We are going to start the week off somewhat slowly before focusing on our newest epiphany in tomorrow’s issue. We will touch on it, however, on page 3 today.

To set the stage for the charts at right we have included a few snippets from Bloomberg articles taken from the end of last week:

Jan. 29 (Bloomberg) — Crude oil fell to a five-week low as the dollar strengthened against the euro, making commodities less attractive as an alternative investment.

Jan. 29 (Bloomberg) — Copper fell, capping the biggest monthly drop since 2008, as the dollar’s rally reduced the investment appeal of commodities, including metals.

Jan. 29 (Bloomberg) — Cocoa prices fell, posting the longest slump in 15 months, as the dollar’s rally eroded demand for commodities as alternative investments. Coffee recorded the biggest weekly drop since September.

The point is that dollar strength is doing damage to the commodity bulls. If the dollar continues to rise then we would expect to see ongoing pressure on the CRB Index.

Below we show the CRB Index and the ratio between Coca Cola (KO) and the S&P 500 Index (SPX) from late 1980 through into 1986. The argument is that as long as the CRB Index is in a long-term declining trend the ratio between Coke and the SPX will resolve higher. In other words the greater the pressure on raw materials prices the better the relative strength for consumer products makers such as Coke.

Next we show the same comparison for the current time period. The Coke/SPX ratio began to rise in early 2006 before correcting back below the moving average lines into mid-2008 as the CRB Index surged relentlessly higher. Through the second half of 2008 as the equity markets tumbled the share price of Coke outperformed the broad market.

Through much of 2009 the KO/SPX ratio has worked lower as the markets returned to the commodity theme. Our thought is that the better the dollar and the greater the pressure on raw materials prices the stronger the KO/SPX ratio should become. KO won’t report 4th quarter earnings until next week but we would be encouraged if the markets actually managed to avoid hammering the stock following the release.

Equity/Bond Markets

We thought that we would explain once again why we keep running the chart at right in the back pages of the IMRA. The chart compares the sum of copper and crude oil futures with the price spread or difference between the Biotech etf (BBH) and the share price of Potash (POT).

First off... we have adjusted the BBH for the take over of Genentech by Roche. Whether our adjustment is fair and accurate is subject to debated.

To really understand what this is supposed to mean we will have to start out with the chart below right. This chart compares the U.S. Dollar Index (DXY) futures with the ratio between Amgen (AMGN) and the Baltic Dry Index (BFI).

Amgen is the largest component of the BBH so any argument related to the BBH is, by and large, and extension of the trend for AMGN. The chart shows that as the dollar bottomed back in 2005 the ratio between Amgen and ocean dry bulk freight rates began to rise. In other words dollar strength tends to go with a better biotech trend in relation to the kind of trend that focuses on commodity prices and ocean freight rates.

Below we show the same comparison for the current time frame. Notice that just ahead of the dollar’s recovery in early December the AMGN/BFI ratio began to rise.

Returning to our top chart the argument is that when the dollar begins to strengthen the focus of cyclical strength should already have begun to shift away from the commodity cyclicals (including the fertilizer names) and back towards the biotechs. If commodity price weakness is ‘real’ then the spread between the price of the BBH and that of POT should rise which, of course, is exactly what has been happening since the start of the new year.