by Kevin Klombies, Senior Analyst

Friday, May 30, 2008

Chart Presentation: Favorites

May 29 (Bloomberg) — U.S. stocks rose for a third day, the dollar jumped to a three-month high against the yen and the 10- year Treasury note’s yield climbed to the highest since December after a government report showed the U.S. economy grew more than estimated in the first quarter. Crude oil dropped the most in two months.

U.S. 10-year Treasury yields ended yesterday at 4.09% and in response the dollar pushed higher and oil prices declined. Many believe- with absolute conviction- that rising commodity prices are merely a reflection of an imbalance between ‘real’ supply and demand. That may be true but on days when the U.S. dollar rises by a fraction of a percent and we see 2%, 3%, and even 5% declines in front month commodity futures prices it is hard to argue against the notion that there is a speculative element involved in the commodity markets these days.

Below we show one of our favorite charts. The chart compares the ratio between the Canadian etf (EWC) and Japan’s etf (EWJ) with the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX).

The chart makes a relatively simple point. Rising energy prices are good for the stock prices of U.S. oil companies as well as the Canadian equity market. On the other hand declining oil prices are better for the non-oils and Japan’s stock market. If one believes the trend extrapolators who continue to vie for the title of ‘highest projection for crude oil prices’ then own the oils and the Cdn market. If, on the other hand, you believe that trees and trends rarely grow to the sky then a reasonable alternative would be to be long Japan although we grant this is a contrarian view not in line with the current trend.

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

The basic argument here is that Japan tends to do quite nicely when interest rates are rising so barring a return to crisis for the major financials the markets continue to argue that interest rates and by extension the dollar look higher. As yields climb the Nikkei/SPX ratio should rise and as the dollar firms commodity prices tend to weaken. We like the way this is shaping up.



Equity/Bond Markets

Below is a thoroughly messy and confusing chart that we have included simply because we believe that it contains a very important message.

Over the past few years the markets have concentrated on one key theme each six or so months. The theme changes- often dramatically- which makes buying and holding a tough proposition.

During the second half of 2006 the stock price of AMR trended higher as commodity prices (including crude oil) declined. As AMR reached a peak in early 2007 the market shifted over to worrying about gasoline inventories which resulted in an upward push for refiner Valero. As VLO peaked in mid-2007 the trend shifted over to the subprime crisis which helped drive gold prices upwards. From mid-2007 through into the start of 2008 the stock price of gold miner Barrick pushed higher.

In early 2008 the trend shifted once again as Barrick began to struggle. This went with a rather huge recovery in the natural gas sector which we show through the chart of Canada’s Duvernay (although we could have also used something like Chesapeake (CHK)).

The argument is that some time around mid-year or around the time the natural gas stocks start to flatten out a new trend should develop that will dominate into the end of the year. While we have no idea- yet- what that trend will be we couldn’t help but notice that consumer products names like Wrigley, Anheuser Busch, and even Hershey are starting to perk up.

Below we show the XAU along with Johnson and Johnson (JNJ). There are any number of ways that we could draw channel lines on this chart but we rather like the way this sets up. The chart conveys the impression that JNJ was pushed down from a rising trend by the recent rally in the euro and gold prices but following the weakness in gold prices yesterday both markets had returned to key decision points. If gold continues to decline then JNJ looks higher.

Finally… below right we show the ratio of the Asia ex-Japan Index divided by Japan. If, as, or when energy prices turn lower the Nikkei should outperform the other Asian markets.