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As commodities reach record highs it seems corrections can’t be too far round the corner. Helen Castell reveals how to chart and make the most of any short-term come down

What takes months to build can take minutes to kick down – and this is nowhere truer than in the mercurial world of commodities. So with oil, precious metals and a number of the softs all bouncing around new record highs, are commodities set for a come down?

Not in the long term, most brokers agree. Rising demand is real and the economic worries that are helping to push prices still higher look set to stay with us for a while. However, as oil and gold end recent rallies by flitting around psychologically important ‘round figures’, some interpret this stalling as the first sign of a short-term slump.

Corrections in commodities tend to be sharp and fast, but that doesn’t mean they should scare you – and there is money to be made. Whether you want to wait for a correction to bring prices down before you buy, or you feel confident of shorting your way down the slope, guessing when a correction could occur and then knowing how to trade it are both key skills in the commodities game.

‘Although there are sound fundamental reasons for the recent dramatic rise in commodity prices – exacerbated by speculative demand – history tells us that a correction across the whole commodity complex is very much overdue,’ says Martin Slaney, Head of Spread Betting at GFT Global Markets UK.

‘In fact, it appears that most commodities apart from oils are right now succumbing to profit-taking after two months of stellar rallies. The oil market has suffered several double-digit percentage corrections since its upward trend from $18 in 2001, and many now believe that a 10% to 20% correction in crude is around the corner,’ Slaney adds.

But a correction, however big, does not mean the party’s over, he stresses. ‘Corrections in bullish commodity markets do tend to be sharper and faster than those typical of other markets and after a cyclical retracement in prices the longer-term trend is still likely to be upwards.’

When the price is right

Commodities prices have been extremely strong over the past few months, partly because of a flight to safety brought on by a weak dollar and shaky stock markets, says James Hughes, Market Analyst at CMC Markets. ‘Whenever equity markets are looking uncertain, you do tend to get a lot of money moved out of them and put into commodity markets. The big questions surrounding all these instruments now is whether they can sustain the growth that they’re currently seeing, and of course that’s where you get a split of opinion.’

So how can a trader tell which commodity is ripe for retracement, when one is coming and what technical levels he should look out for?

With gold prices reaching record highs mid-March, when they bounced just above the psychological barrier of $1,000, a significant correction in this and other precious metals could be around the corner, many brokers predict.

‘The metals overall look a bit extended,’ says Sandy Jadeja, Chief Market Strategist at ODL Securities. Gold prices have been on an uptrend since last year, supported by strong economic growth in Asia, where demand for gold is traditionally strong, as well as the usual build-up in futures prices during late August to September ahead of Christmas jewellery sales, he says.

Statistically though, prices tend to stall in March, and combined with the psychological effect of $1,000 being reached, a turnaround now looks in sight, he says.

‘Many are expecting to see gold move the same way as US crude oil did when it reached the $100 a barrel level,’ says Hughes. ‘We saw it touch that briefly and then fall back lower and not be able to sustain any gains above that level.’

If gold prices break below the key pivot low of $931, ‘that will be indicating that the intermediate-term rally is over,’ predicts Jadeja. ‘That tells us that we are heading for a correction.’

And according to Jadeja’s technical analysis, the next stalling points on gold’s short-term decline could be $916, $892 and then $868.

Copper meanwhile has rallied 40% in the past year, but its correction seems already to have started, Jadeja adds. On 11 March it was down 6% from its high and looked to be approaching $358, its 38% Fibonacci retracement level, he noted at the time.

Other sectors that could be due a correction are natural gas and soybeans, he adds. ‘Because we’ve had a fairly mild winter, you’ll probably see natural gas coming off, maybe about 3-5% over the next couple of weeks,’ he said 11 March, when it traded at $10.06. ‘I can probably see natural gas even come down to around $9.25.’

Soybeans meanwhile rallied 32% between January and March, and as of 11 March were already back down 15%. ‘The question is,’ Jadeja says, ‘is this a correction or are we going to see another rally? As long as soybeans on the March contract do not break below $12.70, we may see another push higher back towards the $15.00 level, before seeing another correction.’

The corrections

There are two elements to trading a correction that are of particular importance – timing and intensity, says Slaney.

‘Trying to predict the timing of a correction, catching the move just right, is often seen as the Holy Grail of technical analysis,’ he says. ‘We hear of “double tops” and so on, but too much attention can be focused on this.’

What matters more is the ability to recognise when a market is actually entering a correction phase, he argues. ‘The old adage of “the trend is your friend” can be as good a guide as any here.’

One of the easiest ways for private investors to trade market corrections in commodities is through exchange traded funds (ETFs), or their sister products, exchange traded commodities (ETCs), says Mark Greenaway, Head of Private Client Services at Sucden.

Sucden offers a wide range of short ETCs in which the value of the fund is inversely correlated to the price of an individual commodity or basket of them. Using its SMART online platform or trading over the phone, investors can buy shares in ETCs provided by ETF Securities, which track either all commodities or individual sectors such as energy, metals, agricultural, livestock and precious metals.

Investors who think gold or silver are in for a dip could therefore buy shares in a short ETC on precious metals, he notes.

Short selling with spread bets is the best way to trade commodity corrections, argues Hughes. ‘With spread betting you get the exact same exposures to the underlying market as everyone else does, you get the simplicity of trading on the pound per point ratio, and you also get it in the cheapest way – the spreads are tight and there are no commission charges involved.’

‘If commodities have been overpriced … that’s great, because if you’re using tools like spread betting or CFDs you can take very minimum risk and play on the short side,’ agrees Jadeja. ‘People with some experience can capitalise on movements in both directions.’

Where the risk is

For more sophisticated investors, the world of options and futures opens an array of opportunities depending on an individual’s risk appetite, says Greenaway.

A higher risk, higher reward strategy would be to sell the outright future on a commodity, he says. But depending on an investor’s profile, Sucden could also advise them to buy puts, to buy put spreads or to buy puts and sell calls. ‘It all depends on their attitude to risk, and how far and fast they think these markets are going to fall.’

The selling point of futures and options when trading commodity corrections is their vast liquidity, he says. ‘You’re trading an exchange-traded product with thousands of participants around the world. It’s really about transparency in the market.’

And as with any strategy, covering your back is key when trading corrections.

‘There’s a misconception when it comes to spread betting that you’re going to have to be stuck in front of your machine all day long, placing forty trades a minute, to be able to make any money out of it,’ says Hughes. ‘But of course you don’t need to do that. It’s all about risk management.’

One useful tool is an ‘automated trailing stop’, and this is available across all GFT’s markets, says Slaney. It enables traders to make the most from a sudden and sharp market move, locking in profits and helping to prevent getting caught out on a reversal, he says.

A possible strategy would be to use a ‘parent and contingent order’, he adds. This involves placing a standard stop order to sell below the current market – for example 5% – with a trailing stop placed above this level, he says. ‘This trailing stop will then automatically follow the market down, so that if the market move does in fact turn out to be a correction, you will not only be short but your stop loss will be simultaneously moving in the direction of your trade.’

The most important tip for trading corrections however is not to get too greedy, says Jadeja. Limit your activity to end-of-day trading, be prepared to make your gains in weeks rather than 20-minute windows, and remember that timing is everything – jump on a moving train and you could end up in the bandwagon.