Donald Coxe – Have commodities started to outperform?

Since Donald Coxe’s departure from BMO towards the end of last year, I have been inundated with enquiries about whether his much-revered “Basic Points” research reports would still be published. The good news is that Donald is planning on resuming these reports, and a new issue may very well appear later this month.

In the meantime, Donald has also resumed his weekly audio commentaries, which can be accessed by clicking here .

The latest recording was made on February 6 (althought the webcast site incorrectly mentions January 30). A full transcript of this recording was produced and is shared with you in the paragraphs below (courtesy of Green Light Advisor).

Transcript The chart we sent out is the relative strength of the Reuters Jefferies CRB Index to the SP500.

The tagline was, “Have commodities started to outperform?”


There’s a lot in this chart and I want to take you through the story, where we’ve got just horrendous economic news. We’ve gone from the bad, to the terrible, to the scary, to the absolutely horrendous with both Canada and the US, announcing the worst job, losses either on record, or back to the middle of the 70s. And yet, we’ve got the stock market up, the TED spread narrowing, the VIX narrowing, and the BKX is strongly outperforming the S&P today.

So we’ve got very mixed numbers. if you’re looking at it from an economist’s standpoint, the world is just spiralling downward to disaster. But the commodity story is gradually changing, and remember as you can see from the chart, the relative strength off the CRB futures to the S&P was a terrific forecaster of what economic news was coming.

Commodities collapsed really before we had the collapse in the S&P, and one very brief spike, and then going down to a new low which was reached at the beginning of December. We’ve been just gradually working a little bit higher. Now you may say, well this is really struggling to find something good out there but theres much more than just this.

As you know, I’ve always put great strength on looking at Investors Business Daily Reports on their 197 stock groups that are traded in the US market. Now Remember, these aren’t just US stocks, these are stocks that trade on US stock exchanges, and over the years, I have found this to be one the most helpful tools in getting an idea of the way in which the market is dealing with its views of the future, as opposed to the economic numbers which basically reflect what is happening right now. When there’s a divergence between the two, quite often it turns out that the performance of the equity groups in the IBD was a better forecaster than any of the economic forecasts that were out there.

Now this isn’t a one hundred percenter, but its a very good indication and over the last few weeks, ie. since this new year began, there’s been a huge change in the makeup of the IBD list of 197 groups. As we look at it this morning, I recommend that you all use this: page B2 of the IBD, andif we look at it this morning, this is the relative ranks over the last 6 months, so therefore you don’t get an instant change. This is not an extremely short-term index; this shows you that over the last 6 months which stock groups have done best, and what’s really crucial is to see how they’ve changed their ranking because they show them, right now, three weeks ago, 6 weeks ago, and then way back; and what we see here is the number 1 ranked group in the whole group is metal ores, gold and silver, and they’ve got several stories in today’s IBD about various gold mining stocks and how well they’re doing.

That’s the number one group. Now, in the top twenty, and they always have a box around the top twenty group, we’ve had a big, big change in the last few weeks. We now have a total of 5 groups, which are commodity related which are ranked in the top twenty for performance over the last 6 months. #13; I’ve just come back from speaking to big group of grocery and wholesale conference in Nevada, and the #13 group is retail and wholesale food. #17 is oil and gas transports and pipelines; #18 is oil and gas refining and marketing; #21, just off the bottom of that, food, flour and grain; #23, food preparation; #26, oil and gas, international exploration and production; and, not doing as well, but not off the bottom of the chart, are Banks, North East, at #47; Banks, Southeast at #52, Finance, Savings and Loan #56, and moving up in just 3 weeks, from 165th rank to #66 is the fertilizer stocks. And, once again today, fertilizer stocks are strong, in fact, the agriculturals are very very strong today.

The importance from our standpoint of this is that the view out there within the commodity industries about the outlook is changing even while the economic numbers just get worse and worse and worse. And I’ve got to take you back to what happened back in the 70s, because this is almost eery as to how much this is the way things were in ‘74, ‘75, One of the statistics published about the unemployment numbers was that these were the worst unemployment numbers since 1975 in the US and Canada, they’re the worst on record. And Canada, of course, has great commodity orientation in its economy. The unemployment numbers tend to be coincident to lagging numbers, and the unemployment numbers will continue to get bad and worse.

Why is the stock market overall so strong? Well, this virtually guarantees that the stimulus package will get passed. Now I’m deeply disappointed in how the stimulus package has turned out. its turned out to be a grab bag of a whole bunch of liberal wishlist programs they figured they could never get passed through Congress under ordinary circumstances but by labelling them as stimulus ther’re going to be able to get them through.

Rahm Emanuel, who’s the head honcho, next to Obama, in the White House said, “It would be a shame to waste the worst financial crisis since the Great Depression.”

So, what we’ve got here is a wolf in sheep’s clothing, but at least we’ve got activity. And, the evidence on the financial side is that the massive re-liquifications that are being done by the Fed, and then the various bailout programs are having their effect, because the TED spread is way down at 92.50, and the VIX index is also way down. Either the stock market is dealing with a total unreality, or there’s already a change out there.

One of the surprises has been the strong performance of the base metals recently, and that’s because both China and Korea have announce that they’re going to be buying base metals to build into their national reserves. Korea is very frank about it because they want to protect margins of their industries against what they see is stronger demand later in the year.

Now this is a sort of a Sovereign Wealth Fund type deal, when commodity importing countries use their reserves to buy in cheap raw materials to protect their goods producing industries, but its interesting that it came on the same day this week. And this is a sign in the key Asian economies, that as bad as things are for them, their export numbers are terrible and all these things that we know about, and the Baltic Dry Index has doubled since being down 99%. Dennis Gartman remarks today in his great letter.

Does this just mean that we’re going down along with the economic numbers, or is the world changing? Its been out thesis that the commodities stocks would start to outperform before the stock market really had reached a recognizable bottom. And that was on the basis that they were the strongest groups going into the downturn, they were the group that led the downturn, and therefore what you want is to see whether that was that the whole story had changed, the whole story of commodities as an asset class, and that that was over. Or whether this was, as it was back in 1974 and 1975, a great pause in a much bigger trend. We, of course, are of the second view.

This is a pause, a dramatic pause, in a much bigger trend, and as you can also see from the chart, what happened with the commodities, was the real collapse occured as the banking crisis really got out of control, and we went to the low, where the CRB futures at the 1st of December, when the whole picture of the banking industry was really grim. This was a low on relative strength for them after the stock market had already reached its November low, so again, its a relative strength reading.

The fact that all commodity stock groups have been strong lately is in itself a really impressive sign of either, total un-reality out there, or that the market is sensing a big change in the wind. As I look at my screen here of all the commodity stocks, every single agricultural stock isi up except one. The oil stocks are somewhat mixed, although oil prices are down. The group is about flat. And of course the precious metals stocks notwithstanding that gold is pausing in here as a group are up, but the base metals stocks are all up, all up substantial amounts.

This again is like 1975, and I beleive that what we’re seeing here is a recognition that financial assets are going to have trouble doing as well as hard assets, because the sheer scale of the reflation, is so dramatic, far beyond anything that was done. Back in the 70s we had inflationary monetary policies which made things worse, but we didn’s have the derivatives there back then driving things. It was actually monetary growth which signalled to people that monetary growth was too much, and that we’re going to have more inflation. And Gold is giving the signal, coming off $38 on what was going to be its eventual run up to $825-850, much later.

For investors, this dramatic outperformance, a one-month date, its just been amazing to these stocks, the last month, I mean we’re talking of double digit returns for a great number of commodity stocks no matter which group you’re looking at. That’s why, of course, the IBD Stock Index shift. Because this is after all, you know, the stock market has been a really bad place to be, the worst January on record. The worst for the S&P on record and so the conventional strategists have gone back to the forecasting ability of the S&P in January and predicting that this could be a year as bad or worst than last year. I’m not going to make an overall stock market forecast here; that will come later. But when you look that while the stock market was going down, that all of a sudden the most beaten up group is starting to perform very strongly, what it is is a fundamental change, I believe, in direction, and therefore, our favourite group is going to continue to give good relative strength.

Now of course, relative strength can still be a negative if the stock market breaks through to new lows. I can’t talk right now about the alpha that you’ve got, but I can point out that despite all the problems we’ve had, we still have a gigantic contango in oil. Now this is being treated by most observers as a sign of weakness. Again, I go back to the 70s. What happened was oil swung into contango, and stayed there year after year. It hasn’t been in contango on a sustained basis, except during the period which ran for about 18 months earlier in this decade, when oil demand kept running ahead of supply, and gradually, people saw this happening, and bought out the futures curve farther, but we swung back into backwardation, and now we’re in this sustained contango. At meetings with clients in Las Vegas, the oil contango was for them, and this is the grocery industry, this is a big part of their costs, they kept saying, ” What does this mean? Why is it that oil prices even a few months out are way ahead, let alone, years out?”

My view is that this is an expression of the relative willingness of producers to sell forward, as against the willingness of consumers to lock in prices that they feel they can live with. And so we’ve got a gigantic rebalancing and hedging game going on here, and I don’t think much of this is speculative activity. I think the speculative activity got excreted from the system by the collapse of the hedge funds, and particularly after the collapse of Lehman, which locked in $65-billion of hedge fund assets, so that the big debate that we were having last spring was that oil breaking through a $100 was purely a speculative thing, and not reflecting reality. It turned out there was more speculation than even I understood. But, we certainly knocked that out because the big players have been decimated. This of course also spreads out into the valuations of the private equity companies which have been sort of the worst area of the financial market recently, apart from the Wall Street banks.

There’s these currents around here which indicate that there’s gradually a belief system that although China and India and Korea and these economies which were the drivers of the commodity bull market, are slowing down, and are having troubles. At the conference, the first speaker in the panel in the morning, who is a guy loaded with data; he’s from First Data. He was just back from China; he said that unemployment rate is skyrocketing over there, the government is desperate and they’re pulling out all the stops. What we know is this is a very responsive command and controlled economy and therefore they still have the liquid assets. Remember, they got a 40% savings rate in China, so those savings can be moved out into the economy. Where as opposed to the US, our savings rate has just finally crept above the zero rate.

If in fact then, these big economies are not going to collapse along with the OECD, then its a very clear cut case as to which asset class is going to do better than the other. That’s the hard asset class. Bbut what’s also fascinating is the change in the prices of the grains relative to other commodities. And, thats at a time when the USDA keeps increasing its estimates of the reserves on hand of the grains. i.e. we’re getting bearish news on the grains from the USDA, very disconcertingly bad news, in fact, as they’ve calculated that particularly in the case of corn, how much isi on hand, and it turns out to be more, and the reason for that is the bankruptcy of these ethanol companies, the Verasun’s of the world. So. of course, ethanol based consumption of corn has collapsed. But when you look out further out on the futures curve, what you see is strength, and then you come down on to the statistic that nobody wants to talk about, which is the sun spots and the weather.

Well, the weather data, you can pick your stories as you want. As I was flying out there, to Las Vegas, sitting watching CNN in the terminal, they had a great scene in Trafalgar Square, which was totally buried in snow, and they had kids rolling in the snow. The only other active people in the square other than the kids playing in the snow, were a group of war protesters. it was explained to us that they’re paid for being there. Once again another snow storm has hit England. Now this isn’t January, or December, its February.

The sunspots have still not come back. Right up to date, we’re still getting very low sunspot acivity. In another 6 weeks, my back of the envelope calculation works it out, if they don’t come back, we will have the longest sustained low sunspot activity, in about 2 centuries. At some point, this is going to start attracting attention from the people out there who are telling us that the only we have to fear is global warming and of course, naturally, in this collection of liberal wishlists that are going to get voted through the senate. There’s huge amounts of money to deal with Global Warming. And, this will another case I believe where the liberals’ agenda will be based on theories that are being exploded before our very eyes about the reality. If the correlations of past history work, then we’ve got a very late planting season coming up at the very least and so we start to count the time because if the sunspots haven’t returned by May, then based on correlations dating back to 1804 when the astronomer Royal, William Herschel, one of the greatest astronomers of all time, saw the correlation of sunspots and the price of wheat, then we’re going to have a shock to the global system, and I believe that that much history should be respected.

While I was on vacation, I read a History of Scotland, and one of the small stories was explaining why Scotland got taken over by Britain at the end of the 17th century. The biggest reason was 6 straight years of crop failure. Now this was the years of the ‘Maunder Minimum,’ in terms of sunspots, the lowest sunspot activity for which we have proven records, because they only, started keeping the sunspot data with the time of Galileo; and of course, Scotland is very far north, and the effect of cooling naturally is felt the further far north you are from the equator you are, because the tropical zones are such a huge percentage of the actual face of the Earth, because of the width of the Earth, the zones, that as you move further north, you get cooler temperatures, then the effect of any reduction of solar energy is felt much more powerfully. In other words the further north you are, the more damage is done from cooling on crop production.

That’s why it is that Brazil can continue to have terrific production of soybeans because they’re so close to the equator, in their main production zones. But what happened in Scotland, was that although crops were erratic, poor to marginally good at times in England, they were much better than in Scotland, because there, they had late Springs, and devastating frosts.

Now will all this repeat itself? The scientific community says ‘no.’ There’s a correlation that you can show, but they can’t show how it works. But as an historian, I have to tell you that I still believe this could prove to be one of the biggest stories of the year, but nobody’s talking about it.

Therefore, if you’re buying into the agricultural stocks, you don’t need to feel that you’re taking a bet on this, because the market is already taking a big bet on it; Not so. There’s just nobody out there except the Farmer’s Almanac, by the way, that said it was going to be a bad planting spring, because of sunspots. You may say, “Come on, you can’t cite the Farmer’s Almanac.” Well, the Farmer’s Almanac has managed to stay in business as long as it has by using the climatalogical data and they were quite candid about it, that it was because of sunspots, or the lack thereof. So that’s the only support there is at the moment that I’m aware of for our thesis.

So what you should do now, in terms of your overall equity exposure, the fact remains that the big stock indices are still weighted to the economy stocks and the financial stocks. The financials have a much lower weight than they had before, but within the financials, and that’s why I talked about these regional banks, I believe that what we’re going to see is continued great relative strength of the bank banks; the regional banks, those who actually know their customers, and do traditional banking, as opposed to the investment banks, and the glamorous Wall Street types who dissipated their stockholders’ equity by levering up with the colateralized debt obligations and all those other monstrous products that they didn’t understand. They ceased to be bankers, and became packagers of toxic waste which was re-labelled as great food.

So if we separate out from this the highly publicized banks which are on life support systems supplied by Washington, then I believe that there’s still enough relative strength being shown there that the economy is suffering, but just because Citibank and these other banks are down 80% or 90%, you shouldn’t say that that means the banking industry is down 80% or 90%.

So the economy is going to be a series of stories here and there, and I don’t believe we’re going to get economic numbers for some time, which are going to be the kind of things that are going to be stock market friendly, so I can’t make out at the moment a case for increased equity exposure. I can simply reiterate that within the equity group the signals that we’re getting are that the commodities selloff on relative strength is over, and that the fundamentals are that people are going to be starting to look further out. The stock market is supposed to be a forecasting tool. What they’re saying is that these reflations are eventually going to work enough so that the world will not go down the tubes, and there will be demand for hard assets. That’s the story of the 70s, and its going to come back in somewhat different form, its going to be a shock to the stock market, its going to be a shock, certainly to the intellectuals and the others in control of the media, but I do believe that this implies that the TSE will once again outperform the S&P this year and therefore, that the worst is over, that you pick your spots.

Now as far as weightings, we are coming out with an issue of Basic Points this month, and we will be publishing revised recommended weightings in the commodity groups. I’m at a bit of a disdavantage here, because I’ve got to; I know that the number of people on the call is a fraction of the number of people who read Basic Points, but I can simply tell you that I believe that we’re getting the signals already from what stock groups are doing as to where your emphasis should be. So I recommend that you check those out and that that be part of your guide as you’re figuring out you’re going to be allocating your capital or for those who are thinking of things like RRSP season in Canada, and haven’t given up the faith on stocks, which stocks it is you want to buy now to put in your RRSP. Not that you’re planning to go back and look at it 90 days from now to see how its done.

The fact remains that the billion people that we’ve added to the world’s consumption side, haven’t all turned poor, just because of all the unemployment in the US. So its still going to be a tough winter and a tough spring, but I think that the world of the future is starting to show itself and our job is to try to predict the future rather than getting to mired down in the gloom right now.

Remember the same economists were telling us things can only get worse. As recently as last June were predicting 2-3% economic growth. Now they’re saying there’s no hope, and I’m not ridiculing the economists, because there are a few of them like Nouriel Roubini, who correctly called it. David Rosenberg did a great job. But the economic consensus just suddenly changed and that’s why we had this V-shaped collapse which came as fast as the collapse came the last time in 1974. And at the worst in 1974, the multiple on the Dow got down to 6 (times). I don’t think that we’re going to see that this time, but it means that you’ve got to be cautious about having said that there’s definitely been a bottom in the S&P and the Dow. But I do believe we’ve seen the bottom for the commodity stocks as a group.

That’s it.

Hat tip: Green Light Advisor, February 11, 2009.

Originally published at Prieur du Plessis’s international investment blog and reproduced here with the author’s permission.