by Kevin Klombies, Senior Analyst, TradingEducation.com, LLC


Thursday, May 29, 2008

Chart Presentation: Offsets

TORONTO (Reuters) - Canadian biotechnology companies have joined a chorus of their global counterparts to rail against the U.S. Food and Drug Administration’s tardiness in approving new drugs.

Products by companies such as Labopharm Inc and Cardiome Pharma Corp have been delayed in the key U.S. market for months, chipping into their revenue and waylaying their plans.

The FDA has blamed a severely depleted staff and dwindling funds for the holdups in approving treatments, while it also deals with an overly cautious U.S. Congress that is keen to turn over every stone.

However, some critics say part of the problem stems from added scrutiny in the wake of the handling of the arthritis pill Vioxx, which was withdrawn by Merck & Co in 2004 following a link to heart attacks.

“It’s going from the sublime to the ridiculous that programs that have cost hundreds of millions of dollars and many years to develop are being hung up by a couple of whiny bureaucrats,” said Brian Bapty, a biotechnology analyst at Raymond James Ltd, in Vancouver, British Columbia.

Generally an excessive rise in one sector goes with or creates an excessive decline in another sector. Sky rocketing fuel prices add to the profitability of the energy producers while driving one airline after another into bankruptcy. Fair enough.

We included the Reuters comments above because they happen to agree with one of our stranger views. In the wake of Merck’s Vioxx problems in 2004 the FDA became considerably more cautious about approving new drugs. Coincidentally or not... in 2004 energy prices turned sharply higher. Imagine where things would stand today if the FDA was in charge of approving cell phones. With a potential link between cell phone usage and brain cancer our thought is that cell phones would still be bogged down in long-term trials.

In any event the chart below shows the ratio between copper producer FreePort McMoRan (FCX) and JPMorgan Chase (JPM) against the U.S. Dollar Index (DXY) futures. Strength in commodities and weakness in the financials accelerated last year as the dollar broke down to and then through the 80 level. At bottom we show the chart of Bear Stearns (BSC) and heating oil futures divided by the U.S. Dollar Index. The point is that the offset to carnage in the financials (Bear Stearns) was an extreme rise in energy prices (heating oil) accompanied by a very weak dollar. As an aside we found Mr. Bapty’s comment about ‘whiny bureaucrats’ fairly amusing.

10-year U.S. Treasury yields pushed over 4.0% yesterday before ending the session at 4.009%. We are going to return to an argument that we made a number of weeks ago because this is exactly where the rubber was supposed to meet the road.

The chart-based argument begins with the way the Nasdaq reached its cycle peak back in 2000. Given that the driver behind the strength in the tech and telecom sectors through 1999 was capital spending it made sense that long-term interest rates should be rising as corporations borrowed and spent huge sums of money.

One often associates the term ‘bubble’ with something false or irrational but in essence all the wonders of the internet that were dreamed of or promised 8 or 9 years ago have come true. It wasn’t the reality that was at issue but rather the forecasts of never ending growth emanating from analysts capable of little more than extrapolating the trend.

In any event a few months before the Nasdaq finally peaked the bond market changed direction. 10-year yields stopped rising in January of 2000 and began to decline suggesting that the demand for credit was starting to dry up.

When 10-year yields broke below the 200-day e.m.a. line in March the Nasdaq turned lower before eventually reaching a bottom in early 2003 a few months ahead of the Fed’s final rate cut to 1%.

Below we show an upside down view of 10-year Treasury yields along with crude oil futures.

The argument stands on a somewhat shaky foundation because it is based on the idea that rising interest rates today are similar to falling interest rates in 2000. To make the charts of 10-year yields appear to move in the same direction we have scaled the current chart upside down so that rising yields go with a falling line.

The idea was that the bond market changed direction back in March as yields moved down to around 3.3%. From March into May yields have risen although not to the point where the 200-day e.m.a. line was broken. However, by the smallest of margins that feat was accomplished yesterday.

The basic point was that crude oil futures should be at a peak when 10- year yields were ready to rise above 4.0%. We have noted in the past that the final show of strength in the Nasdaq in March of 2000 occurred as yields touched and then bounced up off the moving average line.

In theory... yields have finally reached 4.0% and this should serve as a major decision point. If yields decline over the next few days as bond prices move lower then we could see one last flurry of energy price strength. If, on the other hand, yields continue to rise then based on this argument the 135 level will mark the cycle highs for crude oil.

Our thought is that crude oil futures will likely return to the 120 level some time next week to test the 50-day e.m.a. line. This line marked the lows in both March and April and will most likely serve as first support once again. When the Nasdaq broke lower in March of 2000 it touched the 50-day e.m.a. line, bounced, and then broke below this line on a quick ride to the 200-day. A similar journey for crude oil would take it from current levels to 120 and then eventually back down to or below 100.

Kevin Klombies is a prolific writer and market analyst specializing in the commodity stock market and bond commodity market trading in the energy sector. He  graduated in 1980 from the University of Saskatchewan with a Bachelor of Commerce degree (Honours) in Finance/Economics.  Click here for full bio >>