by Kevin Klombies, Senior Analyst

Thursday, May 22, 2008

Chart Presentation: Comparison

May 22 (Bloomberg) — Oil’s rally to a record above $134 a barrel came as traders bought crude to cover wrong-way bets that prices would decline, according to data from the New York Mercantile Exchange.

The number of outstanding futures contracts, known as open interest, fell 8.1 percent in a week to 1.36 million at the same time that prices rose 2.6 percent, the data show. Falling open interest and rising prices are signs that traders are buying to exit so-called short positions that would profit if oil fell, and lose money as they rose.

We are regularly amazed by the number of ways that crude oil futures prices have managed to move higher since touching around 50 in January of 2007. Over the first half of that year oil price rose because there was a perceived shortage of gasoline. After a pause through the summer oil prices moved higher ostensibly because of colder weather or as a result of any number of threats to short-term supply. At present the argument is that prices are rising because traders- most especially in the deferred contracts- are being squeezed into covering short positions.

We return today to a chart-based argument that we have run in these pages on a number of occasions over the past few months. Below we show the Nasdaq Composite Index from 1998 into late 2001 while below we have included crude oil futures from the end of the fourth quarter in 2006 to the present time period.

The idea is that the Nasdaq’s ‘bubble’ began in October of 1998 and lasted through into March of 2000. Through the final four or five months prices rose almost parabolically as the Nasdaq ramped upwards from around 2800 to 5000. Through the cycle the Nasdaq rose from 1500 to around 5000 before falling all the way back to- and eventually below- the 1500 level.

If we line up the start of the rise for crude oil prices in January of 2007 with the Nasdaq back in October of 1998 we create a picture that goes some way towards explaining what is going on at present. If we take the comparison literally- to the day- the projected peak for crude oil prices would be expected some time next month. On the other hand if we look beyond the next few weeks the argument would be that into the third quarter of this year oil prices could easily break back below 100 before returning to the original starting point around 50 some time towards the end of 2009.



Equity/Bond Markets

Below is a comparison of, from bottom to top, the stock price of AMR, oil refiner Valero (VLO), gold miner Barrick (ABX), and Canadian natural gas producer Duvernay (DDV on Toronto).

The comparison has been set up to show how the equity markets have cycled from theme to theme since the second half of 2006. First the airlines moved higher as AMR rose from around 20 to 40. Next the refiners dominated the trend amidst fears of a shortage of gasoline (rightly or wrongly we continue to believe that any time you can buy as much of something as you like- as was the case with gasoline last year- there really isn’t a shortage) followed by a nice brisk run in the gold miners through the second half of 2007.

As the gold miners reached a peak the equity markets rotated into the natural gas sector as Duvernay turned higher from below 30 before touching around 58 this week.

The point is… one of these days the energy theme is actually going to come to an end and when it does the markets will move on to something new. The key is that the energy theme has to at least start to flatten out- similar to the gold miners earlier this year- before a new group can leap to the forefront.

Quickly… the offset to weakness in the home builders back in 2005 was a positive trend for consumer defensives such as Coca Cola (KO). We show the comparison below to point out that a case can be made for a return to strength for the consumer defensive names.

We argued on many occasions that the stock price of Wal Mart (WMT) should turn higher at the peak for energy prices. On the other hand energy prices typically trend with the Asian growth theme. Below right we show WMT along with the ratio between Hong Kong’s Hang Seng Index and the S&P 500 Index. The chart suggests that similar to early 1997 the start of a rising trend for WMT was based on weakness in the Hang Seng/SPX ratio.