Chart Advisor: Commodity Stocks Crack

By J.C. Parets & All Star Charts

Friday, 12th may, 2023

1/ Commodity Stocks Crack

2/ Dr. Copper Breaks Down

3/ Will Inflation Finally Cool?

4/ Nasdaq Reasserts Old Leadership

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1/ Commodity Stocks Crack

We’re finally witnessing an expansion in downside participation this week as selling pressure spreads among cyclical stocks. First, bears took control of the banks. Now, we’re seeing commodity stocks follow the same path lower.

Here is a short-term look at the Metals & Mining ETF (XME) along with the Oil & Gas Equipment and Services ETF (XES):

Regardless of whether it is materials or energy stocks, any group with exposure to commodity prices looks vulnerable these days. The short-term tops in both of these indexes are a great illustration of the bearish price action we’re seeing.

Notice how both XME and XES rallied higher off the lows from last fall but have since been grinding in sideways ranges. The formations we’re left with are head and shoulders tops, a classic reversal pattern.

While XME already appears to be resolving lower, as it closed at its lowest level since November today, we’re watching XES and other energy indexes closely to see if they also complete tops. These charts are likely to resolve in the same direction.

2/ Dr. Copper Breaks Down

The risk-off tone that began earlier in the week is intensifying as more and more assets break to new lows. But nothing stings bulls quite as badly as the breakdown in copper futures.

Copper just undercut a key polarity zone marked by the August 2022 pivot highs.

Those pivot highs represented a critical level of resistance that became support earlier this year. Fast forward to today, and former support has given way to the bears, confirmed by an oversold reading on the 14-day relative strength index (RSI).

These indicators suggest that the path of least resistance now leads lower for Doctor Copper, often seen as the market’s chief economic barometer.

Dwindling demand for copper suggests that an economic contraction could be around the bend. More importantly, it doesn’t bode well for cyclical assets and commodities in general.

3/ Will Inflation Finally Cool?

Copper is breaking down. Crude oil is turning lower. And even gold is pulling back as the equity indexes are drowning in a sea of red.

With selling pressure hitting the markets, especially cyclical assets, will inflation finally cool?

Check out the 10-year breakeven inflation rate, which is on the verge of printing fresh two-year lows:

The 10-year breakeven has pounded the former 2018 highs from above at approximately 2.15 since late September 2022. A break below this key level and the prior cycle’s peak would signify a thorn in the side of commodity bulls.

If and when the 10-year breakeven inflation rate loses that level, inflationary asset —stocks and commodities alike—could experience additional selling pressure.

4/ Nasdaq Reasserts Old Leadership

One of the most important relative trends we like to evaluate is the relationship between the Nasdaq 100 (QQQ) and the Russell 2000 (IWM).

The Nasdaq 100 represents large-cap growth, while the Russell depicts small-cap stocks.

Below is the QQQ/IWM ratio dating all the way back to the early 2000s:

After a prolonged sideways period for the past three years, the ratio is pressing against a shelf of former highs at the dotcom bubble peak and 2020 highs.

If this ratio breaks out and reaches new all-time highs, growth and technology should experience an acceleration in their current leadership role. At the same time, this is a very logical level to see some mean reversion in the form of small-cap outperformance.

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Originally posted 12th May 2023