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Chart Advisor: Inflation Rotation

Investopedia

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Investopedia
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Tuesday, March 2, 2021

1/ Agricultural commodities rise with interest rates 

2/ Basic Materials Sector poised for move higher?  

3/ What does the move in copper prices mean? 

4/ The bottom line

1/ Agricultural Commodities Rise with Interest Rates 

Stock market indexes retreated in the last hour of the session today with most of the components in each index trading lower. However, the positive move from one sector helps to paint a better picture of what may be happening among investors. In the chart below, Invesco’s DB Agriculture ETF (DBA) is compared with the U.S. Treasury 10-year Note Index (TNX).  

The red, wavy indicator below the chart panel is a correlation coefficient (3-month time frame) which shows how these two instruments have been in a state of positive correlation over the past three years. As investors have begun to anticipate the effects of inflation, it may also be that they have begun to look towards commodities as a hedge against rising prices. 

It is noteworthy that the move in both instruments has accelerated higher recently. This acceleration has coincided with an increased degree of volatility in stocks. These two dynamics may imply that professional investors are continuing to make a sector rotation from stocks to commodities in some degree. 

2/ Basic Materials Sector Poised for Move Higher?  

If it is true that inflation expectations are driving investor decisions, then some kind of evidence should appear in the markets. To see it, chart watchers need look no further than State Street’s Basic Materials Sector Index ETF (XLB) and some of its largest holdings. This ETF closed higher today and has been moving in an upward trend for the past month. Among the largest holdings within the ETF, the one that stands out is Freeport McMoran (FCX), known for its large copper mining operations. The price of gold and silver also rose today, and this company has a significant amount of gold and silver mining operations as well. 

3/ What Does the Move in Copper Prices Mean? 

The chart below takes a closer look at FCX and the price of copper as tracked by Barclays Capital’s iPath Series B Bloomberg Copper Subindex Total Return ETN (JJC). FCX has been outpacing the price of copper, but the shape of the price action for JJC (orange line) is unmistakably similar to the move in FCX shares.  

The long-held notion that copper prices predict the overall health of the economy seems to be relevant here, even if it only implies inflationary pressures in the current context. It is possible that copper prices are forecasting an increase in demand for the industrial metal which may translate into increased productivity in the larger economy in the coming months. But if inflation is the reason for rising prices, that productivity may never materialize. 

4/ The Bottom Line 

Stock prices slid while Basic Materials Sector rose, suggesting that investors are concerned about inflation. With precious metals and agricultural futures trading higher, the market seems to be validating this worry.  

Originally Published on March 2, 2021

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