DELEVERAGING- Gold and Commodities Teetering on the Brink of a Bear Market?

By: Nadeem_Walayat

Gold and other commodities plunged below key short-term support levels following Tuesdays US Interest rate cut to 2.25%. The consensus seems to see this as a healthy correction or is this a signal for a potential end of the commodities bull market?

My view for some months has been that the west will move from a period of stagflation (the present) to a period of deflation towards the end of this year. Therefore at some point during this year the commodities bull markets would be expected to recognise this change in fundamentals and peak well before deflation makes itself evident. The major trend expectations are illustrated in the below graph from an earlier article on the current stagflation and future deflation prospects.

Back to Gold and other Commodities

Gold bug fever has been building up during the latest run up from $770 to new time highs above $1020. News headlines of gold breaking $1000 has seen many, many people across the world cashing in their jewelry much as occurred during the Jan 1980 peak in commodities in the lead up to the 1980 election as the US Fed raised interest rates to bring inflation under control. My current expectation is for the Fed to raise rates following the US election but the rate rises are expected to be muted and not longstanding as inflation is much less of a problem this time around as we have the ongoing escalating deflationary impact of the Great Deleveraging of the Derivatives Market of 2008.

Gold and Commodities are NOT immune to the impact of deleveraging, as evident by the sharp drop in Gold yesterday. Given the amount of volatility and uncertainty on a day to day basis, as we witnessed by the Bear Stearns Bust last week and the attack on HBOS by hedge funds this week that apparently tried to take out Britain's biggest mortgage bank. The FSA (UK regulator) launched an investigation into the banks trading and those responsible for starting the rumours ..rumours? I would have thought that acting on market moving rumours is part and parcel of day trading ??? So I don't completely understand what the FSA is hoping to achieve through its investigation into 'rumours'.

The deflationary impact of the deleveraging may be to such an extent by November 08 that I could scrap the prospects for US interest rate rises during 2009 , especially if US CPI inflation has started to fall by then.

Gold Current Technical Picture

The gold price plunge to $940 (and I have to say uncannily called by Mike Paulenoff just before the US Interest rate cut on Tuesday) on my reading of the charts signals the start of a significant multi-month downtrend which is inline with my earlier expectations of a bearish trend in commodities into Mid 2008 from an March peak. The chart shows a trend targeting a significant decline towards the $850 zone. On making a base around $850 gold should resume its up trend towards the new highs set above $1000. Its behavior at that point will determine whether gold will make a blow off top well above $1000 or a double top pattern before commencing upon an anticipated deflationary multi-year bear market.

Agricultural Commodities

I have bought into the impact of climate change, population growth and emerging markets middle classes that support the view for strongly bullish agricultural commodities for many years. Though the run ups to date in the soft commodities do require some speculative unwinding which is now starting to take place. So I view any significant downturn in the agricultural commodities sector as an opportunity to accumulate good food growing stocks.

Crude Oil and Oil & Natural Gas Companies

Peak Oil is real, its not a case of speculative opinion so there is no doubt in my mind that investments in Oil companies remain good long-term investments, despite what the crude oil price does in the immediate future. Companies such as Shell and BP are trading on P/E ratios of less than 10 ! That's not indicative of being bid up to $110 bull market mania levels as the crude oil price has, this despite the Pseudo Democratic Russian Government changing the Russian Oil contract rules as it goes along which tends to hit oil companies that have invested billions in Russia's energy resources.

Yes crude is headed higher in the long run, but a run up of over 40% over mere months is not a sustainable trend. So expect crude oil to follow gold lower to back towards $90 from the current $103. The key here to weathering downturns in the commodities sector is to focus on high dividend paying companies that have a good track record of sticking to the dividend payments. The same goes for Natural Gas companies i.e. long-term investments in high dividend paying companies.

US Dollar Bottom?

The implications of a forward deflationary scenario are that the US dollar will make a bottom this year and rally .Technically the USDX has fallen to new all time lows and thus there is no pre-existing support that can be referred to, therefore this requires the US dollar to develop an upward trend before a bottom can be called. A bullish scenario would require the USD to rally all the way to above USDX 78 from the current level of 72. After it breaches above 78, the dollar needs to make a base on the subsequent decline as indicated in the above chart to give it any chance of signaling a major change in trend.

Emerging Market Stock Markets

Still tumbling and unwinding their over valued and over-leveraged state. I am eager to accumulate emerging markets at apparently knock down prices, but need to await better technical charting pictures. The downturns to date have fulfilled earlier targets for the asian indices, which in Japan's case 'a basket case investment' having fallen out of its bottom, is not surprising!

China - I sold out of China in October due to ridiculous valuations, and see very little reason to get back in, about 2 weeks ago I wrote that investors in China need to watch out for the dictatorship sending in the tanks to quash any dissent amongst the populous, this is exactly what happened this week! This coupled with high market valuations still makes china an avoid, though having declined through its 4000 target, it is now no longer 'You would have to be MAD to buy into this market' investment. Watch for a major update on the global stock markets in the coming week as the emerging markets are now moving into sustainable up trend territories.

Your deleveraged analyst

By Nadeem Walayat

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Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 120 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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