoke for many other bankers when he stated that deflation would not be allowed a foothold.

  6. Patriot July 9, 2006 9:09 pm

    Why would anyone think the USD will still reign supreme when the fundamental conditions exist that will trash this colored paper that has absolutely nothing backing it up? All world currencies are being inflated and in the end all those countries that have resouces being bought and used by the great economic powers will demand real wealth which looking at history tell us silver and gold not pretty paper money which is being produced by the basketfulls. The nationalisation of natural gas in S America is just the first step in this direction. The hatred of America justified by its foreign policies will make it even harder for them to accept paper money which they know is worth nothing. It seems its very hard for so called experts to believe the economic future of the US is not in the hands of its people or its rulers. There is a time coming when nothing absolutely nothing the Fed does will matter a whit concerning the control of the USD and precious metals. They have given away so much of the store we have nothing anyone wants anymore. The holding of trillions of unbacked paper is such that even now on the news its being converted albeit slowly and hidden but nevertheless converted to metals. The spot markets in metals in London and New York are much lower than those in the far east and other places but this is not much reported. Could it be what I beleive that the corrupt degenerate rulers of the US are still selling gold at huge discounts to keep their fraud dollar scheme in place? I for one believe we do not have near as much gold as the gov’t lies and says we do, and some day metals being finite they will run out. At that point only those who possess real money, which for the last ten thousand years was gold and silver, will be the ones who prosper. That is if the scum corrupt traitors called the US govt does not try to steal it from those who saw this coming.

  7. JDR July 9, 2006 9:18 pm

    “Why would anyone think the USD will still reign supreme when the fundamental conditions exist that will trash this colored paper that has absolutely nothing backing it up?”

    In a leper colony, sometimes the man with three fingers is King. The other players may not like it, but for the forseeable future the USD will remain the world’s reserve currency. In a crisis where else would they put their trust?

    Eventually some other financial structure will replace the dollar but that is years or even decades away.

  8. Sandalaphon July 9, 2006 10:01 pm

    God only knows what will the long term markets will do … but hey, we’ve got far more exciting stuff going on above our heads.

  9. Daman Prakash jain July 9, 2006 11:47 pm

    Many of your readers seem to think that India is buying gold. This is wrong . I live here in India, and have extensive knowledge of bullion business here. They have made gold and silver very volatile. This is good for speculators but bad for physical markets. People here are afraid to buy at such high prices. I am sure today the market may be dictated by technicals but it will return to demand supply fundamentals once the facts are widely known. I am sure Gold and silver usage and demand has come down drastically in traditional markets. This steep decline is no where matched by combined buying by all ETFs. Thus to entice the traditional sector the market may reverse to acceptable prices. For gold it would be somewhere near 500, and silver somewhere near 8.50

  10. lee obrien July 10, 2006 4:16 am

    COMMIDITIES WILL TAKE A WELL DESERVED HOLIDAY. Maybe a 6-9 month sabbitical?

  11. David Kennedy July 10, 2006 4:40 am

    I have never read Prechter’s book, but from reading snipets and reading reviews of his work cited by many authors of various missives, I understand he has been calling for a depression for about 15 years now. Eventually he will be right but he might die first! I do believe the Kondratiev cycle is correct however. Prechter, to my understanding, has a stellar record at being wrong.

    If I am mistaken with this preception please post a feed back. Thanks everyone.


  12. David Kennedy July 10, 2006 5:03 am

    I just read some good news about China’s growth from Everbank’s Chuck Butler. He writes “The Daily Pfenning”. Below I copied a snippet which shows China’s demand is growing to new records (likely India is also). India will miss most of the gold bull because they do not see gold as a currency. I think the Indian people are not aware of the drastically reduced purchasing power of the dollar so they think $620 gold is expesive, when in fact it is cheap because the dollar will not buy what they think it will. They will hold onto to dollars and one day wake up in a world of $1,650 gold.
    Enough of my musings please now read Cuck’s commet from July 10th:

    Speaking of Asian currencies… China announced last night that their Trade Surplus widened in June to a record $14.5 Billion… That’s Billion with a capital B! WOW! And I thought their previous record of $13 Billion posted in May was unbelievable! The “boys” in Washington D.C. aren’t going to like the color of that report… China is on pace to top last year’s Trade Surplus of $102 Billion, and again, this won’t make the “boys” on the hill happy…

    I look at this news differently though… I look at it as another piece of proof in the pudding that China’s economy isn’t slowing, like we keep hearing about… Recall that last week they posted a strong +10% GDP… And can you believe it’s been almost a year already since China dropped the Peg to the dollar? I wonder if they are planning any anniversary announcement?

  13. ronandreas July 10, 2006 6:52 am

    China’s trade surplus is predicated on the ability of U.S. consumers to buy. India also has huge earnings from outsourcing (not included in trade surplus figures) that are vulnerable to the U.S. economy. I fear that the U.S. slowdown will quickly go international. Europe will have the best local demand and will slow the least.

    Dirk has it right. The monetary problem will go away with the trillions of stock and real estate depreciation. Inflation pressures will subside with $40/ barrel oil, negative hourly earnings growth, $1/lb copper etc…

    China will satisfy it’s local commodity needs from it’s own sources and from longterm arrangements developing foreign resources.

    How much will gold be worth in this scenario? I wouldn’t bet the farm on it.

  14. cornhusker July 10, 2006 7:22 am

    Guys, it’s really very simple:

    The raising of rates is but a smokescreen, when the Fed decides to get serious about saving the dollar, they will simply increase bank reserve requirements relative to all loans written (new & old). This one action will single-handedly put the brakes on the world economy…the dollar will rise substantially. Didn’t Bernanke mention something to this effect, off-handidly, in a not-so-long ago speech about “more prudent lending practices”?

    I’m 90% cash right now and expect to be at this rate or higher for at least the next 24 months. Hey, 5.5% CD rates aren’t so bad right now! The only stock I hold is “AMEN”…low-float, low cap, reseller of power in Texas…I am not recommending you buy this stock, just disclosing what I’m currently holding.

    Good luck.

  15. cornhusker July 10, 2006 7:52 am

    Also, for any of you guys who are interested, I was able to lock-in two bank CD’s through my broker at 12 years & 10 years, respectively, at 5.2% & 5.5%. My money is on a Japanesque, 0-rate environment by 2010…this depression will likely be much more severe than the last, considering the massive amount of debt we carry & the lack of manufacturing in this country…the “service” jobs will be the first to go. I’m in a “service” business, so I’m taking the necessary steps to protect my family from a protracted downturn in business. Oh well, back to work…

  16. m_astera July 10, 2006 8:58 am

    I don’t mind wagering, but right now all I personally see in the above charts is manipulation.

    The Fed can do anything they like whenever they like, and then there’s the plunge protection team and the SEC etc. allowing huge unregulated short positions to manipulate the market.

    This isn’t betting which way a free market will move, it is playing blackjack against a dealer with a stacked deck who is allowed to re-stack the deck in their favor anytime they like.

  17. Dan July 10, 2006 9:06 am

    With regards to stocks, the next 4 year cycle low is due, ideally, between October 2006 and April 2007. Since 1896, the DJIA has seen 27, 4 year cycles. From cycle high to cycle low, the average loss has been around 32% with losses ranging from 8% to 90%.

    A move BELOW 1168 on the S&P will confirm the 5/8, 1327 high as the 4 year cycle high. A 32% loss of the S&P would take price back to the 900 level. Moves BELOW 1237 and 1219 would likely be early warnings that price is headed for a test/break of the key 1168 support level.

    The most important aspect for the S&P with regards to the next 4 year cycle low will be whether price ends ABOVE or BELOW it’s prior 4 year cycle low of 768.

    ABOVE 768 will imply the FED’S massive money infusion efforts (hidden M-3) have overwhelmed the natural market forces and suggest that the economy is headed for HYPERINFLATION.

    BELOW 768 will suggest that the natural market forces have overcome the FED’S liquidity infusion efforts, and that the economy is headed for a DEFLATIONARY/DEPRESSION.

    If we are indeed still in a historic bear market that started in 2000, the bottom will likely occur in conjunction with a 4 year cycle low. Currently, 2010 appears to be a more likely candidate than 2006.


  18. Ron July 10, 2006 10:02 am

    The price of commodities, as in all else, will be dictated by supply and demand.

    As we know, not all commodities are the same. Are we talking Oil, or soybeans; gold or wheat; uranium or oranges?

    Yes, shortages can be contrived in many cases, but that is almost always short lived. The rising demand of the rising middle classes in countries like China and India (and others as well) will put pressure on supplies over the long run.

    The key lies in what people must have versus what they would like to have. Gold jewelry is not a must, food is. There is not yet an adequate supply of an alternative for oil - prices will continue to rise.

    In general, we may experience corrections, but the overall trend will be up for some time to come. Just not evenly across all commodities.

  19. m_astera July 10, 2006 3:52 pm

    I posted earlier about the commodities market being manipulated. In my view, this is being done deliberately to keep investors out of gold and silver. Those who jumped in a few months ago are shying away, so if we get a crash or a valueless dollar, they will end up with just that: a valueless dollar and a bunch of worthless stocks. The manipulators will have the precious metals while everyone else goes down the tube.

    As I said, it’s just my view, but it makes sense to me. The present money supply glut and horrendous debt looks curiously like the prelude to earlier manipulated crashes.

    From the tone of most of the posts on here, the manipulators are succeeding quite well in scaring people off. I think I’ll ride it out. I’d rather be sitting on fifty pounds of “worthless” precious metals than a wheelbarrow load of worthless paper.

    Best of luck to you.


  20. Nish July 10, 2006 6:49 pm


    Inflation or deflation has been the question for a while. As I understand these should be answered by the rate of money supply growth and nothing else. The money supply has been increasing so we will probably see an asset deflation expected for commodities because the store value of your labor. But inflation in the cost of livinig will occur because the extra liquidity has to go somewhere.

    Unless, the world governments actually create negative growth in money supply, then all asset groups will crash and we can go see a movie for 10cents again. This is highly unlikely except in the case where the governments and the big banks fear that the world population will loose faith in the fiat currency.

    Both scenarios commodities provide you freedom from fiat money. By that I mean holding physical gold and silver, no etfs or certificates.

    POP QUIZ: What countries / currencies have the slowest money supply growth. I don’t know the answer that is why I am asking.

  21. xradarusa July 10, 2006 9:22 pm


    Have followed Prechter’s work for some 25 years…there may be some truth to Wave Theory…but nothing usable. Some have called it the Idiot Wave Theory, complete with fibo-nutti numbers and a new soft science, psychonomics. P made one correct call about 1980…the bull market in equities. He then called the top with the crash of 1987, and has been calling the top ever since. The theory is quite convoluted, and predicts the past with 100% accuracy.
    There’s also an inherent contradiction in all his newsletters: the wave theory alone is supposed to predict the price action of almost anything into the future, but he always includes lots of fundamentalist stuff to support his reading of the waves.

    As you know, the fundamental stuff out of your TV box, WSJ, Barrons, etc is probably the main reason you dont make money gambling…er investing in the markets. You there in Rube City, Iowa, or Hicksville, IN are always the last to know……

  22. the stranger July 11, 2006 6:26 pm

    I paid up for the Elliot Wave International newsletter a while back. I’m not a trader, so the myopic view was useless to me, plus I disagreed with half of all comments. I cancelled after three months. Before that I’d bought two of Pretcher’s books. Read one; got a lot out of it. But I have no desire to read the other one.

    Pretcher introduced me to the imperfect science of Elliot Wave. And he demonstrated (convincingly) that we may be at the crest of a Super Cycle. This in turn led me to the Kondratiev cycle and then some; I am in debt. But his caviler micro-assumptions and his political perspectives I have no use for.

    When I read that, “the dollar will go down” I always wonder… do they mean in value, relative to real goods? Or do they mean relative to other currencies, which are just as able to inflate supply? As for the later, I don’t even care to guess.

    As for the former I don’t agree that increased monetary inflation always leads to price inflation. Increased monetary inflation tends to price inflation, but unevenly with a misallocation of resources. But increased monetary inflation can be stored as well, for use at a latter date. Think about these two exceptions to supply & demand then add (no, multiply) the fact that we have no clue what the actual monetary inflation number is (I don’t mean just the Fed; everything – depravities, etc). I believe a dark synergy exists here for which no model exists.

    Add also the fact that the Federal Reserve dollar is backed. It’s backed by faith in the United States of America; a faith that is rapidly dissolving. Reduce credit, reduce treasuries, reduces the supply of FRNs… but will it increase the value? Not necessarily. If one of the multiples is zero, the calculation is simple. Personally, I think the world no longer sees the Fed Dollar as a store in value; just a still functioning medium-of-exchange.

    My current thinking is commodities are in a continuing bull market because demand is pressuring supply; a relentlessly devalued fed-dollar only augments this situation. Take away the devalued dollar and the bull remains intact. If a depression occurs, demand is reduced in some areas; if population shrinks demand is reduced in all areas.

    I think holding cash is a good idea. But I don’t consider Federal Reserve IOUs cash; not constitutionally anyway.

  23. Rich July 13, 2006 7:34 pm

    We’re in Peak Humanity, all commodities will become more expensive over time as demand continues to outstrip supply. Unless there is an “adjustment” to the global population you can bet that oil, and therefore gold, will continue to rise with some gyrations up and down, but the trend will remain up.

    After the big crash in Gold in early 06 we are now seeing the mighty metal bouncing right back. Expect it to retrace its former upward movement and march right past its peak of earlier this year. Gold and oil will reach new highs in 06, oil will hit $100 before the year is out and gold will go over $800.

    Changing subject for a minute. In the last Great Depression the US was a rising global star, but Britain was the superpower and Germany was about to become one, with Japan close behind.

    In the next Great Depression (or Depression2!) the US will be the only superpower and will control the global currency. This means the next depression will be different indeed from the last one. You can expect the US to become more and more militarily aggressive as the strength of the US dollar is called in to question more and more. Ultimately any threat to US economic dominance will be rectified using US military might.

    I’ve adjusted my perspective radically over the years, I used to believe the US economic system would collapse under debt, now I see a system of pyramid debt that is backed by the greatest military force ever seen in our Galaxy. This combination leads me to believe the US can survive a long time with a hamstrung US dollar.

    Cheers Rich

  24. Marc Authier July 14, 2006 8:57 pm

    People don’t want to admit it. Americans particularly, cannot admit that there will be a physical limit to modern society. And the limit is the peak in natural resources. Oil and most of the resources are still available but a what cost?

    People have still a tendency to think hat technology will solve everything. Not true. At least not for the forseeable future. What would happen if every Indian or Chineese citizen consumed the same amount of resources as an American or even an European? Why such a hypothesis seems to Americans that impossible or improbable?
    It will happen and if ever your politicians in Washington or the rest of the West, tries to stop it, we will have another world war.

    Never mind the negativism about commodities. I don’t believe in deflation. Deflation is just plain hogwash.
    And commodities will be the place to be for many years to come.

  25. JDR July 16, 2006 9:32 am

    “Peak Humanity” is an interesting concept, perhaps fueled a bit by our historical conceit. Can any of us really judge the history we’re experiencing? We can look back and compare the “now” to the “then” and sometimes see trends, but we can’t accurately project them into the future.

    Looking back I see the 1970s as the era when collective human knowledge and wisdom peaked, and since then it seems we’ve been on a headlong rush to destroy knowledge as we digitize everything and much of it loses context.

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