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


Thursday, June 12, 2008

Chart Presentation: Comparisons

Crude oil prices surged higher yesterday following a surprising decline in U.S. weekly oil inventories. Surprising to some, we suppose, but not to those who read Morgan Stanley’s report last week that called for a spike in the price of oil. The reasoning was that the Middle East has been shipping record volumes to Asia which has led to a 20 million barrel decline in the ‘oil in transit’ pipeline to Atlantic destinations. All of which means that U.S. inventories have declined by more than 7% over the past four weeks even as Chinese imports increased by 25% over the last month.

Over the past few months we have compared the chart of crude oil futures prices with the Nasdaq Composite Index into the March, 2000. In yesterday’s issue we focused on the argument that the trend for crude oil prices is remarkably similar to that of the Hong Kong stock market into the summer of 1997. We thought we would start things off today by combining all three charts- the Nasdaq into 2000, the Hang Seng into 1997, and crude oil futures from the current time period.

The argument put forward yesterday was that Asian growth turned negative with the peak for the commodity currencies and the Asian equity markets around the start of November last year. In 1997 the Hang Seng Index pushed upwards after the peak for oil prices and the commodity currencies while in the current situation oil prices continue to rise following the peak for the commodity currencies and the Hang Seng Index. All of which just means that if we take the comparison literally the current month is similar to August of 1997 for the Hang Seng Index.

When we compared the Nasdaq Comp.’s chart to crude oil prices we found that the trends were almost identical. This comparison suggested that crude oil prices this month were comparable to the Nasdaq in March of 2000.

Our point is that even if these chart-based comparison were perfect to the week they still did not indicate that crude oil prices would collapse in May or even early June. They did suggest, however, that downward pressure would begin around the second half of this month leading to a month and quarter-end test of the 200-day e.m.a. line.

For as intriguing as this may be our view is that we won’t even begin to get interested about lower oil prices until crude oil futures break below the 50-day e.m.a. line. This moving average served as support for the Hang Seng and again for the Nasdaq so it will take something south of 120 for crude oil before we start to get excited.

Perhaps the best thing about following the markets is that each and every day is different. On the other hand the markets have a tendency to repeat cycles and trends in a manner that feels completely unique.

Our point, we suppose, is that the recent weakness in the S&P 500 Index has the potential to be quite bullish. Not today, perhaps, but within the next few days or weeks. Why? Because the markets are repeating a trend that we have all see at least twice in the past two years.

Below we have stacked charts of the ratio between Caterpillar (CAT) and Pepsi (PEP), the stock price of CAT, the 10-year yield index (TNX) for U.S. Treasuries, and the S&P 500 Index (SPX).

The argument starts with the CAT/PEP ratio. The ratio (shown along with copper futures on page 6) tends to trend with base metals prices and given that copper prices have been weaker the ratio is starting to decline.

The CAT/PEP ratio peaked in May of 2006 and again in July of 2007. In both instances this marked the top for CAT as well as the S&P 500 Index.

The charts suggest that once the CAT/PEP ratio reaches a peak and then turns lower the S&P 500 Index will move into a correction. So far, so good.

The ratio made a third peak last month as copper prices reached a top. Another way to view this would be through something like the ratio of the Morgan Stanley Consumer Index to the Cyclical Index which we have included on page 4.

Notice that while the top for the CAT/PEP ratio in both 2006 and 2007 did not hit the exact peak for 10-year yields... it was still reasonably close. The argument is that long-term Treasury yields will be flat to lower over the next four to five months.

The detail that we found most interesting, however, was what happened in 2006 and 2007 to mark the low point for the S&P 500 Index. In both instances the SPX hit a bottom almost exactly to the day when CAT and the CAT/PEP ratio hit their respective 200-day e.m.a. lines. In other words the sooner CAT declines to or below 76 the better.

The peak for the CAT/PEP ratio marked the highs for ‘cyclical’ versus ‘consumer’. The broad decline in the stock market ran until CAT reached its 200-day e.m.a. line. Once the consumer theme began to strengthen it tended to outperform for close to six month.

Through the 2006 and 2007 cycles the SPX declined with Caterpillar and then rose with the consumer and pharma sectors. With the pharma etf (PPH) sinking like of stone this year it is clear that we have yet to get to the positive offset to the cyclical’s negative trend. That should evolve, however, over the next few days or weeks.

5.

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 >>