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Commodities need stock market stress test – Bloomberg Intelligence

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(Kitco News) In order to see which commodities can continue trading at elevated levels, the sector needs a stock market stress test, according to Bloomberg Intelligence.

There are signs that commodities rally might have peaked, and only a broad market selloff can determine which commodities will survive, said Bloomberg Intelligence senior commodity strategists Mike McGlone.

"Iterations for an enduring commodity peak are growing, and the stock market may be the final support pillar. U.S. Treasury bond yields topped out in March. Copper, corn, and lumber peaked in May. The dollar has recovered since June and crude oil may have reached its apex in July, when China cut its required reserve ratio. Even gold is facing pressure from Bitcoin," said McGlone on Monday.

The question McGlone looked at in his most recent report is whether commodities are too dependent on rising equities.

"A takeaway from our relative-performance analysis is that commodities may need a stock-market stress test to determine which are the most likely to sustain higher prices," he stated. "About a year ago, copper remained firm vs. an equity-market wobble, signaling that the metal was ripe for advancing. The problem is that the new copper high above $10,000 a ton proved ephemeral … The primary issue with advancing commodities: the Bloomberg Commodity Spot Index is essentially unchanged since the end of 2019 when measured vs. the S&P 500."

McGlone pointed out that inflation, crude oil, and gold have underperformed the stock market, which is a sign of deflationary forces at hand. If equities stop rising, the negative trend for commodities should strengthen.

Crude and copper are two great examples of commodity peaks, at $77 a barrel and $10,000 a tonne, respectively. And there is a historical connection with the stock market performance here, McGlone added.

"West Texas Intermediate crude oil may have peaked near $77 a barrel along with copper above $10,000 a ton, and the key broad commodity-market risk is a pullback in the stock market, based on recent history," he said. "The last two major declines in crude (2018 and 2020) were almost tick-for-tick with the S&P 500. At about 0.90, our graphic depicts the highest 20-quarter correlation between the Bloomberg Commodity Spot Index and S&P 500 in our database since 1960. The last time this correlation measure peaked was in 2013, just before crude oil collapsed from $100 a barrel and the entire commodity complex followed."

Now, there is a risk of WTI reverting back to its mean since 2014, which would mean a drop to around $50 a barrel, McGlone noted.

Another thing working against further commodities upside is supply elasticity due to technological advancement.

"Five years ago, it cost about $50 to extract a barrel of shale crude, now it's closer to $30. Businesses have adjusted to Covid-19, as evidenced in our chart showing S&P 500 Ebit at a record high. If equity prices fall or earnings stall, the highly correlated commodity market risks a drop with greater velocity," McGlone wrote.

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