It is fact that equity prices prosper when commodity prices are relatively stable. Normally, it is the instability of commodities on the upside that disturbs equities, such as that experienced between 1973 and 1974. However, downside volatility in the commodity pits can be even more devastating. Just consider the sharp drop in both markets in the second half of 2008, 1921 or even the 1930/32 experience.
That said, we can use long-term trends in commodity momentum to signal favorable long-term environments for equities. This chart, for instance, features our secular commodity momentum indicator. It is calculated by dividing a 60-month by a 360-month MA of commodity prices. We have inverted the actual series so that it moves in the same direction as equity prices. The arrows show when the indicator signals a secular decline in commodity prices is underway. In other words, when it crosses above its 48-month MA (the dashed red line). Every instance has been followed by a long-term uptrend in inflation adjusted equities. The reason for showing this chart lies in the fact that the momentum indicator is extremely close to a buy signal (secular sell for commodities).
It is important to note that previous buy signals were followed by a positive long-term environment for equity prices, but that did not preclude sharp cyclical shakeouts developing along the way.
For instance, the 1868 and early 1950’s signals were almost immediately followed by a shakeout which formed part of a larger uptrend.
This article was written by Martin Pring, the Investment Strategist to the AdvisorShares Pring Turner Business Cycle ETF (DBIZ).