Based on the energy data received this week U.S. inventories of crude oil are roughly 8% above the five year average, gasoline inventories are 8.6% above the five year average for this week, while distillate fuel inventories remain a whopping 27% greater than the average. The point, we suppose, is that we shift over from the summer driving season to the winter heating season with little in the way of fears of supply shortages.

Our first page focus has to do with two energy-based relationships that seem to have some relevance with respect to the trend for Chinese equities.

Below is a comparison between the Shanghai Composite Index and the ratio between the Baltic Dry Index (BFI) and crude oil futures.

The peak for ocean freight rates relative to crude oil futures prices was reached around the start of the fourth quarter in 2007. Since this also marked the highs for the Shanghai Comp. the argument would be that as long as dry bulk shipping rates are stronger than crude oil prices the trend for Chinese equities should remain positive.

After hitting bottom during the fourth quarter of 2008- a month or two ahead of the low point for U.S. Treasury yields- the ratio worked through a series of peaks into 2010 before slumping lower. In recent days shipping rates have started to tentatively rise. Combined with a somewhat softer trend for crude oil futures prices this week the BFI/crude oil ratio has moved somewhat higher.

Further below we compare the Shanghai Comp. with the spread between copper futures (in cents) and crude oil futures (in dollars times 3).

The ongoing argument has been that when copper prices are stronger than crude oil prices (i.e. the spread line is trending higher) the Shanghai Comp. tends to rise.

The spread peaked out in early 2010 around the time that Treasury yields began to trend to the down side. A spin on the argument might be that a push to new highs at some point this year would make the case that the Chinese equity market is still in a rising trend while at the same time suggesting that the free fall for Treasury yields is coming to an end.

The bottom line? Strength in ocean freight rates and copper prices relative to crude oil helps bolster the Asian growth story that has been driving the cyclical trend since late 2008.

Equity/Bond Markets

So... what does the Shanghai Comp. have to do with the U.S. bond and equity markets? It is apparently time for one of our typical leaps of logic. Here goes.

Below is a comparison between the S&P 500 Index (SPX), 10-year U.S. Treasury yields, and the Shanghai Comp. from October of 2008 through March of 2009.

Notice that the Shanghai Comp. bottomed weeks ahead of Treasury yields and months in front of the SPX. In other words Chinese stocks were one of the first markets to turn higher and as the trend began to improve it created a domino-like effect that carried through into yields and U.S. large cap equities.

Below we show the same comparison for the current time period.

The point is that the Shanghai Comp. made a bottom around the start of July.  While it is obviously still some distance below its moving average lines the two charts on page 1 today suggest that it may well be moving into an improving trend.

The argument would then be that if the Shanghai Comp. led both yields and the SPX between late 2008 and the first quarter of 2009 then a return to a rising trend this quarter suggests that we might not be too far away from a bottom for 10-year yields.

Will it take the SPX into late October to turn higher? We suspect that the lag will be shorter this time around given the absence (so far) of a corresponding banking collapse.

Our argument is predicated on the assumption that the Chinese stock market is swinging back to the upside. Our sense, however, is that it really hasn’t altered the bullish trend that began around the end of 2008.

To explain we have included a chart of the ratio between Wal Mart (WMT) and the S&P 500 Index (SPX). The argument is that the offset to a negative trend for the Shanghai Comp. is a rising trend for the WMT/SPX ratio. Given that it hasn’t shown any indications of strength since it peaked in early 2009 it may not be too big of a leap to suggest that the Shanghai Comp. is still in a rising trend following a fairly serious correction to consolidate some of the earlier price strength.