Chart Presentation: DXY 82

Within the context of the thesis that we have presented over the past number of months we would have to write that yesterday was ‘close but not quite’.Commodity priceswere definitely weaker both on an absolute basis and relative to the U.S. equity markets but the lows from last month managed to hold in too many places to mark this one has truly paid. Close but not quite.

At top right we show a chart of the ratio between Phelps Dodge (PD- bought by FreePort McMoRan in 2007) and the S&P 500 Index.

The argument from a year or two back was that the PD/SPX ratio peaks at the top for the commodity cycle or, perhaps more succinctly, at the relative strength top for the commodities theme. The idea was that the ratio had reached a high in 1981 and then again thirteen years later in 1994. We argued that if the cycle followed true to form the next major commodities peak would be hit some time during 2007.

Below we feature a comparative chart of the U.S. Dollar Index (DXY) futures and the ratio between FreePort McMoRan (FCX) and JPMorgan Chase (JPM).

We used Phelps Dodge for years to represent the base metals theme but after it was purchased by FCX we shifted much of our work over to names such as FCX and Rio Tinto (RTP).

In any event things were progressing in a fairly reasonable manner through the first half of 2007. The FCX/JPM ratio- another take on the PD/SPX ratio shown above right- had pushed up to the highs set during the mid-1990’s. In other words the markets had pushed the financials(JPM) higher from 1995 through 2001 as the dollar moved upwards and then shifted back to the metals and miners from 2001 into 2007 as the dollar declined.

The argument- more or less- fell apart last year as the dollar failed to hold support around 81- 82. The ratio between FCX and JPM exploded up through roughly 1.6:1 on the way to almost 3.5:1 by the late spring of 2008.

The point is that for years we argued that the commodity rally was merely a resetting of relative prices as the markets shifted from theme to theme until all major sectors had ‘had a turn’. The sectoral rotation went from orderly to chaotic last year when the U.S. Dollar Index broke below 82 but the closer it gets back to this level the greater the pressure on the commodities sector.