US Stocks buoyed by bear in commodities

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

-By Brian Hoffman

Should American equities start to climb higher — and, steeper — we could see a hyperbolic move and then a correction

Blame last year’s bear market in commodities — particularly in gold bullion.

That’s right. Thanks mainly to the bear, returns from the broader U.S. stock markets in 2013 almost tripled the 10 per cent return of the S&P/TSX Composite Index. In December, the S&P 500 in the U.S shot through the 1,800 mark. There’s now support at that level.

Should U.S. stocks start to climb higher — and, steeper — we could see a hyperbolic move and then a correction.

For example, should the S&P 500 reach 2,000 over the next few months, we’d likely see a correction since the ascent would become unsustainable. In the meantime, commodities will once again likely be a key factor this year in the relative performance of Canadian stocks to their U.S. counterparts.

Last October, the S&P/TSX Composite broke through 12,800. This point, which provided significant resistance over the past two years, is now a support level.

But to be more competitive with U.S. stocks, Canadian equities need a rally in commodity prices. We saw this in the late 1970s, as well as in the years leading up to the market meltdown of 2008. During these two periods, Canadian stocks outperformed their U.S. counterparts, thanks to strong commodity prices.

Those prices largely reflected a perceived scarcity in many commodities — especially, crude oil. With gold bullion, the run-up during the latter part of the ’70s was fueled by inflation, while its peak in Sept. 2011 owed its existence to fears of higher inflation, as well as a weaker U.S. dollar.

For now, inflation remains low regardless of whether you believe the stats from North American governments or the rates households are actually experiencing. But with 10-year interest rates starting to move higher, the bond market is beginning to sense that higher inflation is working its way into the economy.

Since the impact of inflation is usually only felt after commodity prices rally, we need to monitor the technical outlook for commodities.

Gold, along with the shares of gold producers, generally shows strength from May to September. Between now and May, we’ll likely see if gold bullion bottoms out around its June 2013 low of US$1,180 an ounce — its current support level — or, if it’s destined for even lower prices.

In December, the metal once again almost sank to $1,180. And a successful test of the June 2013 low could provide a double-bottom from which gold prices could stage a significant rally.

On the other hand, a breach of the $1,180 level would be very bearish as gold prices, along with the shares of gold producers, could then fall a lot lower.

Keep in mind that gold has retraced, or given back, about 60 per cent of the move from $680 to US$1,900 an ounce, giving critics of gold bullion lots of ammunition.

To reverse gold’s downward trend, a move to $1,600 an ounce is needed and could occur in the latter part of this year.

Should the metal make an all-time high above $1,900, we could see gold move even higher. How high? The late 1970s offer a clue. In 1976, gold bottomed out at roughly $100 an ounce, only to zoom to roughly $800 in 1980.

So, from $1,180, a similar move would see the metal roar to more than US$9,000 an ounce. Yet, for that to happen, inflation rates would have to rise sharply.

Monitoring is essential

But gold isn’t the only commodity that’s now important to keep an eye on. Oil and gas also need to be monitored.

In the U.S., oil prices are now trying to find support at US$93 a barrel, while gas, which has rallied smartly, faces significant resistance at US$4.50 per million BTUs.

Should gold and oil prices stage a rally, you might then consider buying the exchange-traded funds I profiled last September. For instance, the iShares S&P/TSX Global Gold Index Fund (XGD-TSX, $10.22) offers diversified exposure to senior gold miners, while the iShares S&P/TSX Capped Energy Index Fund (XEG-TSX, $17.12) is a diversified play on big-cap oil and gas producers.

Given the breach of the $11 support level, the technical outlook for the price of iShares’ gold ETF has weakened. But the technical outlook for the price of the oil and gas ETF, which may find support around $16.75, has actually improved.

If you follow a more diversified approach — one that includes exposure to the S&P/TSX Composite Index — you may find your portfolio has sufficient weighting in commodities for your comfort level. As usual, investors should watch for breaches of key support levels on broader stock market indexes. They should also monitor the prices of individual stocks they may happen to own.

Moreover, as equity markets ebb and flow, investors should try to manage risk by ensuring their exposure to both stocks and fixed-income holdings jibes with the long-term mix they’re seeking to attain. Indeed, they should check this alignment every six months.

Just keep in mind that if you want to offset losses caused by a rise in interest rates over the next few years, make sure the bonds you buy have shorter durations.

 

Brian Hoffman, CPA, CA, is a member of the Canadian Society of Technical Analysts. He’s based in Toronto.

 

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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