by Kevin Klombies, Senior Analyst

Friday, June 20, 2008

Chart Presentation: Cycle Comparison

June 19 (Bloomberg) — Crude oil fell more than $4 a barrel, the biggest drop in 11 weeks, on speculation demand will decline, after China said it will raise fuel prices starting tomorrow.

Today’s argument begins with a chart ‘detail’ that we do not have the room to show. In January of 2000 the long end of the U.S. Treasury market began to rise in price… months ahead of the final peak for the Nasdaq. Similarly bond prices turned higher in July of last year even as China’s equity markets steamed to new highs.

The point is that with hindsight we know that the bond market did not turn higher at the start of 2000 because there was a shortage of bonds or for any of the reasons hauled out to explain why it was that interest rates were falling even as the Nasdaq roared towards 5000. The bond market turned higher because it was anticipating- correctly- a significant slow down in economic activity.

Bond prices began to rise last summer as the subprime mortgage crisis built momentum leading into something just short- to date- of $400 billion in losses. However with the benefit of almost a year’s worth of hind sight we also know that the Shanghai Composite Index is now down more than 50% from its highs of last autumn.

The charts at bottom right compare the product of crude oil futures times natural gas futures from 1999 into 2002 and from the start of 2007 forward to the present date.

If the bond market pivoted upwards in January of 2000 ahead of the eventual peak in the Nasdaq then we can see that energy prices continued to rise for a full year and only turned lower in January of 2001. The chart shows that by early 2002 the combination of oil and gas prices had not only declined but had fallen all the way back to levels last seen in the first half of 1999.

The argument would then be that energy prices should make a cycle peak through the end of this quarter before returning back to the lows of January 2007. While many would argue that 100 crude oil is low or that 80 represents ‘value’ the chart-based argument suggests that ‘crude oil times natural gas’ should bottom out a year from now around ‘300’. In January of 2007 the product of crude oil times gas touched the 300 level on 50 crude oil and 6 natural gas. As well we should point out that the ultimate low for the Nasdaq was made between the fourth quarter of 2002 and the first quarter of 2003. Time-wise this suggests a bottom for the Chinese equity markets sometime out in the summer of 2010.





Equity/Bond Markets

Above we argued (obliquely and opaquely as usual) that we could quite easily see $50 crude oil before the final bottom is reached and that this will come as a result of a marked slow down in Asian growth reflected by a seemingly relentless decline in the Chinese stock market.

The problem at present is determining WHEN the trend for energy prices will finally turn lower and in recent weeks while arguing that the trend change should take place through the end of this quarter we have stated that either way we aren’t going to get too excited about short-term weakness in oil prices until the 50-day e.m.a. line is finally broken.

On this page we have included three comparisons of the S&P 500 Index (SPX) and the ratio between crude oil futures and the U.S. 30-year T-Bond futures.

The ratio rises when oil prices are strong or when bond prices are weak. It declines when oil prices are falling or when bond prices are pushing higher.

The argument is and has been that the peak for this ratio- both in 1990 and again in 2006- was made at the low point for the SPX. Another chart detail would be that the ratio’s final high was made on October 11th, 1990 and on July 14th, 2006. In other words the trend changed from strong oil, rising interest rates, and negative equity prices over to weak oil, falling interest rates, and rising equity prices a couple of weeks after the start of a new quarter.

If history were to repeat almost exactly the equity markets would remain under pressure until some time next month. A conservative option would be to keep one’s investment powder dry until after the crude oil/TBonds ratio had fallen below its 50-day e.m.a. line. That won’t catch the bottom but it will be fairly close.