Daily Gains Letter

Declining Commodity Prices Ahead with Weak Global Economy

By for Daily Gains Letter |

Profit from Weak Commodity PricesOil may be holding above $40.00 per barrel, but investors shouldn’t get too comfortable. The chart foreshadows oil prices could falter and maybe even drop below $40.00.

It’s true that speculation has influenced the direction of oil to some degree, but much of the negative sentiment has to do with a declining global economy that shows some despair. And while gross domestic product (GDP) growth in the U.S. is pretty decent, what we are witnessing in the global economy cannot be saved by what is happening domestically. That suggests weaker oil prices ahead—along with weaker commodity prices overall.

How Stalling in Global Economy, China Will Affect Commodities

The World Bank just cut its outlook for the global economy and the eurozone for this year. The reality is it could get much worse.

What investors have to understand is that the stalling in the global economy will impact not only oil demand and prices, but also other commodities that move in conjunction with the direction of the global economy.

Copper is declining to dangerous support levels not seen since the global economy was pulling out of its recession in 2009. Copper is dependent on GDP growth, which is at a crossroads.

Yet all eyes will be focused on China as the country gets set to deliver its fourth-quarter GDP. Based on what we are seeing in the country, the number could be ugly.

Of course, what we will likely see is a somewhat massaged version of the true GDP reading from Beijing. The government controls the flow of information it wants the world to see, so a steady decline is preferred over a drastic cut. I expect a reading of about 7.1% to 7.3%, but understand that the true reading is likely below the seven-percent threshold. This drop in China’s GDP is sure to affect commodities and the global economy.

Just take a look at copper to understand what’s happening in the global economy. China is a top buyer of copper. With the stalling in the Chinese economy, the demand for copper should also decline unless the country decides to stockpile its reserves at the lower prices. This is something China has done in the past with copper and other commodities.

A downward surprise from China will wreak havoc with commodities. In fact, we know the big boom period for commodities, also known as the commodity supercycle, is over.

Take a look at the chart of the Thomson Reuters/Jefferies CRB Index, which represents broad overall trends in commodity prices. Currently, the index is sitting below its 50- and 200-day moving averages (MAs) in a downtrend that began in June 2014 and showed a bearish double top. Prices are now nearing the index’s lows around 200, last seen in 2009.

Reuters - Jefferies CRB Index

Chart courtesy of www.StockCharts.com

The long-term chart shows 200 as a major support level after the index broke higher back in 1972. Since then, the index has traded sideways with major support around 180–185 during the period from 1998 to 2002. The long-term moving average convergence/divergence (MACD) indicator (seen in the lower portion of the chart below) is showing a sell.

Reuters - Jefferies CRB (EOB)

Chart courtesy of www.StockCharts.com

With the index dependent on the demand for commodities, including copper and energy, we could see additional downside moves.

The Possible Investment Opportunity…

So what does this mean for investors? Where’s the investment opportunity? Investors could consider playing the weakness in commodities and the global economy via put options on an exchange-traded fund (ETF) like the PowerShares DB Commodity Tracking ETF (NYSEArca/DBC).

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