by Kevin Klombies, Senior Analyst

Thursday, November 15, 2007

Chart Presentation: Crude

Through much of 1985 Saudi Arabia was actively supporting crude oil prices through its actions as OPEC’s swing producer. After repeatedly warning the other members that continued cheating and discounting would not be tolerated the Saudis eventually turned from defending OPEC’s price to actively fighting to regain market share. Through late 1985 and into 1986 the price of crude oil declined from close to 32 down to 10- 11.

To the best of our knowledge there are few fundamental similarities between today and 1985. Certainly we are not aware of major excesses of supply although from time to time OPEC officials do comment that the global markets are well supplied with current high prices due more to geopolitical risks, the vagaries of weather, and some amount of speculation.

Aside from the fundamental differences we did want to point out the rather marked similarities between the charts of crude oil and commodity prices between 1984 and 1985 and these same two markets from 2006 into 2007.

The CRB Index and crude oil futures peaked around May of 1984 and then moved flat to lower through the summer of 1985. In August of 1985 prices began to ramp upwards until crude oil prices reached a major cycle peak late in November only to tip back to the down side to resume the down trend that had begun back in 1984.

The recent commodity trend is substantially less negative than the one that commenced in 1984 but from many perspectives the trend did turn negative last year. Similar to 1984 the CRB Index made a cycle peak in May of 2006 and then moved lower through this past summer.

The most interesting similarity would have to be the sharp recovery that began in late August and that has continued into the middle of November. Aside from that there is the fact that oil price today are now almost exactly triple the level of prices at the highs in 1985 suggesting that in a worst case scenario it might be theoretically possible for crude oil to reach the low 30’s by next spring.

Of course all of this is mere conjecture born, we suspect, out of the realization that one of these days crude oil prices are going to decline on something other than a Tuesday and actually react in a bearish manner after the weekly inventory report- due out today.



Equity/Bond Markets

The markets have been trapped within a circle for some time now. Long enough, we suspect, for the computer models and algorithms to position massive amounts of money on the assumption that the trend will continue for ever and ever.

The U.S. dollar has weakened as the Fed has cut interest rates at a time when other central bankers are fretting about inflation. The Fed has cut interest rates because the banks and brokers were wading through a subprime-related crisis. As the dollar declined commodity prices moved higher and as commodity prices strengthened non-Fed central bankers became even more concerned about inflation which, in turn, helped weaken the dollar and strengthen commodity prices. We suppose it all makes sense- to a computer model- but one might think that buying commodity futures while the U.S. is tipping into recession might be somewhat risky.

In any event the chart at right shows Bear Stearns (BSC) and heating oil futures. Notice the rather compelling relationship.

Over the past few days the odds of a December Fed rate cut have fallen from 100% to just over 70% as the banks and brokers have ‘dropped the other shoe’ after marking down and writing off questionable assets. In response the financials have caught a bid, the dollar has firmed slightly, and commodity prices have stopped rising parabolically. This may not be 2007’s version of Saudi Arabia fighting to regain market share but in a world where the only fundamentals that matter are the direction and momentum of a market the breaking of the virtuous circle through a recovery in the banks and brokers might be just as important.

From our point of view crude oil prices ‘should’ have turned lower almost a month ago and ‘should’ be closer to 75 than 95 on the way to the low 60’s. To get a sense of how strange all of this is consider the page 4 chart comparison based on the trend of natural gas prices. The only fundamental positive for gas these days is its relative ‘cheapness’ to crude oil so its price rises even as the stock prices of the gas producers and drillers decline. From our point of view that simply does not make any sense over any length of time.

Below right we show Japan’s Matsushita (MC) and Anheuser Busch (BUD).

When MC snapped higher in late October following a positive earnings report the chart suggested that prices had been forced lower through the third quarter and were now returning to the trading levels of last June. Fair enough.

What intrigues us about the BUD chart is that it also fell in price from June through August and then rose into October. The difference is that MC turned lower once again at the start of October while BUD continued upwards until the middle of the month. If one (we admit it- we did) were to make the effort to count the days that BUD lagged behind MC in October and then add them to the time following the recovery for MC in late October… BUD should be ready to rally right about… now.

All of which, of course, is mere conjecture and, quite possibly, high fantasy but given the long-term relationship established between BUD and the Cdn dollar (discussed yesterday with the chart at top right on page 4 today) and the small cracks in the relentless circle of logic that has dominated trading over the past few months this has a certain feel of rightness to it.