DBC ETF: A Way To Play The European Winter

Introduction

It’s true; commodities prices are on the decline. Oil (CL1:COM) recently slumped to a fresh 2022 low of $70.10/bbl. Gold (XAUUSD:CUR) has barely recovered from its recent return to its lowest point since April 2020. Wheat futures (W_1:COM) are badly bruised and trade now at $761/bushel. Even cotton has had its fair share of bearish pressure recently. But somehow, there’s a silver lining here.

The worst days for commodities in this cycle may be practically over as the US Federal Reserve takes its foot off the interest rate hike pedal. With this action, the price of the US dollar may weaken, causing the price of commodities to weaken against other currencies. If inflation, unemployment, Fed funds rate, US Dollar (DXY) and GDP growth all turn a rosier picture than expected (I hate to use the word recession as I think it has lost some meaning), commodities may be due for a notable uptick. But I don’t believe that time is now. Not yet…

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.

The DBC is Setting Up For An Upwards Blast

The Invesco DB Commodity Index (NYSEARCA:DBC) tracks the DBIQ Optimum Yield Diversified Commodity Index Excess Return. In simple terms, a pool of commodities. The index is curated to serve investors looking for a cost-effective and convenient way to gain exposure to commodities futures.

Read of Relative Money Flow

An upward movement on the relative chart of DBC/SPX500 means DBC is outperforming the S&P 500 (SPY). Conversely, a downward movement means the DBC is underperforming the S&P 500.

Although it can be considered to be showing bullish signs, I am not convinced of a bullish resumption before a retest of the immediate monthly support. The price is not reacting from a logical point currently, and there’s a lack of a trap (false breakout) for buyers, which is a necessary condition for my trading.

That said, my expectations for the DBC vs. SPX500 pair are for a bear trap to emerge in the coming months, followed by a sharp bullish reversal to the monthly resistance on the chart. As such, I am adopting a “hold” stance on DBC, whilst being bullish on the overall bias.

Read of Absolute Money Flow

On the absolute chart for DBC, the overall trend is bullish, but as with the relative chart of DBC vs. SPX500, there has yet to be a sighting of a trap like a false breakout to the downside to trigger the buys.

Price has started a pullback from close to the $30.94 monthly resistance. Although recently, prices have been basing at close to $24.19, I believe the buyers have temporarily run out of steam and that they would need to recoup downwards to find a reliable support launchpad to resume the bullish trend. The $21.72 monthly support is where I anticipate prices to go, implying a rapid 10-11% pullback to refuel for the next bullish wave.

DBC ETF Composition

Energy makes up more than 51% of DBC:

This makes DBC a very useful ETF to play energy-focused commodity themes. In 2022, this seems especially relevant since the Russia-Ukraine war has impacted natural gas supplies into Europe and the second most important season Europe has been preparing for (after FIFA of course) is now here; winter!

Looking at the Top 5 holdings composition…

The top 4 oil and gasoline futures’ exposures together make up a large 45.4% of DBC’s overall weight. And given that the overall energy sector exposure is 51.0%, this implies that 89% of overall energy exposure in DBC comes from the top 4 oil and gasoline futures. In other words, DBC is quite top-heavy and concentrated ETF.

Key Fundamental Drivers for the DBC ETF

Severity of European Winter

We know energy supply is largely constrained in Europe. The only key variable is demand. If demand is higher than expected, prices are going to go up.

So how much energy does Europe need this winter? That of course depends on how cold it gets. Hence, leading indicators focused on getting an answer to this question is what I am tracking. And yes, that includes reading typically boring weather reports.

As per the most recent data by Severe Weather Europe, an Arctic Blast of cool – nay; chilling – air is heading for Europe. To what extent will this matter? To what extent will this increase consumption of energy reserves? I am tracking how this would unfold as I watch DBC on the sidelines for now.

Weakening US Dollar DXY

The US Dollar Index has had a notable bullish performance in 2022, mostly on the back of an aggressive US Federal Reserve monetary tightening policy. But let’s not forget; although the Fed will decelerate the pace of rate hikes less than what was market expectations, it is still going to ease rate hikes as inflation is tamed.

That said, the DXY appears to have found some monthly support around the $103.447 level. However, I believe this is only temporary. Over the coming months, I expect to see a small distribution pattern form within the range of $103.447 – $107.000, followed by a bearish resumption to the next monthly support below at the round level of $100.

Historically, a weaker dollar usually fares well for commodities, giving the DBC a good chance at a bullish blast.

US 10Yr Yield

With inflation now cooling off, commodities are likely to emerge bullishly due to the dynamics they share. As I mentioned already, the US Fed is scaling back on its monetary tightening campaign, meaning it will deliver lower and lower rate hikes over the coming months until the peak rate of between 4.5 and 4.75% is achieved.

I believe the US 10Yr yield’s march up will see a pause now as monthly resistance at 4.3% is hit. According to my assessment, price may be range-bound for a while before eventually dropping down to the monthly support level of around 3.0%.

A fall in the US 10Yr yield will shift economic sentiment incrementally more towards ‘risk-on’ moods. This will make commodities relatively more attractive.

Summary

I was heavy in commodities at the start of 2022. Now as we get close to the end of the year, I am looking to rejoin the commodities bull run again after a period of time-correction. On DBC, I need to see confirmation of the buys in the form of a trap or a false bearish breakout at the nearest monthly support. Perhaps this will come along with the fundamental triggers discussed. Hence, I am currently adopting a “hold and watch” stance. Once I see premature buyers getting trapped on the wrong side, I intend to swiftly switch to the buys.