by Kevin Klombies, Senior Analyst

Wednesday, April 23, 2008

Chart Presentation: Currency Twists

April 22 (Bloomberg) — Crude oil rose to a record $119.86 a barrel in New York as the dollar dropped to an all-time low against the euro, prompting investors to purchase commodities as an inflation hedge.

With commodity prices at record highs while the dollar is at a record low against the euro we start off today with a slightly different perspective as we take the CRB Index and multiply it by the U.S. Dollar Index (DXY).

Day after day the argument is that commodity prices are stronger because the dollar is weaker. In fact only a week or two ago an OPEC official stated that for each 1% decline in the dollar crude oil prices had recently been rising by around $4 so, coincident or not, this is the widely accepted ‘truth’ that the markets have been trading from.

The top right chart compares the CRB Index times the DXY and then compares it to the stock price of General Motors (GM). Intermarket-wise the argument would be that GM will only turn positive once commodity prices finally weaken although one might be able to argue as well that a flat commodity market and plunging dollar could be a positive as well. Either way the CRB Index times the DXY has swung back to the highs set in the spring of 2006 coincident with the first peak for copper prices just over 4.00 while GM has pulled all the way back to the 2006 lows.

We suspect- and we do not think that we are going too far out on a limb with this one- that the future will include airline travel. Of course there may only be a handful of airlines left in a few years but, even so, the idea of travelling quickly by air- especially over large bodies of water- instead of walking, pedaling a bicycle, driving an automobile, or paddling a boat seems to make long-term sense.

We mention this because the Airline Index (XAL) last peaked in 1998 at the bottom for Asian growth and commodity prices and has been declining for the better part of a decade as the Australian dollar (tied closely to the commodity trend) has moved higher. From a top around 200 in 1998 the XAL closed yesterday at 20.51. As recently as January of 2007 when crude oil prices declined to 50 the XAL reached roughly 67 so over the past 5 quarters as the price of crude oil has risen from 50 to almost 120 the market cap of the U.S. airline industry has declined by over two thirds. Those who believe that crude oil is going to reach 150 or even 200 might want to think about investing in shoe manufacturers because the future is going to include an awful lot of walking.



Equity/Bond Markets

Below we show the yield index for 10-year Treasuries (TNX) and the ratio between Japan’s Nikkei 225 Index and the S&P 500 Index (SPX).

Chart-wise the Nikkei has been trending inversely to interest rates since 1994 which simply means that the Japanese stock market only does well when interest rates are rising. The U.S. stock market, on the other hand, slipped into a similar relationship in 1998. It may well be that all of this has something to do with China’s currency devaluation in January of 1994 but that is a topic for another day.

The point is that yields bottomed in mid-March and this went not only with the lows for the SPX but also for both the Nikkei and the Nikkei/SPX ratio. We argued yesterday that if the current trend resolves in a somewhat similar manner to 2000 then the first indication of a trend change would be an upward pivot in yields with the first real pressure showing up once yields broke to new highs. The idea would then be that this would go with the Nikkei/SPX ratio moving above 10:1 and given that is a nice round number we thought we would mention it today.

Below we show Apple (AAPL) and Genentech (DNA). Just when you start to think that the markets trade off of fundamentals we toss in a chart that, we suspect, only makes sense to momentum-driven, computer model-creating, B-school grad quant geeks. We have absolutely no idea why DNA and AAPL should be trading as virtual mirror images of each other but that has most certainly bee the case. Yesterday AAPL declined almost 8 points ahead of earnings and DNA rose more than 2 points for no apparent reason.

The chart below right compares copper futures with the price spread or difference between the 30-year and 10-year Treasury futures. The argument of late has been that copper prices tend to decline when the spread rises and the only way the spread is going to rise appreciably is through higher 30-year prices or lower 10-year prices.