by Kevin Klombies, Senior Analyst

Friday, January 25, 2008

Chart Presentation: Commodity Rebound

In terms of our various theses yesterday represented a mixed session. On the one hand the bond market snapped lower to confirm that the markets have moved passed- for the time being at least- the point of maximum stress in the banking sector. On the other hand traders returned to the old theme pushing the euro, crude oil, gold, and copper to the upside while selling off consumer-oriented stocks such as Wal Mart and Johnson and Johnson.

At right we show the comparison between the Morgan Stanley World-ex. U.S.A. Index divided by the Dow Jones Industrial Index (essentially everything else divided by large cap U.S.), the ratio between Wal Mart (WMT) and the S&P 500 Index (WMT/SPX), and the U.S. Dollar Index (DXY) futures.

One explanation for the quick return to the commodity theme would be the position of the World ex. USA/DJII and WMT/SPX ratios. As money has moved away from the dollar since early 2002 consumer names like WMT have underperformed the broad market while U.S. large caps have underperformed virtually everything else. In other words the basic trend for the past six years has favored foreign markets over the U.S. and the commodity theme over the large cap consumer growth stocks.

The point is that in the midst of the crisis money was moving back towards the safety of the dollar and the large cap U.S. consumer names but as the crisis began to abate the first reaction by traders was to pitch the dollar and move back into commodities and foreign markets.

The chart at bottom right compares the CRB Index (commodity prices) with the ratio between the Canadian and U.S. equity markets.

The argument is that in a strong commodity trend the Cdn equity market will outperform the U.S. equity market and that has most certainly been true over the past few years.

Our view is that the CRB Index has peaked so yesterday’s rally along with relative strength in Canadian shares was merely a bounce in a negative trend. However, if we are wrong then both the ratio and the CRB Index will push on to new highs which will make the very compelling case that the post-2001 trend is still intact. We will attempt to show both of these charts on a regular basis in the back pages so that we monitor the short-term action.




Equity/Bond Markets

The markets presented us with a bit of a paradox yesterday as shown through the chart at right. The chart compares the stock price of Bear Stearns (BSC) with the ratio between heating oil futures and the U.S. Dollar Index (DXY).

The heating oil/DXY ratio rises when energy prices are strong or when the dollar is weak. Conversely it will decline when energy prices are softer and the dollar is strong. Since this ratio has been trending inversely to the major U.S financials the sharp recovery in the banks followed the next day by a quick rally in energy prices on the back of a weaker dollar definitely gives us pause. On any given day the markets can do just about anything but consistently stronger energy prices and a weaker dollar is exactly the opposite of what we would expect if the financials are now on the mend.

Below we show the Nasdaq Comp. and the Bank of Montreal (BMO) from 1999 into 2000 while below right we show Mitsubishi UFJ (MTU) and the CRB Index from the current time frame.

Through 1999 and into the first quarter of 2000 the Canadian banks were trading lower as capital pushed into the cyclically strong Nasdaq along with the U.S. dollar. One of the hall marks of the peak in the Nasdaq in March of 2000 was the sharp recovery rally in the Canadian banks. This indicated that the direction of the flow of capital has reversed although it would take another six months before most traders realized that the base trend had actually changed.

We have argued that the dominant trend through 2007 was ‘commodities’ and that this tends to go with strength in foreign (non-Japan) equity markets. Our chart-based argument has been that Japan’s MTU is similar to Canada’s BMO into 2000 so when the commodity theme finally turns negative we should see the trend change through strength in the shares of MTU. The markets presented us with a ‘false start’ in November as MTU pushed sharply through the 200-day e.m.a. line before failing back towards the lows into January. Continued strength in MTU should help confirm our view that the CRB Index is now ‘over the top’ for the second and final time for this cycle.