by Kevin Klombies, Senior Analyst

Tuesday, September 18, 2007

Chart Presentation: From Copper to Crude

The Federal Open Market Committee (FOMC) meets today to decide on the near-term direction of short-term U.S. interest rates. The Fed funds futures suggest the Fed will reduce the funds rate by 25 basis points although many seem to feel that if comes down to a coin toss the Fed will likely cut the rate by 50 basis points.

Sept. 17 (Bloomberg) —Crude Oilrose to a record $80.92 a barrel in New York on signs that the Federal Reserve will lower interest ratesat its meeting tomorrow to bolster economic growth in the U.S.

Our problem here is that energy and metals price tend to drive interest rates and not the other way around. To read thatcrude oil futuresprices have gone to all-time record highs on the prospect of falling interest rates is certainly more than odd. From an intermarket point of view the financials have been under pressure all year because commodity prices have been rising so we could argue that instead of cutting the funds rate and risking a sharp decline in the dollar a better solution would be to open up the Strategic Petroleum Reserve to push energy prices lower.

The chart shows the S&P 500 Index from March through November back in 2006.

The entire equity markets correction during the summer of 2006 fit between two points in time- the peak for copper prices in May and the eventual top for crude oil pricesin August.

Rising copper prices are often a positive for the equity markets while strength in oil pricescan become a negative. Between the peak for copper and the ensuing peak for crude oil the equity markets were quite negative last year.

Our point is that copper futures prices peaked this year in July and through trading yesterday crude oil futures prices had yet to find a top. The S&P 500 Index reached its highs along with copper in July in the same manner that it topped out in May last year. This is another spin on the argument that we can still have a very bullish equity markets outcome if, as, or when energy prices finally stop pushing upwards. The problem or concern is that if history were to repeat oil prices could push higher for another month which would lead to yet another equity market bottom during the month of October.



Equity/Bond Markets

The chart compares the pharma etf (PPH) with the ratio between equity and commodity prices.

The argument was that downward pressure on interest rates began around the middle of 2006 and this led to a rising trend for equities relative to commodities. We have alternatively used the stock price of Schering Plough (SGP) and the PPH to show this trend and relationship. The point today is that this trend can’t handle too many more days like yesterday with the CRB Index higher by 1.2% and the SPX lower by .5%.

Below we show the stock price of Mitsubishi UFJ (MTU) and the product or combination of the CRB Index times the U.S. Dollar Index (DXY) futures.

The argument is that commodity prices are rising- at least in part- due to the dollar’s weakness. The problem is that commodity prices are not rising as quickly as the dollar has been falling which creates the downward slope for the combination. This measure of cyclical strength explains why interest rates remain under pressure and, we suspect, why virtually all of the non-commodity cyclical sectors (from the Japanesebanks to biotech and even to the autos and airlines) have been so sluggish. The only cyclical game in town these days is commodities in general and, we suppose, energy and grains prices in particular.

The chart below shows the stock price of Boston Scientific (BSX) and the ratio between Exxon Mobil (XOM) and BSX.

In 1993 and again in 2000 the ratio between XOM and BSX reached roughly 7:1 and then on the first correction lower it fell to around 4:1. Each peak went with an extreme for interest rates and marked the start of a shift in theme away from energy and back to health care.

With the ratio once again at the highs and an imminent interest rate change apparently due it was our view that BSX should do better here- at least until the ratio had fallen back to around 4:1.