The first currency offers some of the most compelling long-term buying opportunities in the world right now with healthy balance sheets, wealthy benefactors, and a positive long-term growth story.

The second…well, let’s just say it’s a great shorting opportunity if nothing else.

In fact, the only thing these two currencies have in common is they’re both considered commodity plays.

Let’s start with the buying opportunity. To go there, let’s head to the land of Samba and Feijoada first. Yes we are in Brazil.

The Australian dollar has leapt 15% since the beginning of the year (indeed, that’s one reason why the Aussie is my favorite currency over the next six months). But while the Aussie has climbed 15%, the Brazilian real has shot up 22.5% year to date. It is running hotter than all currencies against the U.S. dollar.

You can attribute a lot of this to the world’s insatiable demand for Brazilian commodities – especially the ones China and India are gobbling up. China’s influence in Brazil has reached such an extent that you could be buying a Brazilian stock as a China play these days.

In fact, a Chinese company recently granted a $10 Billion loan to Petrobas (Brazil’s largest oil company) in exchange for first rights to the oil that Brazil will drill at its newfound reserves.

The Australian theme, (China buying up the world’s commodity reserves strategically) is alive and kicking in Brazil too. As I have said before, as China continues its strategic grab for world power, Brazil will remain relevant in the global economy.

The commodity dollars are the most vulnerable to a reversal of the recent rally in risk appetite as earnings season begins. Stocks ended June trading at the highest level relative to earnings since 2004, a year when the world economy grew 4.1% in real terms. With the OECD, IMF, World Bank, and all major central banks in agreement that the world economy will shrink this year, shares look highly overvalued. The Canadian, Australian and New Zealand Dollars are now on average 94.6% correlated to the MSCI World Stock Index, suggesting that any return of risk aversion will weigh very heavily on the commodity bloc. How are DailyFX analysts playing this environment? Read their top ideas for trading AUD, CAD, and NZD in the days ahead.

Don’t Jump Into This Commodity Just Yet

As many other commodities, wheat prices have peaked in June. A bit earlier actually: at 677 US cents a bushel on June 1st, while stock indices and the CRB index posted a high on June11 or 12.

Over the long term, we can identify several technical patterns on the weekly chart. The current one is an uncertainty triangle built by the green ascending support line and by the red descending resistance line. Those two lines are the lower and upper limits of the trading range since last October. This trading range has been narrowing for the last 9 months. The price action found some support around 475 cents in last December (point A), but some new support higher, around 500 cents, a few months later (point B).

The recent resistance level has been around 675 cents (point C). It is set on a line that comes from August 2007. This line was actually the neckline of a “head-and-shoulders” pattern built by points D (head), E and F (right and left shoulders).

Once cleared, this neckline which was a support level has become a new resistance level. On a weekly basis, the current price action looks bearish. The Commodity Channel Index has just crossed its zero line, showing that there is no medium-term momentum. The 20-week Williams %R is also oriented downward: this oscillator had detected an overbought configuration in early June.

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On a daily chart, the Relative Strength Index confirmed this overbought configuration and the following bearish signal. The Money Flow Index indicates that the peak posted at 677 cents triggered some profit-taking as money has gone out of the Wheat futures during the whole month of June.

Because those indicators reach low values, a bottom on the price action may be possible. That’s why we expect a further correction of the price action towards the support line (the lower band of the triangle). The current target could be then the area around 530 cents. Then it would become an opportunity for a new bounce.

The commodities markets have been bouncing back for 3 months. After the huge plunge occurred last year due to massive deleveraging and soaring risk aversion. The CRB index lost 57% of its value when it sharply fell from an historical high of 474 points to a low of 200 points in 7 months (points A and B on the weekly chart).

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The last price of the price action is 245 points, which means that the CRB index has already rebounded by 22.5% since the low of last February (point B). On the current levels the index may find some resistance. There is indeed a technical line that could prevent the price to go higher immediately. This long-term resistance line joins the lower highs posted in 1988, 1996 and 2003. The break of this resistance 6 years ago triggered a strong bullish signal and generated a massive move upward. It was the beginning of the commodities boom.

The index fell below this line in late November last year. Now the rebound has driven the index back to this previous resistance line. Despite it has been cleared in the past, it may become a new opportunity for traders to sell commodities.

Click to enlarge

On the daily chart, the Chande Momentum Oscillator (CMO) argues for a potential continuation of the current uptrend. The CMO can also be used to measure the degree to which a security is trending. The higher the CMO, the stronger the trend.

TH CMO has also not entered its overbought area (this is confirmed by the RSI) and no bearish divergence appears in the chart pattern.

The 30-day moving average has just reached the 100-day moving average. A crossover would confirm that a further momentum is possible and would drive the price above the resistance line. In this scenario the next targets could be the levels of 265 and 305 points, which are the 2 first retracement ratios of the decline occurred between points A and B.

Asian equity markets ended mixed Monday, with South Korean stocks shaking off initial concerns in the wake of a nuclear test by North Korea to end only slightly lower after a choppy session.

Tokyo stocks rebounded after dropping in the previous two sessions with steelmakers pacing gains, while Australian shares declined as authorities lifted a ban on short-selling.

Trading volumes were weak in several regional markets on caution before a holiday in the U.S. and the U.K.

In Seoul, the benchmark Kospi made a tentative start but sank as much as 6.3% by midmorning after North Korea conducted an underground nuclear test early Monday. But the market recovered sharply to end just 0.2% lower at 1400.90.

“Historically, we have experienced that the market volatility because of political issues is only short-term,” said Dongwook Han, strategist at Hyundai Securities.

Referring to the recent market gains, Han added that improving South Korean and global economic fundamentals and the likelihood that liquidity in markets around the world will be sustained in the second half of the year could push market further up in coming weeks. He expects the Kospi to hit 1700 points later this year.

A number of key stocks dropped sharply in Seoul during the session, but recovered the lost ground in afternoon trading. KB Financial Group ended 0.9% lower and Hyundai Motor gained 2.3%, while Hyundai Securities gave up 4.4%.

Japan’s Nikkei 225 Average ended up 1.3% at 9347 and Hong Kong’s Hang Seng Index closed up 0.4% at 17121.82.

Australia’s S&P/ASX 200 fell 0.6%, Taiwan’s Taiex ended little changed, China’s Shanghai Composite rose 0.5% and New Zealand’s NZX 50 dropped 0.7%. India’s Sensex ended 0.2% higher while Singapore’s Straits Times advanced 1%.

In Mumbai, the highlights of the session included a near 21% surge in the shares of Ranbaxy Laboratories following a management change over the weekend. Bharti Airtel dropped more than 5% on news it planned to buy a 49% stake in South Africa’s MTN Group.

The currency markets saw volatile trading in the wake of North Korea’s nuclear test, but also recovered. The U.S. dollar jumped as high as 1,269 won, but pared gains and was recently at 1,248 won, compared with 1,247.4 won Friday.

Referring to the won’s sharp movements, Standard Chartered strategist Thomas Harr said investors were used to the posturing of North Korea. “This may be an opportunity for offshore investors to sell the dollar/won later.

In other currency trading, the euro fell against the U.S. dollar as risk aversion picked up, at $1.3984 from $1.4015 in New York on Friday. Against the yen, the euro was buying 133.03 yen, after rising to 133.43 yen. The dollar was changing hands at 95.08 yen, from 94.85 yen on Friday.

Among financial stocks in Australia, Australia & New Zealand Banking Group dropped 1.4%, Commonwealth Bank fell 2% and Suncorp-Metway gave up 2.9%.

The Australian Securities and Investments Commission said it had lifted its ban on covered short-selling of financial stocks, though it added it could quickly re-impose the ban if needed. The ban was put in place on Sept. 21, 2008, in the wake of the collapse of U.S. investment bank Lehman Brothers.

“There has been some impact when you consider that the financial sector is the weakest across our market,” said Shaw Stockbroking’s head of trading Jamie Spiteri. “But] there wasn’t a huge increase in traded volume today. I think there has been some impact, but the decision to lift the ban isn’t surprising.”

Commodity plays gained in Japan and Australia on higher metals prices, with Nippon Steel up 2.7%, JFE Holdings rising 3.7% and BHP Billiton up 1.2%. Shionogi jumped 5.7% in Tokyo on news it would market a new influenza drug in Japan next year.

In Hong Kong, China Insurance International Holdings gained 8.5% on a plan to buy a 47.8% stake in Ming An Insurance.

Shanghai-listed shares were volatile amid concerns about a glut in share supply after Beijing indicated it would remove an unofficial eight-month ban on initial public offerings as early as next month.

“Worried investors think new share offerings will divert cash from the secondary market,” said Chen Jinren at Huatai Securities.

Singapore Petroleum surged 20.2% in afternoon trading on news of PetroChina’s offer to buy Keppel Corp.’s 45.5% stake in the company and make a general offer for the rest of the oil refiner, if Keppel’s stake sale proved successful. Keppel was up 6% on the prospect of a windfall from the sale of its stake, and PetroChina finished down 0.8% in Hong Kong and ended up 1.9% in Shanghai.

Spot gold was down $4.10 from New York Friday, at $952.40 a troy ounce. Front-month Nymex crude oil futures were 64 cents lower on Globex at $61.03 a barrel, after rising 8.2% last week, including a 1% gain on Friday.

“You’ve definitely got to be asking some questions about how much further prices can rise before we’re going to see some real evidence of demand recovery,” said Toby Hassall, a trader at Commodity Warrants Australia, who tipped crude in a $60 to $65 range for now.

Will natural gas make a comeback?

The odds are pretty good that bargain hunters buying natural gas at today’s bombed-out levels could probably double their money in under a year.

All thanks to the fact that we could soon be facing rising industrial demand and the possibility of supply outages caused by the looming Hurricane season. Not to mention that demand typically rises during the summer as individuals turn up the air conditioning.

There’s no doubt about it; the best risk-adjusted speculation now for commodities investors is natural gas. There’s no other commodity that’s this cheap, this battered and this oversold (see chart below.)

From its high in July of last year, spot natural gas prices have now collapsed a cumulative 74%. In 2009 prices have declined 37%. Crude oil – on the other hand – has been driven higher by big supply cuts by OPEC and Russia earlier this year, seeing prices rise 19% to $53 a barrel.

Over the last several months, natural gas has been hammered as the global economy suffers its worst recession since 1981-82 coupled with soaring gas inventories. Though an extremely volatile commodity, natural gas at these levels has historically been a strong speculation following big bear market crashes.

Canada is home to some of the best natural gas companies, including Encana (NYSE-ECA). The stock is more than 50% below its all-time high and pays a 3.6% annual dividend at current prices.

It’s time to ride natural gas.

At just $3.55 BTUs (British Therman Units) it’s hard to believe prices can head much lower. All the bad news is already baked into gas prices. It’s my favorite energy play right now in Commodity Trend Alert (CTA) – celebrating its 7th year this summer.

Every investor has been tracking Gold price for several weeks now. The Bullion is the only asset that appears to be a safe haven in those trouble times, but what about the two other main precious metals, Platinum and Silver? Prices for those two metals have jumped back since the lows posted in last October, but at a much slower pace than Gold. This is something that smart investors know: Gold is always the driver. It means that mechanically Platinum and Silver prices should replicate the recent surge on Gold prices.

Between March and October 2008, Silver prices (blue line) declined by 55% but bounced back by 47%. The bearish configuration seems to be over and the medium-term price action may be a continuation of the rebound. Right now the overbought market triggers technical sell orders that pushed prices lower. From a high of $14.60 on February 20, the current price is now at $12.71and should correct further down towards $11.50. It’s a previous high posted twice (points A and B on the chart) that is likely to become a new low because considered as a new entry point for investors.

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The rebound has been even slower for platinum prices (black bars) as they fail to breakout above the first Fibonacci retracement level of the broad decline occurred between June and October 2008 (points C and D). Despite the momentum is positive (MACD, moving averages crossovers, Momentum technical indicator…), the market was overbought (ellipses on the RSI) and the presence of the first Fibonacci resistance has impeached a further momentum. The recent momentum is supported by the 25-day moving average.

The next few days may be a continuation of the downward correction for both precious metals. However the medium-term remains positive. The replication of the Gold price action with a time interval is more than probable. The key factor for this scenario?

If Gold breaches above $1,000! In this case Silver should jump the previous low price of $17.00 and Platinum towards $1,500, which is the 50% Fibonacci level.

The Reuters/Jefferies CRB Commodity Index is a commodity price index created in 1957 and currently made up of 19 commodities (petroleum products, base metals, agricultural products…). It has a critical role as a transparent and widely available benchmark for the performance of commodities as an asset class.

In our last update of August 13, the bearish technical indicators were arguing for a further move on the downside. At this time the CRB index was trading at 385, and the expected target for the correction pullback was 363, which was a key Fibonacci ratio. The price action eventually fell below this level as it posted a closing low price at 341 on September 16.

A strong rebound has already driven the Index back to 366, the closing price yesterday. Investors consider that the correction that occurs on the global commodities markets has been too strong in a relatively short-time frame. Despite the lower demand worldwide generated by a slowing economic growth, the financial credit crisis and the action plan decided by US authorities is likely to make the US Dollar plunge. That’s why, as a mechanical hedge against the decline of the Greenback, the commodities have bounced back sharply.

Three days ago (September 22), surging prices for oil, silver, soybeans and gold sent the CRB Index to its biggest gain in more than five decades.

All 19 commodities in the index gained. However the very next sessions should be choppy as the price action has just reached a first resistance line. This resistance is built by the lower high points (points C, D and now E) posted since the beginning of the retracement initiated in early July (point A).

Click to Enlarge

Between A and B, the CRB fell by 28%. Despite the recent bounce back, the price action has failed to cross above the medium-term resistance line at 374, which also corresponds to the 23.6% Fibonacci ratio of the 2 months-and-a-half-decline, and to the 30-day moving average. There are consequently 3 good reasons for traders to sell back the CRB.

However the technical indicators have turned bullish therefore a further upside move is probable. The RSI showed that the CRB was clearly oversold, so did the Commodity Channel index that is now well oriented on the upside. The MACD has triggered a bullish signal last Friday.

If the current price development succeeds to clear the resistance level and to jump above 375, the next targets would probably be the next Fibonacci ratios, therefore 390 (38.2%) and 405 (50%).

Investors tend to forget that commodities are an extremely volatile asset class.

Price swings have always been violent and the recent surge lasting through July drew a huge amount of fast money from hedge funds and other institutions - which are all liquidating as I write this. Bank failures and bailouts have also pressured prices as liquidity-starved institutions make a run for hard cash.

But you must remember that commodities plunged in value in the mid-1970s en route to incredible all-time highs by January 1980. That’s happening again in 2008.

The CRB Index surged to an all-time high of 226.80 in September 1974 - at the height of the inflation squeeze, banking crisis and Arab oil embargo - and then commodities crashed to a new low of 175.90 by February 1975, a 22% plunge.

Gold prices, which Nixon set free in August 1971, soared to a high of US$184 an ounce in December 1974 based on the London monthly close. Prices then crashed all the way down to US$109 an ounce by August 1976. That’s a dizzying 41% drop.

Commodities can suffer a major bull market reversal, and that can make new investors nervous. Honestly, it wouldn’t be a surprise if commodities posted a negative year in 2008 after seven spectacular years of consecutive profits.

It is actually a positive development to see speculative money exiting the asset class because it takes policymakers’ attention away from high prices. Case in point: Earlier this summer Congress held special hearings to voice their concern over oil price manipulation. Now that prices are falling, Congress will once again turn a blind eye to the next run-up in the prices.

If you believe, like I do, that inflation is still very much embedded in the financial system then you must also adhere to hard assets, including gold. There’s absolutely no doubt in my mind that we’ll see much higher inflation as a result of this extravagant spending.

In my Commodity Trend Alert (CTA) service, we’ve recently raised our hedges against commodities. I anticipate tough markets for most of the sector until clearer signs emerge that the Fed has arrested deflation.

Still, I’m buying distressed oil companies and oil equipment stocks - and I’m buying oil right along side some of the best positioned global insiders. The energy sector remains the only segment of the marketplace heavily accompanied by net insider buying since prices began dropping in July.

Gold, which FDR confiscated in 1933, would probably rally in a deflationary economy. We got a taste of the huge gold rally to come when gold jumped over a US$100 last week after the AIG rescue.

Also, gold stocks haven’t been this cheap and bombed-out since 2005. In fact, the mining stocks trade at a seven-year low versus physical gold! You should be aggressively buying up this sector now.

Since July, commodity bulls have been trampled during the worst credit crisis in history. The entire complex has gone from being extremely overbought in June to heavily oversold in late September.

In just 30 days, the markets have violently transitioned from concerns about inflation to a sudden panic over deflation. The credit crunch has stopped inter-bank lending and corporate borrowing, leading us to the worst panic in American capitalism since the 1930s.

It’s also resulted in the most indiscriminate commodity sell-off since the bull market began in late 2001. And 2008 might be the first year since 2001 that commodity benchmarks finish in negative territory.

And until the deflation (i.e. the environment of rapidly declining prices) ceases, commodities will remain vulnerable. Never in the history of capitalism have commodity prices rallied during a severe contraction in bank credit.

When commodity prices are tanking, no one wants to know about mines, grades or new discoveries. Attention is on sliding share prices, falling prices for the commodity themselves, so rarely do investors concentrate on the underlying growth or ideas behind a company’s decision to do something. The only time heads pop up and look around when there’s some corporate activity: the chance to exit an investment because someone else has popped along with what seems to be a great offer in a falling market. That’s the greater herd theory at work: value can only be found in what the mob sees as a good idea or investment. And when times are tough and investors are scarce, interesting and intriguing news from the mining sector can slip past, almost unnoticed. In the past week or so we saw a couple of examples of this with Kagara Ltd revealing a very rich nickel strike in Western Australia, to go with mining plans for a big deposit it has outlined elsewhere in WA and Western Areas also revealing an upgrade to its Spotted Quoll prospect, which is in the same area (along the same strike zone actually) near Forrestania in Western Australia. Kagara last Wednesday had its shares suspended pending an announcement about the quality of the strike at its romantically named Lounge Lizard prospect in WA. That was done and the shares remained off the boards until Friday when it revealed that the strike was a very attractive grade of nickel (two years ago the shares would have gone mad). Kagara, which is a zinc and copper producer said it had found an intersection of “massive and semi-massive” nickel sulphides at the Lounge Lizard deposit in West Australia. “Kagara Ltd is pleased to announce a record intersection of massive and semi massive nickel sulphides in hole LFPD18W2W1 at the Lounge Lizard deposit in West Australia. The intersection is comprised of three zones of massive sulphide with an aggregate drilled width of 33.46 metres within a 76.50 metre section. “The intersection lies approximately 150 metres up dip of the previously announced indicated resource of 5.7 million tonnes at 1.08 % nickel which includes an indicated high grade resource of 263,000 tonnes at 6.42% nickel “To Kagara’s knowledge this intersection is the best in terms of contained nickel drilled, either historically or in recent times, in the Forrestania region and will result in a significant increase in the Lounge Lizard resource,” it said. But Kagara shares have been weak and are down sharply in the past week. They finished at $2.50 yesterday, down from $3.15 a week ago on Tuesday. They hit a 52 week low of $2.39 this week, breaching the previous low of $2.63. That’s a fall of around 19% in a week. The sharp fall in commodity prices has been the driver as no one wants to know anything about new metal discoveries. Copper, nickel, lead and zinc remain under pressure, and so does the Kagara share price The Kagara strike is north in the same area of Western Area’s Spotted Quoll nickel discoveries, which that company reported on earlier this month. It too has a very significant nickel discovery, but the market doesn’t want to know. Shareholders will be hoping for more at the AGM in Perth later today (Friday) The shares closed at $8.60, down 98 in the past two days. Investors are treating it like all other mining companies. No talk of a ‘boom’ here these days. Here’s part of what Western Areas said last week. “The Board of Western Areas is pleased to announce a 118% increase in the high grade mineral resource at Spotted Quoll.

“The revised mineral resource estimate at Spotted Quoll now comprises a total 1,045,900 tonnes at an average grade of 7.2% nickel for 75,140 tonnes contained nickel to only 300 metre vertical depth.

“The majority of the mineral resource (88%) is in the high confidence Indicated Mineral Resource category.

“This excellent result confirms the potential for a major underground mine below the proposed open pit. Western Areas is already considering early development of an underground mine which could produce ore concurrently with the latter stages of the open pit.

“In this event, production could significantly exceed the target 8,000 tpa nickel from Spotted Quoll. A mining proposal for the Spotted Quoll open pit has been lodged and, assuming this is approved by the end of 2008, ore production is expected to commence in the Sept Q 2009.

“The revised mineral resource rates Spotted Quoll as one of the world’s highest grade and most continuous nickel deposits, less than 12 months since its discovery in October 2007.

“Importantly, Spotted Quoll remains open at depth and open along strike. Further mineral resource upgrades are likely as drilling continues between 300m and 600m vertical depth.”

A map on page two of this announcement on Friday from Kagara shows the proximity of the two companies’ big strikes.

This was the second bit of good news from Kagara in recent weeks.

On August 22 it revealed more details about the deposit it was working on at Admiralty Bay with discussion about a possible mine. The shares rose after that, but that was very much different to the reaction to Friday’s announcement.

“Kagara is pleased to announce an initial resource estimate for the Admiral Bay deposit containing an Inferred resource of 72 million tonnes at a grade of 3.1% zinc, 2.9% lead, 18 grams per tonne silver and 11% barium reported at a nominal 2% zinc equivalent cutoff.

“This is a subset of a larger Inferred resource containing 97 million tonnes at a grade of 2.4% zinc (2.3 million tonnes of zinc), 2.9% lead (2.8 million tonnes of lead), 16 grams per tonne silver (48 million ounces of silver) and 16% barium also reported at a nominal 2% zinc equivalent cutoff.

“The model has been restricted to a 2.1 kilometre section of an 18 kilometre strike length of known mineralisation and the resource remains open to the east and west along strike.

“$35 million has been spent over the past 18 months at Admiral Bay and confirmed Admiral Bay as a deposit of world significance.

The company said the resource remains open to the west where the closest drill hole is located 2 kilometres along strike and which encountered a 13 metre intersection grading 4.3% zinc, 3.1% lead, 29 g/t silver and 9% barium and also encountered 25 metres grading 4.5% zinc, 0.8% lead, 23 g/t silver and 3% barium. Intersections of up to 20 metres at 8.3% zinc, 4.9% lead, 36 g/t silver and 21 barium from within the resource, have demonstrated the potential for higher grade zones within the overall resource.

“Scoping studies using the resource grades and contemplating a 10 million tonne per year underground operation have shown that the operation has the potential to produce 300,000 tonnes of zinc, 250,000 tonnes of lead and 4.5 million ounces of silver annually.

“Metallurgical test work has shown that coarse grained very high quality lead and zinc concentrates will be produced at recoveries in excess of 95% into very high quality concentrates.

“The cost of production is expected to be in the lowest quartile of cash costs worldwide.

“Metallurgical test work is continuing on the recoverability of barite to a saleable product and it is expected that a proportion of the 2 million tonnes of barite processed annually will be recovered which will further reduce the cash cost of production.

“A number of development options are currently being considered for taking the project forward.

“Drilling over the past 12 months has shown that defining a reserve from surface drilling is currently cost prohibitive and an exploration shaft with 2.5 kilometres of lateral development will be required to bring the project to a bankable status. At present, a diamond drilling program to obtain geotechnical information in preparation for the sinking of a shaft is nearing completion.”

So Admiralty Bay has a lot of potential, but there are higher costs than first thought in getting to them and getting them out.

But as attractive as they are, the market has gone right off resources and mining stocks in particular. It’s an old story for miners about the fickleness of the herd.

As I said yesterday, the commodity bull market isn’t over…not by a long shot. Even with the higher dollar and the temporary correction in oil prices, it’s still a mistake to think we’re on the cusp of a commodity bear market. 

This simply isn’t the same oil bull market we saw in the 1970s. For starters, the energy sector is not as reliant on U.S. domestic consumption compared to 10 or 20 years ago.

Compared to the last oil shock in the 1970s, China was barely a factor in global consumption. Today China is the primary reason why most commodities are in a secular bull market. That’s also the case regarding oil. It’s a primary demand-driven trend that won’t end anytime soon.

The Chinese are becoming big global consumers. Total domestic retail sales in China grew a formidable 23% year-over-year through July compared to just 0.1% in the United States. The Chinese are avid consumers and of course, major exporters. The economy will continue to grow and that means the consumption of raw materials, including oil.

Compared to the 1970s when China was barely a dot on the consumption map, today they   devour excess supplies of most commodities - especially on corrections or when prices dip lower. The Chinese hoard commodities during big corrections.

Barely Any Demand Destruction in China

What some investors fail to understand is the primary source of new oil demand comes from the emerging markets, not the United States or Europe.

According to Merrill Lynch, oil demand growth in the emerging markets has never contracted year-over-year in the modern era. Although demand destruction has started in the emerging markets, the overall trend for consumption remains long-term bullish.

Total oil supplies remain in deficit to the tune of roughly 2 million barrels per day or 87 million barrels of demand compared to 85 million barrels of supply. That discrepancy in supply and demand has been consistent for over a year and remains threatened by supply bottlenecks in many oil-producing markets and threats of regional conflicts.

Oil Stocks are Cheap

A stable dollar is a plus for world growth because a lower dollar will help moderate inflation for many emerging market currencies. This should stimulate economic growth and demand for oil and other distillate fuels at a time when the global economy is slowing.       

Provided that U.S. interest rates remain low for the foreseeable future, and they will, global economic growth will continue. Oil prices will find a floor. That makes energy stocks a great buy at these distressed levels.

I’ve been busy buying oil and energy services companies over the last few weeks following big price declines. Most oil stocks are not priced for US$75 oil let alone oil prices north of US$100 per barrel. And compared to banks, energy stocks have real assets and real earnings!

Cash-flows for the majors in the United States, Canada, and Europe are bulging and dividend payments are still increasing. These stocks now trade at 52-week lows and should form a bottom over the next several few weeks or sooner as oil prices finally trough.

Thank God for the Chinese!

To recap, the global macroeconomic picture is nothing like it was in the 1970s. This is perhaps the most significant bullish point I can make about this big correction for raw materials. We don’t have skyrocketing interest rates and double-digit inflation.

China is now a major player with regards to commodity consumption. It was almost insignificant 30 years ago. Thank goodness for the Chinese. If they didn’t exist the bear market in U.S. stocks and bonds would be far more severe, the dollar would be near-worthless and commodities would be trading in the basement.

Provided that global interest rates remain historically low and the United States and Europe can eventually stabilize the ongoing credit crisis then global economic growth should reaccelerate later in 2009.

A stable dollar will also mitigate inflationary pressure globally and that’s a positive development for new consumption. Also, slowing growth and lower commodities prices now will eventually open the door to central bank rate cuts in 2009 - a boon for commodities.  

The time to buy or accumulate new positions in the energy sector is now. The oil majors and the oil drillers have been smashed hard over the last six weeks and offer great value in an otherwise sluggish earnings landscape. Earnings for the oil majors and the drillers will continue to flourish even at US$75 oil, which I don’t expect unless the Chinese economy collapses. And that won’t happen anytime soon.    

Blame It On Oil and Germany

What’s causing the latest drop in gold prices? You can blame it on the resurgent U.S. dollar, falling crude oil prices, and the latest batch of economic data in Germany. The latest data coming out of the biggest Eurozone economy points to a contraction of second quarter gross domestic product (GDP). This data was critical because it compelled foreign exchange traders around the globe to shift their focus and dump the euro last week.

A big drop in crude oil prices is another major factor lending support to rising stock values since mid-July. As inflationary pressures continue to ease, the market has begun to discount the possibility of a quick economic recovery in the United States later this year.

Lower commodity prices act like a tax cut for consumers. These lower prices reduce the coast of living and allow consumers to spend more disposable income to non-energy and food items.    

The dollar, of course, had been heavily oversold for months. Since peaking just north of 1.60 euro, the greenback has rallied an impressive 6.5% since early July.

In Europe, economic growth is now slowing sharply following the release of second quarter German GDP, which showed a contraction. Along with other stumbling economies in the Eurozone, the European Central Bank (ECB) is unlikely to keep raising interest rates this year - especially if oil prices continue to decline.

That makes U.S. dollar assets more attractive for prospective investors because Europe is behind the United States in the economic and credit cycle.

The Reuters-CRB Index is the benchmark for commodity performance, reader. Just to refresh you a bit on its price action during the last few years, let’s have a look at a long-term weekly chart.

Click for a larger version

A double-bottom (points A and B) occurred in 2001. As you can see, that was ground zero for the commodities boom.

The first bullish trend started in early 2002 and wound up in August 2006. During this period the CRB Index rose 92%.

One year of consolidation followed. Then the second bullish trend meant 58% gains for investors…until July this year. Then commodities took their second correction, breaking the long-term support line.

That’s the big picture. Now let’s switch to a short-term daily chart.

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The second bullish trend mentioned above developed between point A and point B. During this period, the 75-day moving average was the stalwart of support. The break below this line on July 18 triggered bearish signals for many traders and fund managers. It was a key point around 435, as it was also the 23.6% Fibonacci retracement level.

The further move downward found a bit of support on the 38.2% Fibonacci ratio, at 408, as the price action rebounded a bit (point C). Yesterday the price closed below the 50% Fibonacci level. We see another drop in the next few days.

The different oscillators and momentum indicators all show bearish configurations that should drive the CRB index lower. The RSI and MACD for example, despite currently reaching low levels, are still bearish.

The fast pace of commodity gains last year wasn’t sustainable. This is the commodity correction we had to have. It’s not the least bit surprising.

But here’s the part you’re probably interested in. Where does it end?

The next target now is clearly now around 363. There’s more than one reason for this.

Firstly it’s the last Fibonacci ratio (61.8% retracement level). Secondly, and foremost, it’s the level of a significant high. It was, indeed, the high of the first bullish trend ended 2 years ago (point D on the chart). Expect it to be the new low in the commodity boom.

This is a further 6% move on the downside from there. At 363 the CRB would be oversold. A technical rebound would be probable. That may be the point to buy back into resources. However, a break below 363 would give some further bearish momentum on the medium-term.

The Commodity and Currency Circle

If the global economy is slowing, and China is forced to work through excess inventory, demand for commodities will be impacted. I’m guessing crude oil prices, in particular, will suffer from the realities I just described.

And remember, commodity prices and currencies influence each other in a self-feeding circle.

For example, falling crude prices could be the one thing that allows U.K. and European central banks to begin lowering their interest rates.

If and when that happens, the dollar will become more attractive relative to those currencies.

It wouldn’t take a bold move on the part of the U.S. Federal Reserve, either (nor do I expect one).

A narrowing interest rate disadvantage between the dollar and euro - or the dollar and the pound - would be hugely supportive for the greenback.

In fact, this may very well be why the dollar HAS ALREADY been holding up given such incredibly dismal news day after day from the U.S. economy.

Take a look at this chart …

Over the last year or so almost everyone’s been pointing to the inverse relationship between the U.S. dollar and crude oil.

At the very left of the red rectangle on my chart, you can see where the tight inverse correlation began to break down. That’s when the dollar bounced higher from its all-time low. Crude soared well beyond its record high at the same time.

Crude rallying and the dollar drifting slowly higher simultaneously? That was certainly no inverse correlation.

But from the furthest right point of that red box is where the tight inverse correlation has resumed. Only this time, the direction is in favor of the dollar. And it comes exactly after a new all-time high for crude prices.

Translation: The buck could be back.

The dollar has been able to continue its rally this week, even amidst a blitzkrieg of central bank announcements. While it has a long way to go - and recovery may not be swift - I think it’s time to keep the dollar rally scenarios in clear sight. Especially now that other economies are catching the bug.