Continuous Commodity Index signaling Deflationary Forces are in the Ascendancy

Those of us who have nothing better to do with our lives than to sit in front of computer screens watching prices change have been watching the battle being waged between the forces of Deflation and the forces of Inflation ever since the credit crisis erupted back in the summer of 2008.

On the one hand is the relentless and merciless pressure from excessive Debt and all the issues arising from that; on the other hand has been the Federal Reserve and its monetary stimulus programs, aka, Quantitative Easing or QE for short. When the Fed has entered the Fray, the forces of deflation have been routed and run off the field. When the Fed withdraws, the opponents regather and send out their war parties to hack and slice once again.

This battle can be seen through the chart detailing the price action of the commodity sector as a whole, namely the Continuous Commodity Index or CCI. As the Fed wins ground, the index rises; as the Deflation forces triumph, this index falls. Right now it is falling and falling in a big way as once again it is threatening to put in a major top on its longer term weekly chart.

Take a look at the two red support levels shown on the chart. The upper red line was the previous bottom made in the index earlier in the year which was broken early last month as traders began suspecting that the Fed was going to indeed end the QE2 program at the end of June. However, they began second guessing that notion with the result that prices were able to rebound and move back above this level and push towards 660. However, as economic data continued to deteriorate and fears of an overall global slowdown increased, the index has now dropped lower through the upper line and are pressing into the lower red line confirming that a double top in indeed in place for the overall commodity sector. The price action is indicative of a market in which a "SELL THE RALLY" mentality has replaced one of BUYING DIPS. In other words, traders are looking for lower commodity prices ahead as they anticipate deflation and not inflation. Only if prices are able to immediately move back above the upper red line will one be able to say authoritatively that inflationary forces are rising in the minds of investors.

If you will also note the particular technical indicator I have chosen to overlay on this price chart, the Directional Movement Indicator, you will see that the solid black line, or ADX, which began rising in July 2010, and accompanied the rise in the index all through February of this year (indicating a STRONG TREND HIGHER) turned down at that point indicating a pause in the ongoing higher trend. The blue line or Positive Directional movement indicator has been trending lower since December of last year while the Negative Directional Movement Indicator, or red line, has begun trending higher since February of this year. What this indicator is telling us is the trend toward higher commodity prices is over for the time being. The upside crossover of the Negative Directional Indicator ABOVE the Positive Directional Indicator, is BEARISH.While the index has not yet fallen through the lower of the two red support lines on the chart, it is signaling that weakness in the sector lies ahead.

The last line of defense will be the rising 50 week moving average what comes in near the 600 level. This level now takes on increasing significance as we move forward. You will note how it held back in April/May 2010 when talk began surfacing that the Fed was going to come up with some sort of additional stimulus to take the place of the then expiring QE1 program. Once that QE2 was announced, the index accelerated higher. Now that the end of QE2 is here and there yet appears to be no improvement in the overall economy nor any concrete steps for a QE3 or some further stimulus from the Fed, the index is breaking down once again. Should it move towards 600 and fail there, we will be entering a deflationary period.

Mr. Bernanke left the door open for further stimulus from the Fed should the economy not respond and economic data continue to reflect deterioration. One suspects that the market is going to force the hand of the Fed sooner rather than later. Again, this Fed has signaled clearly that it is deathly afraid of deflation and will do whatever is necessary to stave it off.

Additional proof of the deflationary mindset taking hold has been the relentless move higher in the bond market which is moving in a manner suggestive of global slowdown fears. While the Fed enjoys the lower long term interest rates (as does the US government which is keeping its exorbitant borrowing costs lower), they do not want a rally in the bond market of the nature that would see money exiting stocks and other assets.