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With Wall Street Leaving Commodities, Should YOU Be Showing Up?

In order for commodity prices to have bottomed, sentiment must fall in line

by Nico Isaac
Updated: November 04, 2014

It's official. Corporate participation in the global commodities sector is like a cruise ship crew after a spoiled shellfish incident. Think: Mass evacuation for the lifeboats.  

On October 31, Hermes Investment Management announced it will be joining the "exodus of financial institutions from commodities" that has so far included several fund operators and investment firms such as Deutsche Bank, JP Morgan, Credit Suisse, Morgan Stanley, and others.

For some, the retreat of Hermes from the severely diminished commodities market could be the ultimate buy signal:

"The mass departures may be a sign that the bottom of the cycle is near. Hermes and big banks are serious large investors; Generally speaking, once you have a consensus and they're all out, then the next move has got to be to go back in again." (Reuters, Oct. 31)

Well, nobody loves a contrarian tipoff more than we do.

It's true: Once investors are "all out" of a specific market, it's often a yellow -- if not green light -- to go back in.

But is that what THIS is?

Well, let's put things into perspective. Back in April, Barclays was the firm du jour jumping the raw materials ship. "Barclays Joins Commodity Exodus" wrote an April 22 New York Times. There's that word again -- "exodus."

There was also something else in the news about Barclays quitting the commodities business that's being repeated now in the news about Hermes: the notion that Barclays exit was a sign of a bottom. 

"They may be leaving just when the party is getting started again" -- New York Times

Not to mention this bullish forecast from May 5, the source of which I'll hold off revealing until after you've read it:

"Our outlook for commodities is the most propitious for a decade. Our view is that returns are sustainable because of global growth and tight physical supply." (Financial Times, May 5)

The "our" in that forecast is Hermes Fund Managers -- the very same entity that severed its commodities ties on October 31 due to "difficulties in making returns" from the beleaguered sector.

So, what does this tell you now, six months later, and with no bottom for commodities in sight?

Well, it shows you how even those directly in charge of pushing commodity business across their very own trading desks aren't always seeing the full picture.

  • They watched the commodity sector shed nearly $100 billion of assets over the past 2 years (as of May 2014).
  • They watched their corporate neighbors fleeing, one by one.
  • They thought they saw the perfect, contrarian set-up for a bottom.

But the set-up was far from.

In the May 2014 Elliott Wave Theorist, we filled in the critical blanks; while Wall Street was retreating from commodities, individual investors were renewing their commitment with vigor. This divergence told us that sentiment was nowhere near the levels of pessimism that define a bottom:

"Commodities remain well below their highs of 2008... and even below their highs of 2011. Normally market action such as this would imply bearish investors. But the opposite is true: investors are betting that commodity prices are poised to soar. As of March 31, Large Speculators in commodity futures, a sector of traders monitored by the CFTC, have amassed an all-time record net long position (with data going back to 1995) in the CRB Commodity Index. Only extreme optimism could prompt such buying, and the Daily Sentiment Index (courtesy of trade-futures.com) confirms this suspicion with an extremely high reading of 95% bulls on February 20.

"In crude futures, there is not only an all-time record net long position among Large Specs, but also an all-time record net short position among Commercials, who have a history of being mostly on the right side of the markets they trade. Markets cannot stand such a high level of optimism among commodity investors for long.

"To conclude, [the charts] display a bearish condition for commodity prices. In commodities, there is too much bullish sentiment attending weak price performance, an even more precarious setup."

To recap: Bullish sentiment for commodities in May 2014 had surpassed the level it was in 2008 -- even though prices are 30%-40% below their 2008 apex. The set-up was not of a bottom, but rather a "precarious" retreat that would ring out the misplaced optimism.

From May, the 19-commodity Thomson Reuters/Core Commodity CRB Index slid 10% to a 4-year low -- its biggest quarterly drop in 3 years; while crude oil prices plunged 25% to a 4-year low.

Now, Hermes has joined the corporate exodus from commodities. But it takes a lot more than one side calling it quits to signal a bottom.

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