by Kevin Klombies, Senior Analyst

Wednesday, August 22, 2007

Chart Presentation: 2014

We quickly skimmed a newspaper article yesterday that suggested that major dealers like Goldman Sachs and commodity bulls such as Jimmy Rogers were now bullish on the grains and many of the softs because even in an economic down turn people have to eat. We are not suggesting that they are wrong, of course, but it still seemed strange because this is exactly the same argument that prevails in the equity markets during periods of cyclical slowness.

Money shifts from the basic materials over to the consumer defensives because, after all, people still have to eat. We understand the rationale behind the argument but we simply can’t recall ever reading or hearing it applied to the ultra-cyclical commodities markets.

One of our ongoing arguments has been that the markets are systematically adjusting relative and absolute prices. A major bull market in U.S. large cap financial, tech, and consumer sectors is followed by a catch up rally in small cap and commodities. Over time the S&P 500 Index has been roughly tripling every 11 years with the dominant theme changing about every six to seven years.

We have spent some time and space arguing that the last time Wal Mart (WMT) turned higher ack in 1997 it marked the peak for the combination of crude oil and the Australian dollar. Since energy and the AUD represent the themes of commodity, non-U.S., and small cap while WMT is consumer, U.S., and large cap this likely makes sense.

Our positive view on WMT was based on our conviction that energy prices and the commodity currencies were now turning lower so it was time for a theme shift that should favor WMT. Fair enough.

Today we wanted to show a slightly different perspective so we have included a chart of WMT from 1992 to the present day and a chart of crude oil times the AUD from mid-1999 forward. The charts have been offset by close to 7 1/2 years to line up the peak for WMT in early 2000 with the mid-2007 top for oil times the AUD.

WMT rose from 10 to 70 during its run and the oil times AUD combination also rose from 10 to close to 70 during its bull trend. The general point might be that oil prices and the commodity currencies may not collapse in the days ahead but it also could be years (and years) before this theme returns to favor. If the commodity sector remains dormant for as long as WMT the next bull run may have to wait until 2014. If history is any guide that means that we will likely turn positive on the commodity sector around 2011…



Equity/Bond Markets

In yesterday’s issue we introduced our newest markets fixation- the reverse 1987. We commented in passing that perhaps the equity markets would ‘crash’ to the upside this autumn but we should note that we actually don’t believe that this is possible. Markets simply do not crash up. They might power up, trend up, swing up, drive up, or trade up but they don’t crash up.

The idea was based in part on the commodity markets and the supported in a general way by the bond market. At right we show that the CRB Index peaked in mid-2006 and bottomed in mid-1986. In both instances the trend for commodity prices changed in the middle of the ‘6’ year.

The charts below right show the U.S. 30-year T-Bond futures in 2007 and in 1987. The charts are offset somewhat to roughly line up the April 1986 bond price top with the June 2006 bond price bottom and the March 1987 bond price down turn with the June 2007 bond price upturn.

The argument is that the trend for commodity prices is the inverse of 1987 and the trend for bond prices is also close to exactly the opposite. The idea then was that perhaps the equity markets would also resolve in a manner that represented the opposite or reverse of 1987 which, of course, might mean ‘up’ instead of ‘down’.

We suspect that the thesis lies somewhere between intriguing and completely insane so while we still have the opportunity we wanted to temper our comments somewhat. Instead of a ‘crash’- either higher or lower- what we could be setting up for some time later this year is a very sharp adjustment in relative prices. Stocks that went up with the commodity markets this year could go down while stocks that went down as the result of commodity price pressure could go up. For example the stock price of Johnson and Johnson could rise back to the highs of last autumn which would create a mirror image of the way the SPX declined in the autumn of 1987.