Trader Talk

Trader Talk: Commodities remain the weak link in the stock market rally

A worker adjusts the valve of an oil pipe at West Qurna oilfield in Iraq's southern province of Basra.
Atef Hassan | Reuters

Commodities remain the weak link in the stock market rally.

On the surface, it looks an all-clear for stocks to hit new highs. Not quite.

Two issues that have been floating around for a couple weeks weakened stocks midday: China and oil. China is slowing its spending on growth initiatives. It is also tightening monetary conditions, and there is considerable talk of more regulatory scrutiny. Base metals on the Shanghai Metals Exchange were weaker overnight. Oil, after rising earlier in the year, has now dropped to a six-month low. This is good news for consumers, but not good news for oil companies.

Put these two together and you have a commodity rout:

Commodities since April 1
Iron Ore down 16.5 percent
Oil down 10.1 percent
Nickel: down 9.9 percent
Zinc down 6.7 percent
Copper down 5.3 percent

With a predictable impact on commodity stocks:

Commodity sectors since April 1
Global X Copper Miners ETF (COPX) down 12.1 percent
SPDR S&P il & Gas E&P ETF (XOP) down 11.1 percent
SPDR S&P Metals & Mining ETF (XME) down 7.6 percent

Not surprisingly, analysts have begun taking down earnings estimates for oil companies. As a result, we are starting to see oil stocks show up on the 52-week low list: Schlumberger, Occidental Petroleum, Apache, Murphy and Range Resources all joined the list today.

Despite these concerns, the overall market is just below historic highs and not just in the U.S. Europe is up about 1 percent on improving economic data, better earnings from companies like sneaker maker Adidas and oil giant Royal Dutch, and on hope French voters will elect a moderate for president when elections are held on Sunday. The German stock market closed today at a historic high.

Earnings in the U.S. have also been strong, and markets like that there has finally been some movement in Washington on tax reform.

What's all this mean? Despite the underlying weakness in the commodities market, there remains an underlying bid to the market. Traders are buying any dips, at least so far.

Oil will remain a problem, but it's not clear how long China will be an issue.

"I don't see it lasting," Brendan Ahern, Managing Director of the KraneShares CSI China Internet ETF (KWEB) said. "The policymakers want to get in front of any issues. They do not want to create a crisis ahead of the big turnover in the Chinese leadership in October."

He believes Chinese authorities will soon start putting liquidity back into the markets.