by Kevin Klombies, Senior Analyst,

In yesterday’s issue we showed a chart comparison between the Nasdaq Composite Index into 2000 and crude oil futures. The argument was that based on the trend for the Nasdaq from 2000 into 2001 we could see crude oil prices decline to roughly 50.

Obviously $50 crude oil is an extreme view so we wouldn’t be surprised if many out there- especially the peak-oil adherents- feel that this is just another one of many absurd chart comparisons that we are prone to show in these pages. Fair enough.

What we wanted to do today is show two relationships that make a somewhat tentative case that our argument is at least plausible. We start at top right with a chart of crude oil futures as well as the ratio between crude oil and natural gas futures from 1993 into early 2004.

The simple point is that significant bottoms for crude oil tend to occur when the oil/gas ratio is well below 7:1. Obviously when the ratio is below 7:1 crude oil prices are not necessarily at a bottom but, on the other hand, when oil prices do reach bottom- as they did in 1994, 1998, and early 2002- the ratio has tended to be somewhere between 5.5:1 and 7:1.

At present natural gas prices are somewhat below 8 although further out the strip prices are close to 8.50. At 7 times natural gas a more ‘fair’ level for crude oil would be closer to 60.

Below right we show crude oil futures and the ratio between crude oil and unleaded gasoline futures from mid-1985 through 1999.

At bottoms for crude oil in 1986, 1988, 1990, and even 1998 the crude oil/gasoline ratio was roughly .0026. Put another way when oil prices decline to the sort of bottom that stands out on a long-term chart the price of oil is roughly 26% of the price of gasoline. As of yesterday gasoline futures ended at roughly 2.37 (237) which means that the ratio is at the upper extreme of the trading range.

Assuming gasoline futures remain flat at 2.37 crude oil futures prices would have to decline to very close to 61 before the ratio would fall back to .26. Given that any trend that would push crude oil prices down to 60 would most likely drive both natural gas and gasoline prices lower as well it isn’t such a stretch to believe that it is all together possible that we will see 50 crude oil- or lower- before the correction has run its course.



Equity/Bond Markets

On the one hand we do our best to be both persistent and consistent. On the other hand we tend to get so far ahead of the markets at the major turns that by the time the trend swings in our direction we feel the need to move on to the next challenge. Hopefully we will exhibit more patience this time around.

We have argued for some time that we like the U.S. dollar, the consumer and health care sectors, large cap compared to small cap, and U.S. equities relative to most foreign markets. We are and have been negative on the commodity markets. We can make a case for Japan and intend to do so again once the Nikkei shows a bit of life but in the main we have focused on stocks such as Anheuser Busch, Wal Mart, Coca Cola, Johnson and Johnson, the pharma etf, and, from time to time Boston Scientific (ugh), Genentech, the biotechs, and perhaps especially Japan’s Mitsubishi UFJ.

The chart at top right shows the ratio between the S&P 500 Index (SPX) and the NYSE Composite Index. This is our large cap vs. small cap chart. The point has been that large cap is as low relative to small cap as the reverse was true back into 2000. Large cap can mean large cap U.S. equities but it also represents the U.S. relative to most of the smaller markets. In other words buying Kuwait, Brazil, or even Zimbabwe is ‘small cap’.

The chart below right compares the U.S. Dollar Index (DXY) futures with the MS World ex-USA Index (i.e. everything but the U.S.) divided by the Dow Jones Industrial Index (large cap U.S.). If we are positive on the dollar- and we have been for far too long- then we have to expect that the DJII will outperform. The trend has been going our way since the end of this year’s second quarter.

Below is a chart comparison that we have included many times in the back pages. The chart compares the CRB Index with the ratio between Canadian and U.S. equities. The first point would be that if the CRB Index is declining then the Cdn stock market should underperform. The second point is that both are holding above the lows made in September so it is difficult to really argue that this one is ‘locked in’. We still need to see at least one more good break to the down side in the CRB Index to mark this one as paid.