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More on the Dollar and Commodities

01/25/02 01:31:07 PM
by David Penn

How strong is the secondary correction in the commodity bear market?

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Commodities have been in a relentless downtrend for several months. In fact, commodities have been in a primary bear market (as I've noted elsewhere) since 1997. This primary bear market has not been without its interruptions; the secondary corrections that Dow Theory suggests will occur intermittently, have moved powerfully - if briefly- in intervals lasting from weeks to months. One of the best examples of a secondary correction in a bear market is the "war rally" in stocks that followed the September 11th terrorist attacks in the United States. Equities, which had been drifting downward all summer, finally gave way to a combination of looming recession and geo-political uncertainty. The speedy response to the attack, including the market and electorate-soothing coalition approach, helped the stock market rally powerfully in the fourth quarter of 2001.

The countertrend rally in commodities, the secondary correction that began with a successful early November test of the bottom established in mid-October, has not been as impressive in percentage terms (only 8-9% from the bottom), although the rally in commodities has lasted just one month less than the rally in equities. Nevertheless, commodities have managed to register a significant higher high in January, unlike the major stock averages, which noted only marginally higher highs in January - where higher highs occurred at all. Whether this movement represents near-term strength for commodities and weakness for equities, or is simply a bull trap not unlike the one that looks to have ended the rally in the Dow, for example, is the important question. The current retreat from the January highs as seen in the CRB index, combined with a downside break of the trendline, is bearishly ominous for commodities.

The greenback heads for a test of the top while commodities look to have already failed their early 2002 exam ...
Graphic provided by: MetaStock.
The movement of the U.S. dollar, which tends to trend inversely to commodities prices, further suggests a more bearish scenario for commodity prices. The greenback bottomed in mid-September, along with the equities market, and rallied from a diamond bottom reversal formation (see "The Dollar's Diamond Bottom: Pullback or Reversal?", October 2001, Advantage) into what could be a diamond continuation formation - particularly given the high volume on the January 15th advance. If there is in fact a diamond continuation developing in the dollar's advance (the diamond lines are included in the chart), then the bullishness of January 15th is as likely a breakout as is likely to be found anywhere. The price objective, incidentally, from this move would be anywhere from 121 to 124 over the next 30 days.

Thus the greenback seems to support the bull trap thesis of the rally in commodities that developed in January 2002. The retreat from 196 has sent the CRB index back into the thick of its trading range between 190 and 194. Even with the downside break of the trendline from the October/November bottom to the present, there remains ample support at 189 to slow any decline beneath that point without significant conviction on the part of the bears (or sufficient despair on the part of the bulls). The fact of the matter remains that commodities have been in a bear market since late 2000 (to say nothing of the longer, deflationary trend in commodities that has existed since 1997).

The current secondary correction has retraced some 20% of the primary move from 235 to 185, which is a little weak as far as secondary corrections go. Typically, anywhere from 33 to 66% of a primary move might be expected to be retraced in the average secondary correction, according to Dow Theory. So if this suggests that the current secondary correction has room to run, it simultaneously hints that the rally is likely closer to its end that it is to its beginning.

The previous significant bottom in commodities came during the first half of 1999, with the CRB index trapped in a trading range between 190 and 185. That consolidation took between six and seven months and proved to be the end of the 1996-1999 bear market in commodities. If a similar bottom is being put in place for commodities in 2002, then it is more likely to develop a somewhat more extensive base than current price action shows. Such an extended base could conceivably come from a stronger dollar, which keeps commodity prices down, as would be reflected both in a continued rally in the greenback (as from the breakout from the diamond continuation pattern) and the continued retreat from the January 2002 highs, as suggested by the "bull trap" thesis.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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