by Kevin Klombies, Senior Analyst

Monday, September 8, 2008

Chart Presentation: An Intermarket Walk

Over the weekend the U.S. government took control of Fannie Mae and Freddie Mac while Hurricane Ike continued to push towards the Gulf of Mexico. Toss in OPEC’s meeting tomorrow regarding oil production and the end result is that just about anything short-term that we have been arguing for or against could be swept off side in a hurry. When in doubt one should probably side with PIMCO’s Bill Gross who stated that the end result of the GSE take over would be lower mortgage rates and higher stock prices. Sounds good to us.

At top right we show a comparative view of the Shanghai Composite Index and the spread or difference between copper futures (in cents) and crude oil futures (in dollars multiplied by three times).

We use the ‘copper plus 3 times crude oil’ combination in a number of ways. The argument is that the price of copper in cents should be roughly the same as 3 times the price of crude oil in dollars. In other words copper MINUS 3 times crude oil should swing back and forth through the ‘0’ line on the chart.

The first point is that the spread was well above ‘0’ from late 2005 into mid-2008. In other words for as ‘high’ as crude oil prices were they were actually quite ‘low’ relative to copper.

The second point is that ‘strong copper’ tends to go with strong Asian growth. The ‘bubble’ in the copper minus crude oil spread occurred as the Shanghai Comp. drove to the upside.

The third point is that the spread has now returned to what we would view as a neutral level even as the Shanghai Comp. trends lower. Relative weakness for copper prices tends to go with slowing Asian growth.

Below right we feature a comparison between the share price of Wal Mart (WMT) and the ratio between Hong Kong’s Hang Seng Index and the S&P 500 Index.

The intermarket argument is and has been that WMT tends to do very well during periods of slowing Asian growth. Notice that WMT’s stock turned higher around the start of 1997 as the Hang Seng/SPX ratio peaked and turned lower. Our little intermarket ‘walk’ takes us from a starting point based on relative weakness in copper prices to slowing Asian growth and on to a rising trend for WMT.