Another Opinion on the Rotation from Commodities to Financial (soft) Equities

Just picked this up off the E-Trade News. The article from this PM confirms the points I have made recently regarding a rotation from the commodities to the financial equities. It sure is nice to see someone independently come up with the same technical indicators that I have identified ;o) The rotation may not be long term in nature, but it sure looks tradeable over the next few months (today's action notwithstanding).

The chart below compares the Financials index, XLF with the oil index, OIL. The relationship between the two is almost perfectly inverse the past month. So, as oil and commodities decline, financials and other related equities will increase. This makes sense because oil / commodities are a reflection of inflation denominated in the home currency. Higher inflation must mean higher interest rates, which must damage financial equities.




"Goodbye commodities, hello financials" 1:01 PM ET 7/24/08 Marketwatch

NEW YORK (MPTrader) -- It seemed as though there was no place to hide when Apple and the technology sector, along with Bank of America and the financials, got clobbered with the rest of the market at Tuesday's open. Though by mid-day, the market did recover in a big way and left behind another significant low within a "rolling bottoming process."

Tuesday's action in the Standard & Poor's 500 Index (SPX) established a low of 1248 and high of 1277. That dwarfed Monday's daily range, closing well above Monday's close and high, so from a strict technical prospective the blue chip index had a key upside reversal.

In addition, unlike the rally off of last week's July 15 low, Tuesday's rally did not have the feel of a temporary oversold rally. The morning sell-off wasn't as dramatic, with the S&P 500 only down 11.5 points from its previous close as opposed to nearly 28 points on July 15. So it was a higher, secondary low -- more corrective looking than that of the previous week, and less susceptible to a mere reactive bounce.

Driving the S&P 500, which has now recovered 6.8% from its July 15 low (through Wednesday's close at 1282), are the financials, which have room to go higher. Over the last several months the percentage that the financials make up of the S&P 500 has diminished just by virtue of the price deterioration, while the energy sector percentage of the index has increased. But institutions in the last week, in particular, appear to have begun to shift their money out of the once high-flying energy sector into equities.

One way to play this trend is through the Financial Select SPDR (XLF) or its sister ETF, the Ultra Financials ProShares (UYG), which moves two times that of the XLF. Since its low of 14.08 on July 15, the UYG is up 68% through Wednesday's close at 23.67.

Traders should look this week for a break of 26.40. That's where the major resistance trendline from Sept. 30 of last year cuts across the price axis, a break of which would be the first major signal of damage to the downtrend that's transpired since the fourth quarter of last year. Beyond that, if the UYG can sustain above 33.75, it would indicate the end of the bear market in financials.

Likewise, the Ultra Short Oil & Gas ProShares (DUG) provides an opportunity to play the downside move in energy shares. The DUG has put in a rounded bottom at around 25.30, closing Wednesday at 36.16, up 42% from its low, as oil prices have declined 15% from their $148 high. Its chart points to 39.50-41.00 next.

Another way to play the trend is through the iShares Dow Jones Transportation Average (IYT), which for obvious reasons is getting a major lift from declining energy prices. The IYT chart shows it made its bear market, corrective low on January 6 at 72.86, and went to new highs after that at 99.09 on May 18. The July 15 low at just under 82 was the pullback low after that new high, and from there it's gone to just above 92 as of Wednesday's close, a 12% gain in just a week. Tuesday was the first time it closed above its 50-day moving average since the first week of June, suggesting the IYT is in a new upleg and heading directly back to 99 to test that high.

Other commodity indexes are confirming what the IYT is suggesting, like the PowerShares DB Agriculture ETF (DBA), which closed below its 200-day moving average for the first time in a year on Tuesday. The PowerShares Commodity Index Tracking Fund (DBC) closed for the second day in a row below its 50-day moving average and looks like it has considerable room to go down as well.

In addition, the streetTRACKS Gold Shares (GLD) looked like it was on its way to retest high levels at around 98 early Tuesday but instead ran out of gas at around 96.20 in the pre-market hours and then reversed in a big way and closed at 93, falling to 90.57 as of Wednesday's close. Chances are the GLD now will move back to below 90, and possibly towards a full-fledged test of its rising 200-DMA, now at 86.80, which must contain any further sustained weakness to avert a total breakdown in gold prices towards $800 ($80 in the GLD).

The financials, transports and stock index ETFs are turning up, while we have sell signals in the, energy, agricultural and precious metals sectors. For people who have followed markets for a long time, this inverse relationship between equities and commodities makes intuitive sense and suggests there are trading opportunities developing that will last longer than a few hours!"

Mike Paulenoff is author of MPTrader.com, a diary of his intraday technical chart analysis and trading alerts on ETFs for gold, oil, equity indexes and other major markets. (mptrader.com)