Trader’s Narrative

Way back in May 2008 I wondered: Will Sprott IPO Mark Top Of Commodity Bull Market?

Yes. Yes, it did.

For those unfamiliar with them, Sprott is a boutique asset manager in Canada. The IPO of Sprott was an accurate tell for the commodity market top because of the firms expertise in and their cheerleading of the commodities markets.

You had to ask yourself this simple question: If they believed that the bull market in commodities would continue, why would they sell such a highly leveraged asset as their equity?

The dashed line is the CRB Index, the most popular measure of the commodities markets and the solid line is the price of Sprott (SII) on the Toronto Stock Exchange. It closed the first day at around $10 a share but fell immediately. It approached that high again to put in a double top and started to fall in lock step with the CRB index. In mid-November 2008 it traded below $2.50 - less than a 25% of the IPO initial price.

Another case of watching what others are doing and not necessarily saying. In general, you want to always be wary of whatever Wall St. sells. They aren’t doing it out of the kindness of their hearts or to be charitable.

This market ‘tell’ was one of the reasons why I was bearish on commodities and for the most part it was the right posture. The only exception lately of course has been the gold market which has surprisingly revived to once again gain the $1000/oz. level. I’ll come back to the gold market another time since it deserves more attention.

For a very long time, commodities were in a protracted bear market. Each time prices went up, they hit the top of a wide channel and were pushed down… until 2004 when the CRB broke above the channel and went on a wild ride.

More and more the bull market appeared unsustainable as prices accelerated. Comparing the bear market channel with the bull market that ensued, it is easy to see the contrast. While the bear meandered lazily with the rhythm of an endurance runner, the bull market shot ahead with a one track mind.

But now, with the price of crude oil deflating fast, the CRB Commodities Index finds itself again in a clear bear market:

To be precise, the CRB Index is now down 24% from the top in July 2008. If this was an equity market, it would have qualified the standard +20% definition of a bear market.

If this is truly a change in the long term trend, it would not only mean a shot in the arm for equities but also the world economy.

So everyone is running around in a panic, dumping bonds and equities for fear that the Fed will increase rates to fight inflation. The 10 year bond yield, which everyone is watching like a hawk all of a sudden, has been blasting higher in anticipation.

Only thing is, I can’t seem to find any footprints of this inflation monster everyone is afraid of. But the markets are a forward discounting mechanism. Maybe they are sensing that inflation, although not here right now, is just around the corner.

True, markets do look forward and incorporate all sorts of scenarios but wouldn’t that same forward discounting mechanism be at work in markets like gold, silver, and the CRB (Commodity Research Bureau Index)?

Each of these markets is also a tell for upcoming inflation. And each of those tells is not confirming inflation fears. Gold, which I’ve already covered, is actually in what looks to be a topping pattern after a multi-year bull market.

The same can be said for silver (and perhaps with much more conviction). And last year, the CRB index broke its long term uptrend line. This trendline had been in effect since the double bottom of the CRB (in early 1999 and late 2001 at the 185 area) so it was very significant.

Getting back to the bond market, for the past 20 years, the 10 year bond yield has been in very orderly down trending channel. Everytime it has hit the top of this channel, bonds have rallied. This has happened about half a dozen times. Once again we are at the top of the channel.

Is it different this time?