A dramatic and troubling tale of omens

Most in the financial industry have been preoccupied by the comments of the Bank of Canada and the United States’ Federal Reserve System and watching the ups and downs of financial markets. However, a dramatic tale is unfolding elsewhere, in the commodity market.

Investors usually focus on equity prices both here and in the United States, but commodity prices have been conveying a more important message. Prices there have been tumbling. A chart depicting that shows a precipitous drop, more than 50 per cent from its peak, and the decline is accelerating, down over 10 per cent in two months.

Much worse is the fact that the most critical commodity price benchmarks appear to be collapsing, namely oil and copper, which always have been the most significant harbingers of future economic trends.

Nowadays the price patterns of these two items are the weakest in two years. Market technicians note that their prices are below their 50-day moving average, something that they consider to be very important, a negative signal. This shift started earlier this year, and represents a reversal of the upward trend that began in March, 2009.

The last time there was a decline through the longer term moving average was in the autumn of 2008, one that preceded the worst fall in the stock markets in a generation.

Is this ominous technical signal really nonsense or is it meaningful? There is every reason not to discount its significance.

The weakening outlook for oil should cause a great deal of concern. It goes without saying that oil is a vital component in transportation and in most industrial processes so its consumption is a telltale signal of a vibrant or weak economy. Copper is a crucial ingredient in all kinds of construction, house building, and plant expansion; it is a key part of many consumer items, everything from automobiles to consumer appliances. If there were a slowdown in these sectors of the economy, it confirms that economic troubles are likely.

Oil and copper are bellwethers of the economy, so a fall in their prices indicates a drop in demand and a general slowdown in business activity.

The resource segment accounts for 15 per cent of the Toronto (TSX) stock exchange index, so the outlook for our stock market is cloudy. On the other hand gold accounts for about 11 per cent of the index, and it has been rising, unusually now, as it historically lags during the summer and early autumn. Clearly, it reflects economic uncertainty.

All those trends should fuel investors’ concerns, and if history is a guide, should not be dismissed lightly.

Bruce Whitestone