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By: Costas Bocelli — July 5, 2012

Did Commodities Just Bottom?

As a group, commodities have been in a long downward slide for over a year since making their last cyclical peak in the spring of 2011.

Aside from numerous investors and market pundits (such as myself) trying to call the bottom in the housing market ever since the credit bubble popped years ago, I would have to say trying to call the bottom in commodities during this bearish cycle has to rank neck and neck in terms of difficulty.

For the commodity bulls, it’s been a frustrating and seemingly never ending slide.  Any semblance of a bottom being formed... or a glimmer of support... has only proven to fail, sending commodity prices to fresh lows.

In fact, since the cyclical peak, commodity prices have made eight lower lows in the 14-month bearish trend.

But has the time now come?  Have commodities finally bottomed out and the cyclical bear market low been made?

From what I’m seeing, both from the technical price action as well as the global fundamental circumstances, commodity prices finally look to have indeed put in a cyclical low.

After I lay out my technical analysis and reasoning, I will share with you three stocks that are highly levered to commodity prices.  They not only have huge upside potential for capital appreciation, but are still deeply discounted right now, making the current reward/risk ratio very attractive.  (And, as an extra "bonus", these three stocks currently distribute regular dividend yields that are currently over double and triple the yields offered on Ten Year US Treasury Bonds.)

Major Technical Damage Has Endangered the Commodity “Bear”

The chart below is a two-year daily on the Thomson Reuters/Jefferies CRB commodity index, a key benchmark comprised of a weighted basket of commodities designed to track the broad trend in overall commodity prices.

From the cyclical peak circled in green, we’ve clearly been in a long extended downward trend, making a series of lower lows along the way (shown by the red arrows).  The only real scare to the bearish trend came early this spring when the broad equity markets made fresh cyclical highs of their own.

But something clearly has changed recently with the price action and sentiment.

First, investors finally capitulated on June 21, not only financially but psychologically.  On that day (the eighth arrow and most recent new low) commodity bulls essentially “threw in the towel and gave up”.  The very next day, I was reading a newsletter piece from acclaimed editor Marc Faber who pens the Gloom, Boom and Doom report.  He noted the extreme negative sentiment and emotional toll it had taken on investors with long (bullish) commodity positions.

Not only did that day mark the eighth cyclical new low that dated back nearly two full years (September 2010), but it also marked the lowest closing low (267.15) during this entire cyclical bear market.

What happened merely six trading days later (June 29), and again this Tuesday July 3, suggests with a high degree of probability that we’ve just seen the cyclical low.

On Friday the 29th, the CRB index rallied 4.55% -- the largest one day gain in over three years, right around the time the US equity market bottomed out from the great recession.  That also signified the cyclical lows in commodity prices as measured by the CRB index.

Friday’s big move saw huge follow through on Tuesday, July 3.  The index tacked on nearly 3%, smashing through key resistance levels such as the 50-day moving average (orange line) and a trend line which I’ve drawn (purple dotted line).  The index closed at 292.64, surging nearly 10% from the June 21 low.

From a technical perspective, odds point to a bottom being put in after fourteen months of decline.  While the rally was swift and probably accentuated by a good deal of short covering, the price action and magnitude looks like more than just short covering, and any healthy retracement should find a higher low of support, perhaps a level near the purple dotted trendline.

Global Fundamentals Have Shifted

Much of the weakness and added downward pressure in commodity prices had been exacerbated by the latest bout with the sovereign debt crisis.  The EU summit forged an agreement that clearly shows a shift has been made in how the leaders will address the crisis.

With a recession fully baked into the markets throughout the Eurozone, the shift has become more aggressive, with less of an emphasis on deflationary austerity and more of an emphasis on growth and stimulus, which should be a tailwind for commodities.

Also, the European Central Bank as well as the Bank of England continues their easy money policy to help re-inflate the real economy while supporting the banking system.

The biggest shift has been coming out of Asia -- mainly China and India, which are large importers of commodities.  With their economies weakening over the past several quarters, the bearish trend in commodities pretty much followed them in lock step.

However, just recently, both of these countries have shifted monetary policy after years of tightening to stem inflation and moderate or temper growth.  Now they’re loosening policy.  Just last month, China cut interest rates and relaxed bank lending guidelines -- a move not seen in years.  Clearly, China and India are beginning to get more aggressive about reigniting growth, which is extremely supportive for commodity prices going forward.

The bottom line is that much of the malaise and slowdown in global growth is widely known and discounted in the markets, especially commodity prices.  Couple the shift and coordinated measures now being taken by global economies to re-inflate growth with the recent technical price action just this past week and, at the very least, we’re close to the low end for commodity prices and possibly have seen the cyclical bear market low.

Three Stocks Levered to Commodity Prices

As I promised, I’ll share with you with three stocks that you can take a look at right now.  All three companies are levered to commodity prices, and all are trading well off their cyclical highs and closer to their lows, which makes the entry levels that much more compelling.

The first is Cliffs Natural Resources (Sym: CLF), a US based iron ore and metallurgical coal miner.  The stock is trading extremely cheap at less than 5 times earnings, and at its current stock price it pays a dividend that yields 5.1%.

The second is Vale (Sym: VALE), a large cap Brazilian miner that is a heavy Asian exporter.  The stock is also very cheap, trading at 6 times earnings.  It also has an attractive dividend distribution which currently yields 5.8%.

And the third is Freeport McMoran (SYM: FCX).  This US based company derives most of its revenue from mining copper, but also has exposure in precious metals like gold.  The stock is currently trading at less than 9 times earnings and also has an attractive dividend yield of nearly 4%.

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