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


Tuesday, July 8, 2008

Chart Presentation: Themes

We are going to return to one of our recurring themes today. At right we show a chart of oil refiner Valero (VLO) from October of 2006 through into March of 2008.

What interests us about the chart is the way VLO trended higher through the first half of 2007. Many will argue that commodity prices trade simply on fundamentals but each time we view a chart that shows a trend running almost perfectly through one or two calendar quarters we suspect that there is a bit more to the markets than merely supply and demand.

VLO sold off into January of 2007 before pivoting upwards. The low close for VLO was made on January 10th while the eventual closing high was made on July 10th.

Our argument has been that the markets have tended to focus on the energy theme through the first half of the year before switching to a new theme following the end of June.

Below we have included a comparative view of the Amex Natural Gas Index (XNG) and Canadian natural gas producer Duvernay (DDV on Toronto). We have used DDV in the past as a surrogate for the natural gas theme although we could just have easily have substituted Chesapeake (CHK) or the XNG.

The chart covers the time frame from October of 2007 through to the present day. In other words we are comparing the energy theme dominated by a perceived shortage of gasoline through the first half of 2007 with the energy theme driven in large part by rising natural gas prices this year.

Similar to VLO the natural gas theme started the year on a weak note as both the XNG and DDV sold off sharply in mid-January. It may be that the natural gas sector will enjoy one final period of strength this month to mark the rally highs but aside from that our argument has been that over the past few years each time a dominant cyclical theme has turned negative it has remained negative for at least 12 to 18 months. If history were to repeat the natural gas theme would spend the next 6 to 12 months giving back all of the price gains made through the first half of this year.

A rising or strong theme has tended to emerge as an offset to an equally negative theme. To explain we show a comparison between the pharma etf (PPH) and the CRB Index during 2006.

The pharma sector turned higher two years ago around the peak for commodity prices. The second half of 2006 featured a strong equity markets trend led in large part by strength in the health care and consumer sectors. The initial recovery in July was marked by an upward surge in the PPH with the trend broadening out in August after the CRB Index and crude oil prices broke to the down side.

The chart below right compares the stock price of Citigroup (C) with Barrick (ABX) in 2007.

While the negative offset in 2006 came from weaker commodity prices the accompanying negative in 2007 was clearly carnage in the financial sector. Around the end of June Citigroup began to slip below its 200-day e.m.a. line as Barrick showed early signs of strength. Between July and January of 2008 the basic trend involved declining financial shares and rising gold prices.

The points that we are attempting to make are as follows. This is the time of year when the markets could well shift away from the energy theme. In both 2006 and 2007 strength in one or more sectors came as a result of weakness in another major sector but exactly what was strong and what was weak was difficult to identify during the first half of July. Much of our focus through the next several weeks will be on attempting to identify new strength and emerging weakness.

Below we show the Philadelphia Gold and Silver Index (XAU) and the stock price of Johnson and Johnson (JNJ). These two sectors have tended to move inversely so gold price weakness could lead to a better second half for JNJ.

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 >>