Troubling Divergence Between Stock and Commodity Prices

It is logical to expect that commodity prices and equity prices are causally linked. It is simply a question of supply and demand. In an expanding economy, demand for commodities should increase and in a contracting economy, demand should decrease. Prices should respond accordingly. As a result, the MarketWatch article by Simon Maierhofer titled "Will the commodity crisis infect stocks" got my attention.

In the article, Maierhofer looks at five periods of declining commodity prices in the past 35 years: 1980-1982, 1984-1986, 1997-1998, 2008-2009, and 2014-2015. He reports that commodities and stocks both declined in only two of the periods: 1980-1982 and 2008-2009 and concludes that "History disagrees with the seemingly logical conclusion that falling commodity prices foreshadow falling stock prices."

Unfortunately, I have to strongly disagree with his conclusion, even using his own charts. Look closely at what happened shortly after the period 1984-1986. Does anyone remember the stock market crash of 1987? It sure would have been nice to get a warning of the impending crash, which is exactly what the commodity market provided.

What about the period of 1997-1998? While the lead time was a little longer, the decline in commodity prices correctly foreshadowed the 2000 recession and the resulting bear market that ensued.

Upon closer examination, four out of the five periods mentioned by the author corresponded to simultaneous or subsequent declines in the US stock market. That leaves us with the 2014-2015 period...

I never put too much stock in any one indicator, but the underlying forces of global supply and demand have similar effects on both stock and commodity markets. That makes the recent decline in commodity prices extremely troubling. The fact that commodity prices peaked in April 2011 suggests that the equity markets are long overdue for a correction.

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About Brian Johnson

I have been an investment professional for over 30 years. I worked as a fixed income portfolio manager, personally managing over $13 billion in assets for institutional clients. I was also the President of a financial consulting and software development firm, developing artificial intelligence based forecasting and risk management systems for institutional investment managers. I am now a full-time proprietary trader in options, futures, stocks, and ETFs using both algorithmic and discretionary trading strategies. In addition to my professional investment experience, I designed and taught courses in financial derivatives for both MBA and undergraduate business programs on a part-time basis for a number of years.
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One Response to Troubling Divergence Between Stock and Commodity Prices

  1. Pingback: Commodity Bloodbath in 2015 | Trader Edge

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