by Kevin Klombies, Senior Analyst

Monday, July 9, 2007

Chart Presentation: Gas

While we await some form of weakness in crude oil futures prices we can’t help but notice the divergence that has been created between oil and gas prices since the start of June. The chart shows that as crude oil futures have risen from roughly 63 to 73 natural gas prices have declined by more than 20%.

What is interesting about this is that the trend for gas prices is very similar to the trends that we have been following for stocks like Nucor (NUE) and Bear Stearns (BSC). The chart below right makes the case that there has certainly been a very tight relationship over the past number of months between natural gas prices and the stock of steel maker NUE.

Crude oil and natural prices can and do diverge but only to a point. The chart below shows the ratio of crude oil to natural gas futures from late 1993 up to the present time period.

In general the ratio can rise to around 13:1 and fall below 5:1. At the three most recent peaks for U.S. interest rates- early 1995, the end of 2000, and mid-2006- the ratio was at an extreme. In 1995 the ratio was ‘high’ with oil prices strong relative to gas and towards the end of 2000 the ratio was almost ‘off the chart low’ with gas prices very high relative to oil. The sense here is that this divergence may not end until the crude oil/natural gas price ratio has moved back to the upper extreme shown on the ratio chart and that this will go with the second and hopefully final peak for interest rates.




Equity/Bond Markets

Over the past number of years- certainly from 2003 forward- the markets have been shifting back and forth between various cyclical themes with the dominant theme represented by rising commodity prices.

When the commodity theme reaches a peak the markets can either rotate back to the non-commodity sectors or simply shift into a bear trend. Given that the equity bull market is getting older the chances of a negative outcome increase each time we get to a relative strength extreme.

We show the stock price of oil refiner Valero (VLO) and the ratio between the Amex Oil Index (XOI) and the Airline Index (XAL).

At the close of trading on Thursday the airlines had been just strong enough to pull the ratio back to the support line. In other words we were either going to get a fresh blast of rising oil and gasoline prices or the entire rally that began to form at the start of the year was coming to an end. Our thought has been that after two quarters of ‘all things commodity’ we should see a roll back into groups like the airlines but we would like to see the ratio break to the down side before we get too excited about the prospect of something new happening.

The chart at bottom shows the ratio of the XAL to the S&P 500 Index (XAL/SPX) along with chip maker Intel (INTC). The basic point is that the airlines are now as ‘low’ relative to the broad market as they have been since the start of the equity ‘bull’ back in early 2003. If the positive equity trend persists and given the extreme position of the oils and mines we would have to argue that the airlines are in a position where they could really ‘fly’.

The chart below compares the CRB Index with the sum of 3-month and 10-year U.S. Treasury yields.

The equity markets have been rising over the past twelve months on lower interest rates and the downward pressure on yields has come from weakness in commodity prices. Our entire thesis has been built on the argument that 10-year Treasury yields and the Fed funds rate peaked at 5.25% so the longer the CRB Index pushes higher the greater the stress on the various markets.