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Monday, September 17, 2007
Chart Presentation: Memory Lane
This is certainly an interesting period of time for the markets and one, we suspect, that in some ways defies analysis by historical comparison. Still we soldier on with our convictions and our arguments even in the face of what seems to be a creeping state of chaos through the global credit markets.We are going to take a little stroll down memory lane today as we show and attempt to explain the sequence of markets events that have helped to build the foundation for our thesis.
We have included a comparison between the sum of copper and crude oil futures (copper in cents and crude oil in dollars multiplied by three times) and the combination of short-term (3-month TBills) and long-term (10-year Treasury) yields. The argument through 2005 and into 2006 was that when we finally reached the peak for the sum of copper and crude oil prices we would also be at the highs for interest rates. Because long-term and short-term yields were quite often trending in seemingly opposite directions we combined the two to create a picture of interest rates ‘in general’.The top for energy and metals prices finally occurred between May and July of 2006 and, as expected, this marked the highs for yields.
After months of trending lower the commodity markets reversed to the upside last January but to date the argument still holds that we have passed the top for U.S. interest rates.The argument then went on to suggest that once the peak for energy and metals prices along with yields have been reached the trend would shift so that equity prices would outperform commodity prices. To show this we used the ratio between the S&P 500 Index (SPX) and DJ AIG Commodity Index (DJCI).
The chart shows that the ratio bottomed between May and July of 2006 and has generally been moving higher. The twist here is that the ratio peaked in January at the bottom for the sum of copper and crude oil and has essentially been moving sideways for the past eight months. When all is said and done, however, the key building blocks for our thesis still appear to be intact.
Equity/Bond Markets
The chart shows the CRB Index from 2006 through the end of trading last week.
We were expecting the equity markets to outperform the commodity markets after the trend change began in mid-2006. One detail that we failed to take into account, however, was that this was not necessarily a negative for the stock prices of the commodity producers most especially during those periods of time when commodity prices were rising.
Our conviction was that commodity prices had peaked so we expected to see the CRB Index trend lower. Fair enough. The chart shows, however, that within the broad channel that defines the negative price trend the CRB Index went from the bottom of the channel in January back to the top of the channel this summer. When equities are outperforming commodities and commodity prices are rising... the strongest stocks will tend to be those involved in the production of commodities.
We can see that through the comparison at bottom right between Coke (KO) and Caterpillar (CAT). KO represents the sort of stock that went with our theme- a large-cap U.S. consumer company- while CAT tends to trend with the cyclical commodity theme. Notice that CAT did very poorly between mid-2006 and January 2007 as it declined from around 82 to 58 but then outperformed by a wide margin from January through July as it rose from 58 to 87. Such is the power and the importance of getting the intermediate-term trend for the commodity markets ‘right’.
The equity markets have been keyed so tightly to the trend for commodity prices- especially oil and the base metals- that at times it seems almost impossible to conceive of anything but a stock market collapse if, as, and when oil and copper prices once again break lower. Our view has been that as we approach the end of the second term for President Bush the markets are likely to shift over to more of a health care/cancer cure theme heading into the 2008 Presidential elections. We submit that one sector that shown up as virtually the mirror image of energy and metals prices- biotech- has potential. The chart below makes the case that the biotech etf (BBH) has tended to rise when energy and metals prices show weakness and then decline when the trend returns to commodity price strength. Similar to last summer, however, the BBH is going to have to get on the north side of the moving average line to really turn positive.
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Kevin Klombies is a prolific writer and market
analyst. He graduated in 1980 from the
University of Saskatchewan with a Bachelor of
Commerce degree (Honours) in Finance/Economics.
Click here for
full bio >>
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