Web colfund.blogspot.com

Thursday, July 13, 2006

Commodities, Bonds and Interest Rates

Equities right now look like they are set for further declines due to weak earnings (Alcoa, EMC, Genentech) as we had expected, and we expect the Fed to pause in August when it sees the earnings growth slowdown allowing equities to rally. How about the other asset classes, namely commodities and bonds? How will they perform in the near term?

Based on the weekly charts, commodities as represented by the CRB index have their upward trend intact. MACD has been losing momentum the past few new highs but no clear divergence is established. On the other hand, treasury yields still have their upward trend intact on the weekly charts but looks toppish and there is a clear divergence forming on the daily.

We think that the bond market is already showing signs that people are expecting a rate pause in August. Bond prices (not yields) and commodities have an inverse relationship. At the beginning of an economic cycle, when interest rates are bottoming out or low, bonds are expensive and the returns are low... commodity producers can thus afford to keep their money in inventories of commodities. As the economy improves, they build up more inventory in anticipation of better sales, while interest rates go up to control inflation and bond prices move down. Hedge funds also join in on the fun, buying up commodities in anticipation of a rush in prices.

However when commodity prices become expensive and interest rates are high the economy will eventually slow and interest rates will have to eventually go down. Here the trend reverses and bond prices will start to rally from the bottom and commodity producers and hedge funds will find better returns for their money from the bond market and rotate out of commodities. We feel this is going to happen in the coming months as interest rates come to a pause with the possibility of going down eventually. We think any strength in commodities and commodity stocks is a chance to sell, given where we are in the economic cycle. BUY BONDS!!!



Post a Comment

<< Home