This week, we delve into the world of natural resources and chart the Chinese company, Chalco. Mining giants BHP Billiton and Rio Tinto have dominated the headlines of late, with BHP aggressively pursuing a bid to acquire Rio.

Click chart to see it in full size.

BHP's bid would create a natural resources group worth more than $300 billion with leading positions in iron ore, copper, aluminium, coal and uranium. BHP first made its three-for-one proposal to Rio in November, having looked at buying its rival several times in the past decade. Marius Kloppers, BHP's chief executive, said the deal would create annual synergies of $3.7 billion within seven years, with large savings coming from the companies’ iron ore mines in Western Australia. But Rio CEO, Tom Albanese, has said that BHP’s 3-for-1 offer, which values Rio at US$147 billion, is “several ballparks away” from what his group would accept.

The saga took a dramatic turn in early February when Chinalco, one of China’s largest mining companies bought 12 percent of Rio's UK-listed shares together with Alcoa of the US.

Market chatter says Chinalco (the parent company of Chalco) and Alcoa could raise their stakes to as much as 20 percent, a move that may help China's top alumina producer defend against high prices for raw materials.

Chalco shares have rebounded 35 percent from their recent trough in January but were still 50 percent off their peak of HK$26.35 in October due to a global selloff and rapid growth in China's alumina and aluminum production.

BHP, Rio and Chalco are likely to remain in focus this week after Asian steelmakers agreed to a 65 percent hike in the price of iron ore after annual price-setting talks with Brazilian miner Vale. BHP and Rio have yet to agree on prices.

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Commodity Store with Sri Jegaraja

• Forging A Merger - Or Not

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The Chalco chart is a complex chart that captures a potential developing trend change. The initial trend break is a rally rather than the start of a new uptrend. Traders are driving the rally, but investors are not yet convinced that there is a genuine change in the future valuation for Chalco. This is suitable for aggressive traders.

We start with three bearish features of the chart.

1. Trend line A defines the long term downtrend starting in October. This trend line is important because it provides a reaction point. Previously prices have rallied to this level and then reacted away from it. This confirms the downtrend, but does not tell us about the strength of the downtrend. Generally a close above the downtrend line is considered as the first component of an entry signal, but this is not necessarily a trend change signal.
   
   
2. The Guppy Multiple Moving Average (GMMA) gives more information about the strength of the trend. The red lines are created by a series of long term moving averages. They provide guidance to the thinking of long term investors. The blue lines provide guidance with regards to the thinking of short term traders.
   
   The degree of consistent separation in the long term group suggests investors remain bearish on Chalco. Any successful trend breakout must move above the upper edge of the long term GMMA. Compression in the GMMA shows that investors are reaching a consensus on the changing future valuation of Chalco. This is required for any successful trend reversal.
   
   
3. The third bearish feature is the resistance level at 15.70. An initial breakout rally has a high probability of developing a pause or consolidation at this level. The developing bullish features suggest an increasing potential for a trend change.

Initially they signal a rally that is capped by the strength of the long term GMMA. These bullish features provide a guide to the technical signals necessary to confirm a trend change. They are:

• Trend line B defines the potential developing uptrend. While prices remain above the line, the immediate trend is bullish.
• The close above trend line A signals a rally challenge to the prevailing downtrend. Price must close above the upper edge of the long term GMMA before a trend change is confirmed.
• The move above the volatility count back line entry calculation confirms the rally strength, but does not confirm a trend break.  The trailing stop loss using the count back volatility calculation is set at 12.86. This is above the value of trend line B and confirms rally strength.
• Traders watch for a series of increasingly successful penetrations of the long term GMMA by the short term GMMA. Trend change is confirmed when the long term GMMA begins to further compress and then turns up. The GMMA compression relationships are the feature to watch as this trend breakout develops. Moving average crossovers do not provide leading signals of trend change probability.
  

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