by Kevin Klombies, Senior Analyst

Friday, February 22, 2008

Chart Presentation: Comments

We start off today with a chart comparison of the ratio between equities (S&P 500 Index) and commodities (DJ AIG Commodity Index) and the ratio between the pharma etf (PPH) divided by the Amex Oil Index (XOI).

One of these days the equity/commodity ratio is going to turn higher. Relative to commodity prices the SPX is now as ‘low’ as it was back in the spring of 2003 when the equity bull market began in earnest.

We have argued that in roughly 6 to 7 year swings the markets either focus on all things commodity or all things not commodity. Into 2000- 2001 equity prices had reached extreme levels relative to commodity prices which led to a long period of adjustment as commodity prices were pushed upwards both on an absolute and relative basis.

The point is that in terms of time and distance our view was that the correction had run its course and we should be ready to move back into a prolonged trend that would favor equities. The hook is that if the equity/commodity ratio rises at the same time that commodity prices are flat to higher virtually all of the momentum in the equity markets shows up in the stock prices of the commodity producers. The end result can be seen through the PPH/XOI ratio. Over the last five years the equity/commodity ratio has moved essentially sideways while the equity markets have moved upwards. Strength in the equity markets has come predominantly from sectors such as energy as the ratio of pharma to the oils has declined by roughly 2/3rds.

In a sense we are replaying the 1970’s once again as the SPX holds flat below 1550 while commodity prices range higher. After close to 8 years of relative price adjustment and correction our conviction remains that when this finally clears away it will be large cap consumer and pharma names that will lead to the upside.

We have made very few comments with respect to gold over the past couple of years but when we have written something it has generally been negative. The caveat, however, was that while we did not like gold we considered it to be ‘low’ relative to copper prices. The gold/copper ratio shown at right makes the case that the gold/copper ratio typically ranges from around 3:1 up to 5:1 so while gold can be flat to lower when copper prices are falling it will tend to rise quite quickly when copper prices rebound. At anything close to 4 for copper and, say, a 4:1 ratio one comes up with some rather extreme upside projections for the price of gold.



Equity/Bond Markets

Below we show the SPX along with the spread between Brent crude futures and the stock price of Canada’s Canadian Natural Resources (CNQ). CNQ is a major oil and gas producer with significant holdings in the Alberta oil sands.

At present Brent crude is close to 30 points higher than the share price of CNQ and at peaks for this spread we find the equity markets at a bottom. Similar to today’s first page commentary relative to commodity prices and within the context of everything that has happened since early 2003 equity prices are ‘low’. Relative to crude oil prices the stock price of CNQ is as ‘low’ as it has been since the autumn of 1990.

The point is that either the equity markets are low or commodity prices are high. Either crude oil prices are ‘real’ at current levels which would then argue that over time the oils should do better or the equity market is ‘real’ suggesting that there is somewhere between 10 and 20 points worth of pure air under crude oil futures prices.

Below we show Boston Scientific (BSX) and crude oil futures.

In order to start the ‘roll’ into some of the non-commodity sectors crude oil prices have to stop making new highs. Notice how BSX pivoted to the upside at the end of 2000 as crude oil futures prices broke down below the 200-day e.m.a. line. Today that would take something close to 82 for crude oil.

Quickly… below right is a chart comparison between Ford (F) and the PPH/XOI ratio that we used on page 1.

The autos have been negative for the past 8 years as the markets have favored the energy sector and commodity prices. On the other side of all of this the autos stand to be market leaders and we suspect that at present they are as unloved as the mining sector was 5 or 6 years ago.