The Deflationary Boogeyman

Commodities have been a horrendous investment since they peaked in 2008. Since that time, using the $CRB commodity index as a proxy the index, has lost almost 60% of its value and those investors who have bought and held have been crushed. This is reflective of the ongoing deflationary cycle that started in 2008 and what central banks around the world are trying to fight, many using untested and potentially dangerous means. I have learned it is best to avoid political or third rail sensitive topics and keep my posts solely about investing, the fact is I have major doubts this misallocation of capital and demand pull they are causing will end positively. They are using everything they have in their arsenal and are running out of options fighting the deflationary boogeyman trying to create inflation.

For those who listened to last month’s market recap, I mentioned the elephant in the room was the dollar as it appeared to be breaking out of a consolidation pattern to the upside and the potential impact on investments. In today’s post I wanted to show how I came to that conclusion. The chart below shows RSI momentum in the upper, the dollar in the middle and the $CRB index in the lower pane. What should jump out at you besides last week's breakout of the triangle, is the strong inverse relationship that exists between the dollar and the commodity index. When the dollar rises, commodity prices fall and vice versa.  For the sake of this discussion, if you assume my analysis about a rising dollar correct, you can see how a breakout higher could have very serious consequences on commodity prices.

Triangle patterns by themselves are some of the most notorious patterns for false breakouts so I am cautious in my breakout call and continue to wait for further confirmation. On the flip side, bull pennants which are a long pole attached to a triangle, are much more reliable and typically mark the halfway point of an entire move. Using that info to project forward, another move higher by the dollar equal to the most recent move could poleaxe commodities another 40% or more. Clearly the market could do anything and my hypothesis is but one possible outcome, but if this were to occur, savvy investors should look to find ways to capitalize on this move as the potential is captivating.

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