Prepare to trade commodities or Australian resources stocks…Part 1

Remember Warren Buffet’s approach, to “Buy while there is blood in the streets”? Using the same thinking, we know that commodities and resources stocks are currently down and at a point in future this will change. This means that you are in a really good position to trade commodities or Australian iron ore stocks, and to profit from the good growth opportunities that are likely to be there following the next major turn.

I recently recorded a podcast on iron ore and covered two major stocks in this space BHP and RIO, which will assist you if you are interested in trading commodities or Australian shares. If you would prefer to listen to the podcast click here, otherwise read the full version below.

If, like me, you regularly pay attention to current news and market reviews, then it would be impossible for you to have missed what has been happening with commodity prices, and particularly the iron ore, and oil prices, which are currently in a major slump. This is an area that affects us all, and most definitely has a major impact on our economy. The Australian government has indicated that the falling iron ore price will cost us around $9.0 billion dollars over the next couple of years.

If you are a trader or an investor, then you really want to keep a finger on the iron ore pulse and be ready for opportunities that will present in future, as following a major decline, or where we have distribution, will be a time of accumulation. This is where the smart traders and investors look to buy, when most are still fearful of a further fall and there is still a lot of negativity in the press.

How can cycles assist us to trade commodities and stocks?

In this podcast, I will give you a recap on what has occurred over the past few years, what may lie ahead, and I also discuss the big miners.

Firstly, this may be the lucky country, the land of sweeping plains with sun drenched beaches and rugged mountain ranges. The land of opportunity, where anyone with the desire can learn to get ahead financially. However, it is no secret that Australia’s financial prosperity and therefore your livelihood, is linked to major commodities, and this will continue to be the case for many decades to come.

What this means to both traders and investors is that our market, or at least certain areas of it, will continue to follow a boom/ bust cycle, and you ought to know how this works. Some suggest that a commodities bust, or slump, can last for around five to seven years. This is great for those who know how to go both long and short in the market. This means being able to profit from a rise or a fall. You can trade commodities and stocks to profit from both.

Now, we know that economic cycles, and cycles in share prices will vary in time, from one cycle to the next, however, the fact that cycles exit means it is possible for you to observe a pattern over history and count forward to determine where the cycle will end. Sounds simple, however, I can tell you from experience that the study of Cycles is a very specialised area. It can take a few years to fully understand how it works in practice, and so you need a simple strategy to help you to do this faster. The application of Cycles is a share market strategy that you can use to trade commodities, stocks, and even currencies.

Not only do cycles vary in length from one to the next, there are also smaller cycles within larger cycles, which you can discover for yourself as you start to learn the basics.

While a previous bust may have occurred over a particular time frame as mentioned, future cycles may be the same length or they may vary slightly, being shorter or longer than the prior cycle. So you need to know how the theory works and what considerations to make to be able to determine the approximate time for the next major high or low. This applies whether you are learning to trade commodities or shares.

Let’s assume that, if the start of the commodities contraction began at around the time that the GFC hit, then based on the theory, and what has unfolded in the past, we might be thinking that the end of the current commodities cycle would be long overdue. However, if we look specifically at the iron ore price, which peaked in 2011, then around 2016 would be the likely target for the next low. This is a simple way to explain how this can be applied, however, this is not a precise measure as the cycle could finish a percentage of its entire length, prior to or following the projected time. This zone for the low we call a cycle orb, it’s like having your very own factor of safety, or fudge factor for where the low may come in.

The major study of cycles is really about measuring from a low to the next low, and so on. We are not just measuring a decline but also the prior rise, or the whole cycle.

When I discussed this theory of the cycle orb recently with a student who is studying our Contracts for Difference (CFD) course, I think she was quite relieved that there was this allowance for when the low would come in, as this meant she could determine a time band for a low. By the way, we go into a lot of depth about cycles in this course, how they work, and how to use them in trading the market.

For now, let’s get back to our discussion on commodities.

When commodities fall, it’s not all bad news. Often other areas of the market hold up well, and over the past couple of years we have seen the Property, Healthcare, Telecommunications and Financials sectors do this, to name a few. Therefore, the impact of the resources sector slump has not been as dramatic as what has occurred when the whole market is in decline. So, some of these other sectors have assisted in reducing the volatility on the market, coming from falling energy and resources stocks.

You may recall Dale saying how most of the time some stocks rise, while some fall, and others move sideways? Well, this thinking can be applied to the sectors in our market, not just stocks. Remember that once you learn how to read the charts you don’t have to take my word for what is occurring with prices, as you will be able to read the charts yourself. Besides, I’m a really big believer in showing you the how-to, and for me ‘seeing is believing’ when it comes to learning to trade shares.

One further point I would like to make about sectors is that by watching them unfold, as more data appears on the chart you get a bird’s eye view of what is happening to any area of the market that you decide to invest in. So, effectively, you see more of the puzzle, rather than just a small section of it. Further, when you learn how to analyse a stock or a sector, you can also apply your analysis to the overall market. It works on anything that has a price history.

We’ve all seen the boom time, and the financial bust that followed with the GFC, however only a few of us will remember the last commodities slump. Given what has unfolded with the recent commodities slump, and the impact on the iron ore price, all of us will remember this correction. More importantly, with the right knowledge you can use it to profit when conditions change, as after a major price slump are great opportunities to profit.

So, if you have been busily studying the market, or maybe you are creating the space in your life to learn how to invest in shares, you may just be doing so at the right time. If you haven’t even thought about learning to trade, make one of your new year’s resolutions for 2015 to learn to trade the share market.

What is in store for the iron ore price?

The all-time high for iron ore was around $187 per tonne in around February 2011. Note that the price went on an incredibly bumpy ride, and fell through to around September 2012, by which time it had almost halved in price, and was trading at around $99 before a rebound occurred. The price turned back up from here until February 2013 to around $154 per tonne. However, sellers continued to take control and so iron ore spiraled downwards.

As the price began to fall away it was possible to apply some price analysis to determine support levels below, where the price may turn. This is like creating a forecast, or looking at what price levels have a high probability of slowing or stopping the fall, which is something really important to know whether you are a short term trader or an investor, as not only do you see the opportunities, you better understand your risk.

For those of you who are good at visualising, when a stock or market corrects, it usually falls in what we call an ABC pattern formation. From the high, when the market is in decline, it forms what can best be described as a zigzag pointing down to the right from the high. During most declines, there will be a period of time after the initial fall from the high when prices correct, and a sharp rise follows. A lot of people buy back in at around this time, thinking that the fall is over, however, typically another decline will follow.

The historical price chart of iron ore shows how this occurs. After rising back up to around $154 per tonne, it fell away to eventually trade at around $68 a tonne. Therefore, the fall from $154 to the lowest price to date, was more than half of the value of the $154 high, and around a 62 per cent decline from the $187 high.

Some of the big players, BHP, RIO and FMG have been significantly impacted by the falling iron ore price, particularly as it continued to fall. My previous analysis on the iron price has shown how it was possible for iron ore to find support at around $87 to $88, which it did temporarily, however the decline accelerated at a much quicker rate than I had expected later in the year.

Iron ore continued to fall to a lower level that I had marked on the chart at around $72/$73 per tonne. At the time, I considered this to be the worst case scenario, in that, if the price were to continue to fall, it was reasonable to view this level as the point it was likely to stop close to.

Although iron ore may find support at just below $68 per tonne before turning back up, it is very important that you always consider both the potential upside and downside when conducting your analysis. There is a strong level on the chart at around $67 per tonne, therefore we could soon see iron ore settle and find support at around this level in 2015.

That said, my current worst case scenario is set at around $47, which represents a further fall of around 30%. If the price were to close strongly back below $67 at the end of any week, it is possible for the price to continue towards this level. We all know that if this occurred there would be a lot more pain for our miners. However, given the decline to date one has to consider this. The positive here is that given the extent of the decline, and what the analysis shows, we can say that most of the current decline is likely to be behind us.

Something for you to bear in mind though, because there is often a lot of emotion behind the selling, prices will often dip through support levels before reversing strongly to recover. In other words, do not expect a price to turn exactly on a particular level.

Now let’s take a brief look at the big miners.

BHP Billiton (BHP)

For those who have had access to trading support or trading essentials, you will have had the opportunity to see more of our analysis on the big miners in our weekly reports. In brief, BHP has fallen through a very important support level at around $31, and a previous major low in 2012. So, what does all this mean?

It shows that the probability has shifted to a further potential fall for BHP. Support exists at around $28, where the share price may have stopped falling for now, and therefore this is why we may now be seeing a short term rebound unfolding. However, after the move up unfolds it will be a few weeks before we know whether or not the stock is going to continue to fall. Stopping a rise is a zone around the $31 level, which previously provided strong support, but is now likely to act as resistance against a sustained rise.

RIO Tinto (RIO)

RIO has unfolded quite differently to BHP, and is still trading above a major level of support from 2012. The main reason BHP continued lower over recent weeks was because it not only had to contend with a falling iron ore price, but the oil price has also been falling strongly. I will talk more about the oil price in the next podcast in this series.

Currently, RIO is at a potential level of support and therefore we need to give it time to test this level. It must rise strongly and hold above $60 over the coming months to prevent a further fall, however, it could still continue to fall in 2015 towards the 2012 low at around $48.50. This could occur in around April through to July 2015. If this lower level is broken, the next level below is at around $41. So, keep an eye on these levels on your chart.

My current analysis indicates that three possible months for a turn in price for the big iron ore miners, however, this doesn’t mean that these periods will necessarily create a peak in price, they may signal a bottom. The month of December 2014 is one of those dates, and therefore we may see a short term recovery. We also have important dates in May 2015, and around December 2015, therefore have these periods marked on your charts.

If you are studying the Advanced Diploma of share trading and investment, you will learn in Module 10 a share market strategy for time that will allow you to determine possible dates for when major turns are likely to occur, which is invaluable knowledge to have. Remember that Gann said that you need Price, Pattern, and Time to analyse a stock, market, or commodity.

Although conditions can change quickly in the share market, major support levels have not yet been confirmed for iron ore shares, and therefore it is important to wait for some solid buying to occur, followed by strong entry rules being triggered before looking to buy into this area.