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


Monday, July 15, 2008

Chart Presentation: Cycle Peaks

For many years we used the stock price of Phelps Dodge to represent the trend for the base metals so we were less than pleased when it was taken over by FreePort McMoRan in 2007. Since late last year we have been showing Canada’s Duvernay as a surrogate for the natural gas trend but that came to an end yesterday following a take over offer from Royal Dutch Shell. We show the chart today on page 4.

One of our views is that a peak for energy prices tends to follow a major cycle peak in one or more equity markets. To explain we have included three charts at right.

The top chart compares Japan’s Nikkei 225 Index and crude oil futures prices through 1990. The Nikkei reached a cycle top in early 1990 with crude oil prices peaking in the autumn.

The middle chart features the Nasdaq Composite Index and crude oil futures prices through 2000. The Nasdaq reached its highs in the spring of 2000 followed towards the end of the year by the final highs for both crude oil and natural gas futures.

Below right is a chart of the Shanghai Composite Index and crude oil futures from the current time frame.

The argument is that one or more cyclical equity markets should peak and turn lower ahead of the final highs for energy prices. The Nikkei broke to the down side months ahead of crude oil in 1990 while the Nasdaq began its downward slide some time before energy prices reached a top in 2000.

We don’t wish to get too specific about ‘time’ but in general the lag between the highs for the equity markets and the eventual peak for energy prices is around 9 to 10 months. The Nikkei topped out in January of 1990 with crude oil prices topping in October while the Nasdaq hits its cycle highs in March with the combination of crude oil times natural gas topping out into January of 2001.

If history were to be kind enough to repeat this year then the forecast peak for energy prices would be some time this summer and most likely during the month of July.

At right we show a chart of Genentech (DNA) from 2005 and a chart of Cisco (CSCO) from 2006.

One of our recent views is that it likely makes sense to ‘chase gaps’ over the next few weeks. By ‘chasing gaps’ we mean going positive on stocks that gap in price by close to 10% due to surprisingly good news. In a perfect world we would figure out which stocks would gap higher in price ahead of the event but we haven’t quite figured out how to anticipate the unexpected on a regular basis yet.

In 2005 DNA’s stock price gapped from a high of 59 one day to a low of 65.48 the next and over the next number of months the stock pushed steadily higher.

In 2006 Cisco gapped from a high of 17.65 to a low the next day of 19.35 and this led to an eventual rise to 29.

Our point is that the current markets are starved for good news and appear willing to chase anything that has the potential for positive price momentum.

Below we have included a rather large comparison between the S&P 500 Index (SPX) and the ratio between Morgan Stanley’s Consumer Index and Cyclical Index (Consumer/Cyclical).

The point is that in 2006 and again twice in 2007 the highs for the SPX were made at the very bottom of the consumer/cyclical ratio while the correction lows for the SPX were reached a month or three later when this ratio reached a peak. In other words the equity markets trend has been determined primarily through the strength in the cyclicals.

Notice that the consumer/cyclical ratio has risen to very close to the highs set in the summer of 2006 when the SPX declined below 1250. The pharma sector turned higher in July that year with oil prices peaking in August and the airlines turning upwards in September.

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 >>