by Kevin Klombies, Senior Analyst

Thursday, March 13, 2008

Chart Presentation: 1996-98

We are going to try to explain our rather explicit ‘macro’ point of view. Timing is, of course, an issue with any and all long-term perspectives but for now we will leave the markets to do as they will while we all too patiently await events to resolve in the expected direction.

Below are two charts of the combination of the Mexican peso and Brazilian real futures, copper futures, and the ratio between wheat futures and the CRB Index. The top chart features the time frame through the commodity markets’ peak in 1996 while the lower chart is from the present time frame.

Data for the Brazilian real futures begins (in our system) in late 1995 so the combination of the real and peso necessarily starts at that time. The idea here is that a strong commodity trend will include strength in many of the smaller currencies normally associated with the broader theme of commodities AND emerging, Latin, and Asian markets. In other words when commodity prices are strong and rising this will go with money moving towards Asia, Latin America, and even Africa.

The next point is that the commodity markets tend to move higher in a series of rotations. Copper prices rise early and once a peak has been reached the rally moves into sectors like the grains. This why we see the wheat/CRB index ratio rising through 1995 and into 1996 after copper prices reached a top.

Money moved towards what we will call the ‘emerging markets’ theme into 1996 which helped push the peso and real to a cycle top. Once the grains finally stopped pushing and the CRB Index turned lower in the spring of 1996 the trend reversed with money moving steadily away from commodities and the smaller currencies and back in large part towards the dollar.

The unwinding of the cycle continued right through 1998 and ended, as trends so often do, in a series of crises that rocked south east Asia, Russia, and finally Brazil.

Our view is that the rally in copper prices towards the 2006 highs concurrent with the relative strength in wheat prices and crisis conditions in the capital-starved U.S. markets suggests that the trend is in the late or final stages and that as time passes the CRB Index and the commodity-related currencies will turn lower in a manner somewhat similar to 1996- 98.



Equity/Bond Markets

Today’s premise is that the markets are now in a position somewhat similar to the spring of 1996. Note that once commodity price finally turned lower in 1996 the counter trend ran for roughly 2 1/2 years so while the next series of markets-related crises will most likely show up in Asia, South America, and eastern Europe it may be several years before we get to that stage.

The peak for commodity prices in 1996 went with the highs for the gold miners so at right we have included a comparison between the Philadelphia Gold and Silver Index (XAU) and the stock price of U.S. auto maker Ford (F).

One might argue with our timing and suggest that gold prices will continue to rise for some time but that doesn’t necessarily invalidate our thesis. The point is that when the commodity markets turn lower the gold miners will peak and turn to the down side and typically when this happens we see a lift in the autos and airlines. Whether this begins today, next month, or even next year with gold prices at 10,000 instead of 1000 is somewhat beside the point. When the gold miners turn lower the trend will have begun. Period. We show the present comparison between the XAU and F on page 4.

Now… through the 1996 time frame (chart below right) we can see that Coca Cola (KO) and Merck (MRK) were trending higher while Wal Mart (WMT) was stuck in a flat trend awaiting the eventual down turn in crude oil prices. Aside from the recent weakness in MRK the trends appear similar enough today to lend support to our argument.

Below we have added a somewhat self-serving comparison. The idea is that the rising trend for the Brazilian real began around the same time as the recovery in Boeing (BA) and, as drawn, Boeing is no longer in a rising trend. In theory this makes the case that cyclical growth has started to decline to the point where capital will begin to shift away from the more cyclical and commodity sensitive currencies leading in due course to a negative trend for the Brazilian real.