Commodities, the Key to the Financial World

Commodities are now beginning to be appreciated and understood by investors. After all, they are the key to the financial world. Friends and family tell me that they don't follow commodities but always want to discuss investing. After a few minutes of conversation they make the connection to oil, interest rates, gold and the value of the dollar - and as this year is proving once again everything hinges on commodities.

One of the main reasons the stock market was at record highs in 2007 was the steadily increasing price of oil. Two of the Dow 30 stocks of Exxon and Chevron had increased dramatically in price because of huge profit margins with record energy prices.

With their high share price there contribution to the index kept the Dow strong. Which just goes to show that commodities drive our markets.

At any given time the biggest financial stories are related to commodity prices. Exxon accounts for about 5.4 percent of the Standard & Poor's 500 Index's value, according to data compiled by Bloomberg. The world's largest oil company carries the most weight of any company since 1985, when International Business Machines Corp. was 6.37 percent, year-end figure.

But even though Exxon's profits are up, expectations are still lower and the stock is well off its highs of 2007 and 2008 - and year to date the stock is down around 4%.

Accordingly the S&P 500 fell 8.6 percent this month, eclipsing the 7.6 percent drop at the start of 1970 for the steepest January decline in the gauge's 81-year history.

The slide in the S&P 500 this month suggests the so-called January barometer will signal a loss for 2009. The indicator was developed by Yale Hirsch, chairman and founder of the Stock Traders' Almanac, and built on the theory that the S&P 500's first-month performance sets its course for the year.

Since 1950, the barometer has been at least 80 percent accurate. One of the exceptions occurred in 1978, when the index rebounded from a January drop of 6.2 percent to close 1.1 percent higher.

Let me share just one more thought about the commodities and futures world in Chicago as the dynamics continue to evolve. The future generations of traders are losing the connection to the risk-takers that walked the exchange floors before them. Let's remember at one time this was the largest concentration of millionaires per square foot of anywhere in the world.

The grand old lady that is the Chicago Board of Trade Building rarely gets to feel the spirit of trading from the past 100+ years gone by. Yelling, screaming and vigorous hand signals has since moved onto computer screens - setting up the move throughout the world and away from a center of financial activity at the end of the Chicago LaSalle street corridor.

Even though investing has advanced with technology the anticipation from Friday's unemployment numbers brought recollections from the days of old.

Back then before the unemployment number was announced the halls and elevators were filled with energy. It has been nearly 20 years since my first day at the exchange but I still get excited as the day approaches for the unemployment data - let's not forget that many use this number to gauge the nation's economic strength or weakness.

It is true that some stubborn souls still linger on the exchange floor but with the exception of futures options almost all transactions are now just mouse clicks. So nowadays financial athletes put on their best game faces and get ready to put their skills to work trader versus trader - all on the computer screen.

It just reminds me that the lessons learned on the trading floor were truly some of the finest forms of education that money can buy.

The job loss totals were staggering but as a forward-looking vehicle the market had discounted the bad news. There was a sense of relief that things weren't worse than expected and the revisions from previous months were reasonable. Stocks rallied nearly 3% across the board and sit at the upper end of the wide sideways range from the past ten weeks.

Almost as interesting is the downward reaction by bonds and rise in interest rates in this WEAK environment. A normal reaction to continuing unemployment escalation would be seen in a treasury rally...BUT... the market is so concerned by the amount of debt necessary to be sold for the stimulus that prices have dropped almost inexplicably.

How this affects commodities is all we care about but some telltale signs reinforce our previous theory that INFLATION, yes I said it again, is a concern.

Barring the renewed flight to safety interest rates have reversed on the longer end for treasuries. What this means is that Bond and Note yields have climbed nearly 1% - a big deal from recent lows of near 2%. And as you may already know, the cost of the stimulus is financed by selling, selling and more selling of paper to the Japanese and Chinese to help America recover.

This is proof positive that inflation can be the problem issue in the futures versus deflationary concerns. It isn't important what any analyst or economic expert thinks - it's more important what the markets are telling us.

Regards,

Alan Knuckman
for The Daily Reckoning Australia

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• Commodities In Your Portfolio
• Financial Services Industry Seems to Have Peaked Out
• Gold, Commodities and Markets
• The Fed’s Unattainable Government Goals
• Golden Shell Games