Softs Ignore Dollar Strength

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The dollar strengthened today based on foreign central-bank policy steps. Oddly enough, while the dollar strengthened the CRB index was up only a minor amount. That’s because soft commodities like corn, wheat, OJ, and soybeans led the index higher with strong gains due to drought conditions and lower yields. The CRB index itself is at an inflection point that will likely decide the fate of commodities for the next few weeks, and possibly months. The index has risen 10% off its lows during June. It would be a significant turnaround for the index if it can break through this area.

Easy Does it

All year long we’ve been seeing central banks ease policy – all except for the U.S. Federal Reserve Bank. The Bank of England continued its QE program with an additional £50B announced today. This seemed to be right in line with consensus although many estimated we’d see £75B. From the European Central Bank, we got a cut in headline policy rates of 25 basis points while the deposit rate was cut to 0%. The deposit rate cut was a surprise but many had expected we’d see at least a 25 bp cut. Many also expected to see an unveiling of non-standard measures like the LTRO and SMP but there was no mention of these policy tools. China cut interest rates for the second time in the last month ahead of a big week of economic data. The most interesting development with central banks today was the interest rate cut into negative territory for Denmark. Not only is money held at the bank losing on a relative basis versus inflation, but also on an absolute basis.

Our own Federal Reserve has been utilizing Fed-speak to try and tame the markets instead of outright changes to policy. We got a projection on ZIRP until 2014 in February, but that’s subject to change. Additionally we had governors leave the accommodation camp as we read in the Fed minutes late in the first quarter, only to come back to the accommodation camp a month later. The biggest actual change to Fed policy came on June 20th when they extended Twist until the end of the year. Nobody expected this policy was going to change coming into the meeting so the dollar didn’t respond by very much.

While foreign central banks ease monetary policy, the Federal Reserve Bank remains policy neutral. If you combine steady monetary policy with better economic sentiment in the U.S. than with economies around the world and you have a bullish setup in the dollar. Despite the bullish dollar, commodities led a rally today based on corn, wheat, orange juice, and soybeans.

I Seriously Drought That

It’s estimated that 56 percent of the country is now experiencing drought conditions, topping the previous record in 2003 of 55 percent for as long as data has been compiled. The National Weather Service said that we’re seeing temperature records being set in the Midwest, creating harsh drought conditions along with it. On the bright side, the drought hasn’t been long enough to put it on par with other major droughts.

The conditions have caused crop conditions to deteriorate. The Mays Report, a contributor on Seeking Alpha, showed last week that the corn crop condition rated as good to excellent was 7 percent lower than the previous week and 21 percent lower than the rating reported on May 20th. The report also noted that soybean’s condition has deteriorated and lies at only 53% in good to excellent condition, down from 65 percent a year ago.

Drought Driven Days

Agriculture futures and agriculture equities are in play due to the drought and that’s helping the CRB index and Agriculture ETFs to rally. In the past two weeks wheat has risen 32 percent, corn is testing its 2011 highs, and soybeans are hitting record highs, well above the 2008 commodity peak. After a year and four months, the PowerShares DB Agricuture ETF (DBA) is back in play, up almost 13 percent in the last two weeks.

The CRB index is attempting to breakout of a major supply zone (resistance). It’s also attempting to break above the February decline. It should likely backfill here or reverse. A breakout above the current supply zone would be pretty bullish. We still have some long-term moving averages to contend with that are moving down. The 200-day moving average was instrumental in February in reversing the December rally. So even if we break above 290 it isn’t an “all’s clear” signal for commodities in general. Thus far, energy and softs have rallied together in June. Now let’s see how precious metals react.

crb 5 jul 2012

Tomorrow’s jobs data might help. If the jobs data is weak, QE speculators would welcome the news and bid up metals. If the jobs data is stronger than expected, we could see the dollar strengthen and precious metals weaken. I only see a few possible catalysts that would move precious metals.

  1. Quantitative Easing: QE would weaken the U.S. dollar, thereby reinforce precious metal prices
  2. Better European conditions (economic and credit): Credit sentiment is improving based on falling 10-year yields for the periphery countries. The scare of Greece leaving the EU and euro has eased but the “all clear” signal hasn’t been given. The euro strengthened immediately on the EU summit June 28th, but has fallen since and is currently trading lower than the pre-summit levels.
  3. The global economy improves, creating higher commodity utilization rates and rising interest rates.

The most likely scenario is more QE. With interest rates near zero, it is the best policy response from the Fed to encourage consumption through the wealth effect. As balance sheets improve for investors, they’re more likely to spend. David Tepper pounded the table for stocks in September of 2010 like we did. On a CNBC interview in 2010 he said,

“They want economic growth. Not only do we not care if there’s inflation, but we want a little bit more inflation. They want the market up. Am I going to say ‘no Fed’ I don’t agree with you, I don’t want to be long equities. We’re a bond place but we changed up to a bit more equities”. – David Tepper of Appaloosa Management, September 10, 2010.


Economic numbers haven’t turned around, they continue to disappoint; however, there’s a growing consensus that the numbers will get better going forward now with a banking union in Europe. I think that’s over simplifying things, but what I do know is that the S&P 500 has traded through the 1363 resistance zone that many technical analysts have been worried about (myself included). A whipsaw back below that level would hurt the current rally, but it was encouraging to see we bounced off of that level intraday today and closed at 1367. Four points is a narrow margin so anything could happen from here. Eighty-nine percent of the S&P 500 stocks are trading above the short-term moving average (10-day) and so the market is overbought short-term and could easily turn; however, more intermediate-term gauges look encouraging with the percentage of stocks above the 50-day moving average at 66%. A break above 70% would be encouraging towards the current rally because we want to see broad participation.

In closing, I think investors have to be selective in stocks right now. Mid-day I saw about 226 stocks and ETF highs outpacing new lows so there’s money to be made in equities; however, we’re heading into the second quarter earnings season and more companies have warned heading into this quarter than in the last. Do your homework and avoid unfavorable sectors and industry groups.

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About Ryan Puplava CMT