The Commodity Bull Market Isn’t Over

05/05/2011 4:00 pm EST

Focus: COMMODITIES

Thomas Aspray

, Professional Trader & Analyst

Commodities have taken a hit recently, but the overall trend remains positive. Consider this multi-week correction your opportunity to build positions in select commodity funds.

The news about global food shortages and stockpiling of scarce commodities by emerging economies like China has been the focus for many over the past year, and the Reuters CRB Index had risen 55% from the May 2010 lows at 450 to last week's high at 691.

The selling across many of the commodity markets has now turned into a stampede for the exits this week, as the Reuters CRB Index, as well as the commodity ETFs and ETNs are now clearly in a correction phase.  

The dollar is also trying to turn higher, and a further rally will add additional downward pressure on commodity prices. The major technical trend for the majority of the commodity markets is still positive, as is the global demand outlook for commodities. Of course, this demand flattens out at various periods when the emerging market economies cool, but this does not alter the major trend.

Therefore, it is my view that a deeper correction and a significant retracement of the recent gains should be an opportunity to establish either 1) long positions in a broad-based commodity vehicle, or 2) targeted positions in a specific commodity market.  In fact, one of the markets I am focusing on appears to be in the process of completing a significant bottom formation. Let's first look at the Reuters CRB Index.

Figure 1


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This weekly chart of the Reuters CRB Index goes back to the peak in 2008, when the weekly relative strength index (RSI) formed a 16-week bearish divergence (line c) in July 2008 as crude oil was peaking.

During this plunge, the CRB lost over 47% of its value. In late 2008, the RSI formed a short-term positive divergence (line d), which was confirmed by the move through its downtrend in March 2009 (line 1). This completed the bottom formation in the CRB.

During early 2010, the CRB Index corrected for five months, losing 10% before bottoming in May. This week's drop in the index will signal at least a test of the March lows at 635, and a decline to test the upper boundary of the trading channel (line a), currently at 620, would not be surprising. The 38.2% support from last summer's low is at 600 with the 50% level just under 570.

The weekly RSI failed to confirm the CRB's recent highs (point 3), as it was not able to move back above its weighted moving average (WMA) while the CRB was making a new weekly closing high. The break of the short-term uptrend, line e, warned that a divergence may be forming. Typically, this length of divergence is consistent with a correction, and not a major top. The most likely downside target is at 600-615, which would amount to a 12% correction from the highs.

NEXT: Several Commodity Funds to Watch Closely

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Figure 2


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The Elements Rogers Total Return ETN (RJI) was designed to track the global consumption of a basket of 36 commodities. It has 35% in agricultural commodities, 21% in both precious and base metals, and the remaining 44% in energy.

RJI peaked in early April at $10.51 and formed a lower secondary peak last week. The weak close on May 4 violated short-term support (line a) with the daily uptrend, line b, at $9.70.

The correction may be able to hold the March lows at $9.33, but if not, there is stronger support in the $9.00-$9.10 area. This corresponds to the 38.2% support level as well as the November 2010 highs.

How to Profit: Go 50% long RJI at $9.24 and 50% long at $9.08 with a stop at $8.57 (risk of approx. 6.4%).

Figure 3


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The PowerShares DB Commodity Index ETF (DBC) is more narrowly focused than RJI, as it includes the commodities like light sweet crude oil (West Texas Intermediate, or WTI), heating oil, RBOB gasoline*, natural gas, Brent crude, gold, silver, aluminum, zinc, copper grade A, corn, wheat, soybeans, and sugar.

*RBOB: Reformulated Blendstock for Oxygenate Blending. This is the benchmark gasoline product traded on the major commodity exchanges.

DBC has declined steadily from the highs made at the end of April, and next chart support (line a) and the daily uptrend, line b, is in the $29.70 area. The March lows ($28.20) are a key level to watch with the 38.2% support at $27.80. The daily on-balance volume (OBV) has dropped below its weighted moving average (WMA), but is still well above its uptrend from the September 2010 lows, line c.

How to Profit: Go 50% long DBC at $27.88 and 50% long at $27.44 with a stop at $26.77 (risk of approx. 5.4%).

NEXT: Promising Ag Commodity and Energy Funds

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Figure 4


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For a straight agricultural play, I like the Elements Rogers International Agricultural Total Return ETN (RJA), which is quite liquid, averaging over 700,000 shares a day.

RJA has been correcting since February (point a) and should be closer to bottoming out than both RJI and DBC. The daily uptrend (line 1) was broken before RJA dropped to the March lows at $10.28. The 38.2% retracement support is at $9.95. This also the equality target if the decline from point c is equal to the decline from points a to b.

There is strong chart support and the 50% support level in the $9.25-$9.50 area. RJA has initial resistance now at $11.10, and a move above $11.35 would be a sign that the correction is already over.

The uptrend in the OBV (line 2) was broken at the same time as price support, and the OBV has now formed a pattern of lower lows. The weekly OBV (not shown) is still above its rising weighted moving average, but could reach it in the next few weeks. It shows a pattern of higher highs, which is positive for the intermediate-term trend.

How to Profit: Go 50% long RJA at $9.96 and 50% long at $9.54 with a stop at $8.94 (risk of approx. 8.3%).

Figure 5


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For a crude oil play, I favor the very liquid United States Oil Fund (USO), which seeks to reflect the performance, after expenses, of the spot price of West Texas Intermediate light sweet crude oil.

Crude oil is getting hammered this week, down sharply from the recent highs. With a lower close this week, USO will likely be completing a short-term top.

The weekly chart support at $42, line a, is likely to be broken, with the 38.2% support just below $40. The weekly chart shows good support at $39.50 (line b), and the March lows are at $39. The 50% retracement support is at $38.30 with the weekly uptrend now in the $37 area, line c.

The weekly OBV completed a major bottom formation in late February when it overcame resistance at line d. It could test its weighted moving average on a further correction. The daily volume (not shown) has dropped below its WMA, but is still above its uptrend.

How to Profit: Go 50% long USO at $38.66 and 50% long at $37.94 with a stop at $36.89 (risk of approx. 3.9%).

MORE: How to Build a Commodity Portfolio with Just One Fund

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Figure 6


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One commodity market that looks interesting now is natural gas, which has been in a downtrend for several years. The United States Natural Gas Fund (UNG) closed above the weekly downtrend the week ending March 26 before declining for two weeks to support at $10.50.

It has since rallied strongly for the past month and moved back above the downtrend. A close above $13 should complete the bottom formation, with next major resistance in the $16.60-$17.60 area. Since UNG hit a high of $127.78 in July 2008, the 38.2% retracement level is much higher at $55.

The weekly OBV was finally able to overcome its downtrend (line c) in January at point 1. As UNG was making lower lows in March, the OBV was rising and formed a five-month bullish divergence, line d. The daily OBV (not shown) also looks very strong, suggesting that the current pullback should be a buying opportunity. There is first good support now in the $11.35-$11.55 area and then again in the $11.00 area. More important support is at $10.50, which corresponds to the April lows. The all-time lows for UNG are at $10.02.

How to Profit: Because of the longer-term bottom formation and the potential for a very powerful rally, I feel a greater risk is initially justified. I would go 50% long UNG at $10.77 and 50% long at $10.44 with a stop at $9.89 (risk of approx. 6.4%).

On February 1, I recommended the PIMCO Commodity Real Return Strategy D Fund (PCRDX) for a longer-term investment theme. The original investment should have been made on March 15, when PCRDX closed the prior day at $9.44, which was 3% below the high of $9.74. An additional monthly investment may have been made on April 15 at $9.70.

PCRDX currently yields 8.7%, and I would still recommend four more monthly investments so that by August 15, your PCRDX position will up to 3%-5% of your portfolio investment. Of course, with this strategy, PCRDX should make up all of your exposure to the commodity markets.

Last week, when I was putting together the analysis for this article, the selling in the commodity markets had not been as heavy, but the level of selling has since increased significantly.

This does not change my overall analysis, but it does suggest that the correction may last longer. While I was originally looking for a correction from the highs that would last five to eight weeks, it may now take 12 weeks before these markets are ready to resume their uptrends.

Tom Aspray, professional trader and analyst, serves as senior editor for MoneyShow.com. The views expressed here are his own. Readers can post questions or feedback in the comments area below or send to TomAspray@MoneyShow.com.

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