by Kevin Klombies, Senior Analyst

Thursday, May 8, 2008

Chart Presentation: 80

Perhaps someone should do us a favor and deliver a few side-of-the-head slaps to help cool our enthusiasm because our sense is that everything is finally coming together. Given our propensity to be early, of course, even if we used the term ‘immediately’ it would be based more on days or weeks than minutes or hours.

We will spend much of tomorrow’s issue working on putting a more detailed argument together.

To start thing off today we show at top right a comparison between the U.S. Dollar Index (DXY) futures, the ratio between the share prices of FreePort McMoRan (FCX) and the S&P 500 Index (SPX), and the ratio between FCX and JPMorgan Chase (JPM).

On occasion we have mentioned that things went somewhat crazy after the dollar broke below the 80 level so we thought we would show what we mean.

One of our views is that the markets take turns pushing prices higher so following a long tech, financial, and consumer growth theme dominated by large cap stocks the next trend will focus on commodities, basic materials, and smaller cap stocks and markets. In other words when the FCX/SPX and FCX/JPM ratios decline for an extended period of time as the dollar moves higher the next major trend will push these ratios lower as the dollar declines.

Everything was progressing quite nicely until the summer of 2007. The FCX/SPX and FCX/JPM ratios had moved back to the higher of 1995- 96 while the U.S. Dollar Index had fallen back to around the 80 level. In a perfect world the rebalancing of relative prices would have been completed with the markets moving on to something new. Instead weakness in the U.S. housing market worked into the financial system causing huge declines in prices along with weakness in the dollar.

The chart at bottom right shows that when the DXY broke below 80 crude oil prices were ranging from around 70 up to 80. Much of what has happened since can be blamed on the decline in the dollar so our argument is that while the dollar made a few short-term forays above its 50-day e.m.a. line in December, January, and February if it is time for a change in trend then the dollar should push back towards 80 which, in turn, would help pull crude oil prices back below triple-digits.



Equity/Bond Markets

The second chart below shows a comparison between Bear Stearns (BSC) and heating oil futures.

The negative trend for BSC began in January of 2007 as energy prices pivoted higher. While the actual chaos did not hit for a few more quarters the chart makes the rather compelling point that a negative trend for the financials was the logical offset to a rising trend for energy prices.

The chart also shows that when BSC collapsed towards bankruptcy in March it went with a surge by energy prices above the rising trading channel. In other words the more extreme the problems for the financials the greater the upward pressure on energy prices.

Below we feature a comparison between Wells Fargo (WFC) and the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX) from 1990.

This chart has and does serve as one of the templates that we are working with. In 1990 as the ratio of the oils to the broad market spiked up through the 200-day e.m.a. line the share price of WFC declined below its moving average line. As long as the oils were outperforming the broad market the banks were weaker but as WFC began to recover- eventually moving above its moving average line- the oils started to weaken. On virtually the same day that WFC moved above its moving average line the XOI/SPX ratio broke back below its line.

The chart at bottom right compares WFC, the stock price of Carnival Cruise Lines (CCL), and the XOI/SPX ratio from the current time frame.

For much of this year the markets have worked right up to the point where it appeared that a trend change was imminent only to fall back again as crude oil prices spiked to new highs. The chart shows that on three occasions since the end of January the stock price of WFC has moved just above the 200-day e.m.a. line as CCL as come within a fraction of a point of doing the same. Our argument is that the trend will change when oil prices have finally reached a peak that, we suspect, will serve as the highs for oil prices for many years to come.