Fundamental or Technical Analysis?

There are two methods used to analyse the markets, fundamental analysis and technical analysis. Both the fundamental analyst and the technical analyst are trying to answer the same question: Which way is the market likely to head, up or down? However they approach the question from opposite directions.

Fundamental analysis is the study of supply and demand or the cause and effect. In circumstances of short supply prices will rise to ration the limited inventory available. A sharp rise in demand will create the same price response because an increase in demand creates short supply. A good fundamental analyst is able to forecast a major price trend well in advance of the technical analyst.  Fundamentalist hold on to the major trends longer than technical analysts because they have the courage of their convictions, but their weakness is that they take a long time to change their minds; sometimes too long.

Technical analysts are concerned with market action only. He believes that the fundamental information is priced into the market and already reflected in the price action. He uses a variety of indicators that are mathematically derived from the price action, usually the period close. These indicators include overlays such as moving averages and trend lines, momentum indicators such as Rate of Change, Oscillators like stochastics and trend identification indicators like the Moving Average Convergence and Divergence (MACD). The range of indicators is growing all the time although it should be said that a truly predictive and fool-proof indicator is yet to be found. The weakness of the technical analyst is that he changes his mind too often and as a result he invariably misses the big money trends.

Correct fundamental analysis can make you money, and so can a good technical plan. However either will go broke if he is not a good trader. A good trader will make money if he can ascertain the correct fundamental or technical tone of the market.

We believe a marriage between the two, combined with a sensible money management plan, produces the best results over time. In our experience the best trades come when solid fundamentals agree with the technical structure of the market.

Example:
In the early 2000’s we witnessed the emergence of China as a major economic power. The domestic demographic shifts were of such a scale that commodity demand spiked as we have never seen before. Demand for all manner of commodities exploded and even though years earlier we had comfortable levels of commodity supply, the rise in demand was such that those previously comfortable supply levels immediately became too tight and price trends emerged that would last for years.
Crude oil was one such commodity. At the beginning of 1999 crude was trading around 12.20 a barrel, can you believe that? $12.00 a barrel! After running up to around $37.00 a barrel in 2000 it fell back to around $20.00 a barrel for a short time. Then it was off!

The first four year leg rallied to $70.00 in 2006 before a short correction and the next leg went all the way to $147.00 a barrel in just 18 months. Topping out in 2008 just as the global financial crisis surfaced. As a result of credit tightening in 2008 and 2009 the same levels of demand could not be supported so prices fell sharply.
During that multi-year rally both the fundamental analysts and the technical analysts were on the same page. A trend backed up by fundamental momentum and confirmed by the technical structure produced one of the best trades of the decade. And we can learn a lot from that experience, namely that the biggest trends produce the biggest profits.

Crude oil was not the only commodity to display solid trends during that time of Asian growth. We saw it in copper, although copper topped out in 2006, and the rally across the agricultural sector occurred between 2006 and 2008.

Where are the next big trends going to come from? We are expecting a major move to occur in the financial sector over the coming years but before we will be happy that our timing is right there are serious issues that need to be dealt with by authorities in Europe and the U.S. We need to get the world back to work.

We also have the view that some agricultural markets are likely to experience tight supply over the coming year and that prices are likely to rise as a result. We are waiting for a technical signal to tell us that the timing is right to start accumulating positions.

Trades like these are fully explained in our Commodity Trend Alert.