When all was said and done yesterday the answer to most questions would have to be that euro strengthened. Why was the stock market stronger? The euro strengthened. Why were commodity prices higher? The euro strengthened. And so on.

In a research note at the end of last week Goldman Sachs commented with regard to natural gas prices that while demand had increased so too had production. The end result was a forecast of generally flat gas prices for 2010 with the caveat that ‘price risk remains skewed to the downside, with higher-than-expected production growth still the main risk’.

Just below  we show a comparison between the U.S. 30-year T-Bond futures and the ratio between crude oil futures prices and natural gas futures from early 1990 through into 1994.

One of our ongoing arguments is that bond prices tend to bottom when the ratio between crude oil and natural gas rises to above 20 times. In other words 100 crude oil and 5 natural gas or 80 crude oil and 4 natural gas takes the ratio up to 20:1 and when this happens the bond market tends to be at a price low.

On the other hand a decline in the ratio below 7:1 tends to go with bond price peaks. The chart shows that the ratio rose above 20:1 in 1990 at the low point for bond prices and then slowly worked lower into early 1994 to mark the end of the bond market’s bull run.

One of the odd things about 2008- 2009 was the way the ratio slammed down to a bottom below 7:1 in December of 2008 to mark the highs for the bond market only to surge right through 20:1 in August to set the initial lows for bond prices. A process (working from a ratio bottom to a top) that might take years to accomplish was completed in less than three calender quarters.

Our points? First, the bond market is proving to be extremely ‘challenging’ this year although the chart at bottom right argues that we are still on the ‘buy’ signal created by the push above 20:1 for the ratio last August. Second, weaker natural gas prices should help to limit the upside potential for crude oil prices. Third, to the extent that the markets seem ready, willing, and able to push prices to extremes it is possible that the ratio will swing back above 20:1 once again which would, of course, create a second positive signal for bond prices.

Equity/Bond Markets

We can think of any number of ways to make the markets ‘more’ complicated so we thought we would return to a couple of charts that might help make things just a bit ‘less’ confusing. Perhaps.

Below is a comparison between the Hang Seng Index from Hong Kong and the ratio between copper futures prices and the CRB Index.

The argument is that the trend for ‘Asian growth’ tends to trend with the copper/CRB Index ratio. In other words copper is one of the commodities that tends to do very well when China’s economy is expanding so as long as it is outperforming general commodity prices the markets are ‘saying’ that there aren’t any imminent problems associated with the Asian stock markets.

The chart shows that the copper/CRB Index ratio fell off of a cliff during the fourth quarter of 2007 as copper prices began to weaken relative to commodity prices in general and energy prices in particular. As the 40-day exponential moving average line crossed down through the 200-day e.m.a. the Hang Seng Index began to decline.

Our thought is that based on this chart there are two outcomes that we should watch out for. The first would obviously be weaker copper prices.  As mentioned last week there is little imminent risk of the 40-day e.m.a. line crossing down through the 200-day unless or until the copper/CRB Index ratio fell to or below 1:1. In other words a ‘weak copper’ outcome would require something south of 2.75 for copper given the current level of 275 for the CRB Index.

The second bearish outcome would follow a sharp rise in energy prices similar to the first half of 2008. This would push the CRB Index higher which would pressure the ratio from the other direction.

In any event the point is that the copper/CRB Index ratio is still strong enough to suggest that Hang Seng Index is not likely to collapse in the very near future.

Lower is a chart comparison between the share price of Intel (INTC) and two moving average lines for the index for 10-year U.S. Treasury yields (TNX).

The argument here is that the trend for Intel (which trends quite closely with many large cap U.S. stocks ranging from Cisco to GE) tends to be positive when 10-year Treasury yields are rising and negative when they are falling. To simplify matters somewhat we are using the ‘cross’ by the 30-day e.m.a line through the 200-day e.m.a. line as our signal.

The chart shows that long-term U.S. yields had fallen far enough and fast enough during the third quarter of 2007 to pull the 30-day e.m.a. down through the 200-day. A few months before the copper/CRB Index ratio marked the end of the road for the Hang Seng Index the U.S. bond market ‘said’ that a problem was developing with respect to U.S. economic growth. Fair enough.

So... through trading yesterday the trend for yields was still strong enough to maintain a positive trend for Intel. The copper/CRB Index ratio was strong enough to support a bullish trend for the Hang Seng Index so... why did the commodity and equity markets rally yesterday? Because the euro was stronger and because the underlying trend is still positive.