by Kevin Klombies, Senior Analyst

Wednesday, July 16, 2008

Chart Presentation: Equities Lead

July 15 (Bloomberg) — Crude oil tumbled more than $6 a barrel in New York amid concern that a slower U.S. economy will curtail demand.

July 15 (Bloomberg) — Copper tumbled the most in a week as falling imports in China and a weakening outlook for the global economy increased speculation that metals demand will decline.

July 15 (Bloomberg) — Corn and soybean futures fell for the second straight day on speculation that favorable weather in parts of the U.S. Midwest will boost crop prospects.

The only problem that we had with the decline in crude oil prices was that it was a ‘Tuesday’. We have noted on many occasions in the past that sharp price declines tend to take place on Tuesdays and have been followed in most cases by strength later in the week. All things considered we would prefer to see crude oil prices move lower towards the end of the week but we will take what we can get.

The equity markets tend to lead the real world so it rarely makes sense to expect declining crude oil prices when the stock prices of the oil producers are making new highs. Please feel free to remind us of this comment the next time we are fighting a rising trend for oil prices as the Amex Oil Index surges into uncharted territory.

The chart at top right compares crude oil futures and the Amex Oil Index (XOI) from 1990 into 1991. The point is that the XOI peaked and turned lower well before crude oil prices reached the final top and then proceeded to bottom in January of 1991 well over a month before crude oil prices reached the correction lows.

The current situation is shown at bottom right. Notice that the XOI peaked back in May and has since declined from over 1650 to around 1350.

The final peak for crude oil in October of 1990 lined up with the XOI breaking below its 200-day e.m.a. line so our view was that crude oil prices should top out when the XOI declined below its moving average line this summer and that this should go with the lows for the broad U.S. equity market. The only thing missing is sufficient weakness in crude oil futures prices to break below the 50-day e.m.a. line which cuts through around 131.




Equity/Bond Markets

The chart at top right compares the trend for Genentech (DNA) with that of the ratio between Mitsubishi UFJ (MTU) and the gold etf (GLD).

The idea is that when European short-term interest rates began to rise in late 2005 a number of sectors turned negative including the biotechs (DNA) and the Japanese banks (MTU). Concurrent with downward pressure in these sectors the trend for gold turned positive.

July 15 (Bloomberg) — Gold rose, extending a rally to the highest price since March, as slumping equities and the sliding dollar sparked demand for the precious metal as an alternative investment.

Last year the banks moved towards and then into ‘crisis’ in the third quarter with the gold stocks serving as the ‘positive offset’. In other words the worse things got for the financials the better things got for the gold miners.

Our view is that strength in the euro will increase the downward pressure on European equity markets and that this will lead to lower short-term European interest rates- hopefully sooner than later. Our view is that when this trend changes it should go with or be preceded by strength in DNA and then work out to a recovery in the MTU/GLD ratio. Our conviction would increase substantially if DNA were to push above the 80- 82 level.

Below we show the ratio between Exxon Mobil (XOM) and Boston Scientific (BSX) from 1992 to the present time period. The simple point is that about every 7 years the markets switch focus from energy to health care or from health care to energy. When the ratio turns lower it will argue for relative strength in health care through into roughly 2011.

Tightening up our perspective we show the XOM/BSX ratio along with crude oil futures prices at right. The ongoing argument is that each time the XOM/BSX ratio moves below the 200-day e.m.a. line it marks either the lows for crude oil or… potentially… a significant change in trend. We have noted in the past that bottoms (similar to yesterday’s) in this ratio have repeatedly (and repeatedly and…) led to 20+ point rallies for crude oil futures so our thought is that this is either the end of the run for crude oil or the launching pad for yet another push on through 150.