by Kevin Klombies, Senior Analyst

Tuesday, March 18, 2008

Chart Presentation: Bonds and the Dollar

We have to admit that we appreciated former Fed Vice-Chairman Alan Blinder’s comment yesterday that the Fed was playing the equivalent of ‘Whac-A-Mole’ as it hammered away at one new crisis after another. It makes for a nice bit of imagery.

The markets were certainly under siege yesterday as the U.S. dollar moved lower against the yen and euro while Treasury prices edged higher. In spite of this commodity prices were clearly weaker as wheat, corn, soybeans, and soybean oil futures traded down the limit.

Below we show a comparison between the sum of copper futures and crude oil futures (copper in cents added to three times crude oil in dollars) and the sum of the U.S. 30-year T-Bond futures and the U.S. Dollar Index (DXY).

The premise is that the sum of copper and crude oil trends inversely to the sum of long-term Treasury prices and the dollar. Generally when bond prices are rising it reflects economic weakness which, in turn, tends to go with lower commodity prices. Commodity prices also tend to trend inversely to the dollar so when the dollar is stronger energy and metals prices tend to be lower and vice versa.

Through the recent state of financial markets chaos Treasury prices have been stronger while the dollar has been weaker but to the extent that the sum of the two has fallen since late January the offset has been a rising trend for copper and crude oil.

The chart below features a slightly different perspective on this argument. Instead of adding the TBonds and dollar together we are working with the spread or difference because this tends to set the trend for gold prices.

The argument is that higher bond prices and lower interest rates will serve as a positive for gold- usually relative to copper prices- while a weaker dollar- especially against the euro and Swiss franc- will also push gold prices higher. The best case for gold would be a strong bond market and weak dollar which most certainly has been the case since the end of the second quarter of last year. In any event the chief risk to the commodity ‘trade’ at present comes from a significant rebound in the dollar.



Equity/Bond Markets

The more things change the more they apparently stay the same. Of course the cast of characters tends to vary but one can be assured that at true equity markets bottoms at least one major financial company will be heading towards bankruptcy.

To show how history seems to be repeating we have included a comparison at right of crude oil futures, the S&P 500 Index (SPX), and copper futures from mid-1988 into 1991 and a second comparison below right of crude oil, the Shanghai Composite Index, and copper futures from late 2005 to the present day.

Copper prices peaked at the end of 1989 and again in mid-2006.

The SPX peaked in mid-1990 and the autumn of 2007.

Crude oil futures rose to a cycle peak in the autumn of 1990 and, quite possibly, late in the first quarter of 2008.

The point is that both charts show the same ‘amount’ of time which means that the top for the equity markets lagged the highs for copper prices by the same duration into 1990 and 2007. Crude oil prices, on the other hand, reached a top about 7 quarters AFTER copper which, if repeated, would suggest that energy prices should turn lower into the second quarter of this year.

The best news, we suppose, would be that the equity markets bottomed in 1990 at the peak for crude oil prices and even as copper prices continued to decline into 1991.

We have also been following a number of comparisons based on the cycle peak for the Nasdaq in March of 2000. Given that it is the month of March once again we thought we would show the CRB Index from 2008 and the Nasdaq from 2000 below. The simple point is that even though the CRB Index declined by the largest amount since 1956 yesterday it shows up on the chart as an almost meaningless correction in a rising trend. At minimum the CRB Index has to take out the 50-day e.m.a. line and then go on to challenge the 200-day e.m.a. similar to the Nasdaq in April of 2000.