Sooner or later in a bear market, even the glory stocks start to come apart.

As a bull market ages and becomes a bear market, stock groups turn down one by one, until even the strongest roll over.  That may be happening now to energy and other commodity related stocks.

- “Bear Trap Opens for Resource Stocks” (subscription required), E.S. Browning, The Wall Street Journal, Monday July 7

I’m gonna get hate mail for this but here goes. 

Is it just me or are the commodity bulls getting on anybody else’s nerves too? 

Demand from China!  BRIC (i.e. Brazil Russia India China)!  $140 oil is justified by the fundamentals! 

And they’re so sure of themselves.  The world is changing.  We’re in a commodities supercycle.  It’s so obvious!  You’d have to be a moron not to see it the way they tell it.  They’re just as certain as the tech bulls were in 1999-2000.

But their days are numbered.

A table in yesterday’s above quoted WSJ article shows that energy and materials are the only sectors that have continued to rip since the October Highs (Sector Performance Since Oct High Table).

But the way bear markets work is that first the original source of the bust gets hit.  Then those secondarily related get theirs.  Finally, the ill effects filter throughout the economic system touching even its farthest corners.

In this case, the housing stocks were the first to go, peaking in the summer of 2005 (TOL 5 Year Chart, DHI 5 Year Chart, SPF 5 Year Chart).

About a year and a half later, as the carnage in the housing market started affecting homeowners ability to pay their mortgages, it filtered through to the financials with their heavy exposure to mortgage backed securities.  They topped out in February 2007 (XLF 5 Year Chart).

At the same time, investors started to realize the impact falling home prices would have on consumer spending and the consumer discretionary stocks peaked as well (XLY 5 Year Chart).

Demand for commodities like oil, copper, iron, etc.... is a function of demand for end goods like electronics, cars, computers, refridegerators, etc...  As consumers become increasingly pinched and the slowdown in the US, the world’s consumer of last resort, infects the rest of the world, overall demand will decline and necesarily commodity demand will as well.  Commodity prices will come down - and so will commodity stocks.

You’re next energy and materials.  Hope you enjoyed it while it lasted (XLE 5 Year Chart, FCX 5 Year Chart, BHP 5 Year Chart).

Disclosure: Top Gun is short Freeport McMoran (FCX) and BHP Billiton (BHP).