by Kevin Klombies, Senior Analyst

Friday, February 08, 2008

Chart Presentation: Coke versus Copper

We start off today with two comparative charts of the U.S. Dollar Index (DXY) futures and the ratio between Coca Cola (KO) and copper futures.

An exchange rate is any currency relative to the U.S. dollar while a cross rate involves two non-dollar currencies. To get a sense of the general trend for the dollar we use the U.S. Dollar Index which compares the dollar against the euro, Swiss Franc, British pound, Canadian dollar, Japanese yen, and Swedish krona.

The top chart shows the time frame from 1993 into 1997 so it includes the last major bottom for the dollar in 1995.

In late 1993 as the dollar began to work lower the ratio of Coke to copper prices peaked and started to decline. Through the long bear trend for the greenback the KO/copper ratio remained below the 1993 high but as the dollar finally pushed up through its 200-day e.m.a. line at the end of 1995 the ratio broke above the resistance line.

The chart below right starts in 2005 and runs through to the present day.

Similar to 1993 the start of the down trend for the dollar was marked by weakness in the KO/copper ratio as money moved towards the metals sector and away from the large cap consumers. However, since KO tends to derive a substantial proportion of its revenue from foreign sales the weaker dollar tends to support its profitability.

From late 2005 into 2008 the dollar has trended lower while the KO/copper ratio has worked through a reasonably significant ‘base’.

Chart-wise the argument is that when the U.S. Dollar Index is ready to punch upwards through the 200-day e.m.a. line and the downward sloping resistance line (both currently around the 78-79 level) the KO/copper ratio should be set to move on to new highs. This could come from weaker copper prices, higher prices for KO, or some combination of the two but once this trend begins it should continue until such time as the DXY has returned to the 1995 highs. In other words while we have been positive on KO for some time we anticipate remaining that way for at least the next twelve months.


Equity/Bond Markets

The chart below compares the S&P 500 Index (SPX) with the ratio between the share price of Caterpillar (CAT) and crude oil futures.

The basic point is that the CAT/crude oil ratio has been rather wildly swinging back and forth through the 1.00 line since early 2002. At ‘1.00’ the price of CAT is the same as the price of the front month crude oil futures contract.

At the bear market bottom for the equity markets in the autumn of 2002 and the spring of 2003 the CAT/crude oilratio reached .60 before rising with the SPX through into late 2003 to 1.30. From there the ratio declined all the way back to .70 only to snap back up to almost 1.20, down to .80, and then back to 1.25 by early 2006.

In mid-2007 the ratio peaked once again around 1.25 as CAT’sstock pricemoved to a 25% premium to crude oil prices followed by a collapse back to the .70 level.

The most obvious argument would be that based on the trading range of the ratio over the past six years it is now at or near a bottom. We could then offer that each time the ratio is at a bottom the S&P 500 Index is also at a bottom.

Another point would be that each time the ratio has turned higher from a significant low the SPX has trended upwards at roughly the same pace or slope. To show this we have included upward-sloping trend lines on the SPX chart.

CAT is currently around 68 and if history is any guide once the CAT/crude oil ratio turns upwards it will continue to rise until it has reached something north of 1.15. In other words once the SPX begins to improve the next peak for the rally should be made once CAT’s stock price has surpassed the price of crude oil by 15% to 20%.

The chart at bottom right compares gold futures with the spread between the U.S. Dollar Index (DXY) futures and the U.S. 30-year T-Bond futures.

After arguing that based on past cycles we should see the peak for long-term Treasury prices some time around the end of the current quarter the TBond futures declined by more than a point yesterday as the dollar moved higher.

The net impact of weakerbond pricesand a rising dollar was a rising spread line as the difference in the price of the TBonds compared to the DXY narrowed. For point of reference the TBonds closed at 117.813 yesterday down 1 18/32 while the DXY was up .63 to 76.93.

Our argument is that gold prices trend inversely to this spread. Not every day, perhaps, but certainly over time. At the peak for the spread between 2000 and 2002 the price of gold was having a hard time staying above 300 while at the recent bottom for the spread gold prices were surging through 900.

We suppose the basic point here is that the spread has fallen from +20 to -45 since early 2002 and to support our negative view on gold prices we have to expect that the spread line will resolve higher either through a stronger dollar, weaker bond market, or some combination of the two.