Bubble Echo in Commodities UPDATED

Oil is in the news, and the huge gulf spill is giving credence to even higher oil prices - yet oil has dropped. At the same time, despite the flash crash, other commodities have continued to rise, closing in on levels last seen at the top of the bubble in July 2008. Are we in a huge Bubble Echo in commodities, and is oil signaling a top?

We all remember how oil went to $147/bbl in 2008 and then fell fast to $31 six months later. As it was rising, the cries of Peak Oil! rang out, but as it dropped, we shook our heads and mumbled about a huge commodities bubble. 

Peak Oil is passé (see chart, courtesy InfectiousGreed), but Oil is half-way back to those bubblicious heights, and again the conventional wisdom is justifying high prices on faux fundamentals and momentary events. Lost in the noise seems to be it rose before the spill. 

 

What is behind Peak Oil is a serious discontinuity: oil becomes more expensive to extract, and global production finds it hard to keep up with demand. We already appear to be beyond the era of cheap oil. Chris Martensons' Crash Course has more on Peak Oil. The US military is worried. His blog has just put out a great resource on this issue, with specific advice for investors, to wit: if Peak Oil hits, we won't see oil spiking to $500/bbl, but a political and military response. 

But we are not there yet. Instead, something else is driving up oil, and it is not increased demand. Miles driven have dropped during the Great Recession, and on a month-to-month basis has dropped since the start of 2010:

Sunday's NYT has a great graphic of oil going in reverse. Even during the oil crises of the '70s, per-capita driving increased. In the Great Recession, in contrast, per-capita driving is decreasing, yet oil prices have bounced back up. What gives? If the demand is down, and we are awash in supply, why are prices back up?

Maybe China is driving demand for oil? Nope. Chinese miles-driven has been flat. Chinese data on this stat may be statistically sketchy, but the NYT reported last Dec how Chinese car sales are booming but gasoline sales are flat. 

As recently as May 2, oil was heading to match its 52-week high of Apr6. Pundits were calling for a breakout. Just before the breakout, we saw an increase in the same sorts of cries to buy! buy! we saw in 2008. So it goes at a bubble top - where were they when oil was hovering at $50? Instead it did a triple top and collapsed. It had bounced off the 50 DMA after the second top, but this time it ran through the 50 DMA without pause, jittered a bit around the 200 DMA (around $76/bbl) and kept falling. 

The best explanation is that we have been in a bubble echo. The signature of a bubble was recognized before the triple top that "trading activity seemed to mirror the pattern leading up to the oil market's breakdown in the summer of 2008." Commercial interest peaked last December, just like it peaked in late 2007, six months before the bubble burst:

 

Oil had also gone into contango (indicating too much oil). Yet even this pundit was caught up in the bubble, expecting it to continue up despite the warning signs. Bubbles can do this to pundits. 

After the peak of commercial interest, speculation drove oil and other commodities to absurd heights in 2008. You can see the same pattern now; speculative has gotten back to bubble levels:

 

Besides oil, Copper (the Cunary in the commodities pits) has given off a big warning signal: it began falling in April around the time oil began peaking, and has since dropped below its 200 DMA for the first time since coming off the commodities peak in 2008. This is a warning sign that manufacturing is slowing.

 

The WSJ's blog noted this warning sign as well, and attributed it to China tightening. This meme is gathering adherents: the FT noted it back in March, and the UK Telegraph's Amborse Evans-Pitchard picked it up in April, that China's credit curbs could cause a Great Unwind of commodities. Chinese base-metal stockpiling reached "epic" levels in early April. Of course the pundit expected it to continue.

But not everyone. David Rosenberg came out with a great predictor of commodities: the Shanghai Index. He shows how it leads the CRB Index by four months (72% correlation). It peaked before 2008 top in commodities, and it peaked again in Nov 2009. Since then it has broken down out of a four-month trading range, right as oil and copper have burst. A week ago CreditWritedowns posted a comprehensive analysis of this indicator and others which supports the Great Unwind thesis. 

  

MPPTrader provides a comparison of oil & copper to gold & silver, showing how the crude oil and copper futures have broken below trendlines. Oil is well below, and copper has recently rallied to test the trendline. If it kisses it goodbye, it is pretty well confirmed that the Bubble Echo is done. 

UPDATE: The STU led its latest update with commodities, showing in the chart below that the CRB commodities index has broken decisively below the trendline that guided its rise since the beginning of 2009 as well as the Feb5 low. The STU has been predicting this for months, and will likely continue to highlight this change of trend since it supports one of their core investment theses: deflation. The PPI came in negative in April, a surprise to pundits, and CPI will be reported tomorrow.

 

Comments

[Michael]

It would be interesting to see how Mr Rosenberg explains the correlation prior to 2006 when the Shanghai index was in a bear market since 2001 while the CRB index was in a bull market.

[yelnick]

Michael, I think the argument is that China only began aggressively stockpiling during the bubble ramp (2004-2008) and wasn't a major commodities force prior to 2000.

[Roger D.]

At the precipice

prec·i·pice (prěs'ə-pĭs)
n.

2.The brink of a dangerous or disastrous situation

http://www.screencast.com/users/parisgnome/folders/Default/media/8c63b5a0-7a57-48fa-b22b-c1dfe6a78aed

[anonymous]

Here's a coal property company for income minded investors yielding 10%. Natural Resource Partners (NRP). $21.59

[Hockthefarm]

Yelnick:

Dent talks a lot about the 29 to 30 year commodity cycle.

1920 - 1951
1951 - 1980
1980 - 2009/2010

Expects bulk of commodity crash to occur in the 2010 to 2015 time frame. Expects prices to remain low until 2020 to 2023.

Just one more example of deflationary forces I guess.

Hock

[Roger D.]

"Not since the Pharaohs and Egyptians worked to screw over everybody and take the money have we seen a group do what's being done to us in our country right now..."
Dylan Ratigan

[Shanky]

Another killer post Yelnick! Thanks as always. Oh, get out your hard hats. Looks like my top call is gonna stick.

[yelnick]

Roger - a precipice indeed!

[Mr. Panic]

Yes, when the averages drop below the lows of Friday May 7th, its freefalling time. Today, qualified as key reversal lower if one includes afterhours futures activity for the SP which thus projects a drop possibly into Friday.

[JT]

I'm a buyer.
:)