Canada's stock market is suddenly riding the crest of a dramatic commodity turnaround, after months of being weighed down by weak commodity prices.
Toronto's benchmark stock index on Tuesday posted its biggest percentage-point gain since November, as a confluence of factors triggered a surge in key commodities ranging from crude oil to gold to copper to wheat.
"The risk trade is back on," said Robert McWhirter, president of hedge fund company Selective Asset Management Inc.
Strategists said that with Europe making progress on the Spanish bank crisis, the perceived threat of a Lehman-Brothers-style banking meltdown is easing.
As that happens, some segments of the financial markets that were hit worst by the mounting fears of the first few months of the year – including commodities and commodity-heavy equity markets such as Canada's – now look poised to lead the way back up.
"Commodities have led this cycle all along. The TSX was one of the first casualties," said John Johnston, chief strategist at Davis Rea Ltd. Investment Counsel.
With commodities turning around and new hope in the market, he said, "It's suggestive that there's a relief trade coming."
Crude oil spiked nearly $4 (U.S.) to $87.55 a barrel, a five-week high, in New York, after Iran threatened a blockade of the Persian Gulf in retaliation for a European embargo on Iranian oil. Gold rose more than $20 to $1,617.80 an ounce, amid talk that the weakening global economy will prompt further monetary easing by central banks – a possibility that generally calmed investor fears and fuelled appetite for risk assets, such as commodities and equities.
Toronto's S&P/TSX composite index soared 252.19 points, or 2.2 per cent, to 11,848.95. The gain came on top of a 172-point rise last Friday. (The market was closed Monday for Canada Day.)
The holiday week in Canada and the U.S. contributed to Tuesday's strong gains on the TSX, Mr. Johnston said.
"Because this was going to be a low-liquidity week, people were hesitant to take on big positions Friday," he said. When commodity prices and global stock markets rose in the absence of the Canadian market on Monday, that prompted Canadian traders to aggressively load up on their positions on Tuesday, ahead of the U.S. Independence Day holiday.
But Mr. Johnston cautioned that it might not last the week.
The European Central Bank is scheduled to make an announcement about interest rates on Thursday, and the market is pricing in the expectation that it will cut rates by at least one-quarter of a percentage point, to 0.75 per cent.
"If the ECB doesn't do anything, we could see big disappointment" in the stock market, Mr. Johnston said.
Given the low valuations and strong potential returns that the stock market offers relative to bonds, strategists say stocks have plenty of room to rally in the next few months. Mr. McWhirter noted that both the stock and commodity markets have turned positive on a "technical" basis – based on the trends and patterns emerging from their price charts – which suggests an upturn is in the cards for the summer.
"There's a rally expected at least until Sept. 1, and maybe through to the U.S. election," Mr. McWhirter said.
The Canadian rally, he said, will depend on continued strong prices for oil. And for the global equity markets, any rally will only last as long as Europe can maintain some stability.
"We can continue to whistle past the graveyard here," Mr. McWhirter said.