Jan. 7 (Bloomberg) – Oil futures tumbled 12 percent, the most in more than seven years, after a U.S. government report showed bigger-than-expected increases in supplies of crude oil, gasoline and distillate fuel as consumption dropped.
We start off with a chart of Japan’s stock market from 1989 into 1991. The Nikkei rose to a huge ‘bubble’ peak at the end of 1989 and then collapsed not once but twice. The first break occurred through the first quarter of 1990 followed by a one-quarter reprieve into early July. As the third quarter commenced the Nikkei appeared to be on the mend before breaking sharply lower through the balance of the quarter to make bottom at the end of September.
The point is that Japan had received massive inflows of capital through the second half of the 1980’s and as money began to leave the stock market dropped sharply, rebounded through into the start of a new quarter, and then collapsed a second time.
We will argue that the entire commodity theme received similar capital inflows over the past few years and that it will take some time for the true believers and late-cycle converts to be pushed out of their positions. In other words while commodity prices have rather obviously declined it is our conviction that many of the owners of commodity-related positions are still holding in the hopes that prices will ‘come back’.
The chartbelow features the sum of the Canadian (CAD) and Australian (AUD) dollar futures. The argument here is that these two currencies represent the broad commodity theme and after breaking- hard- to the down side through the third quarter of last year the CAD plus AUD sum was on the rise through December and into early January as traders began to feel better about commodity prices.
If the CAD plus AUD were to follow a similar path to the Nikkei back in 1990 then some time during the first or second quarter of this year prices would start to buckle once again. In fact, it is conceivable that the ‘sum’ could fall as low as 1.00 (suggesting an average of .50 for both currencies). The Nikkei fell very close to 50% in 1990 (from 39,000 to 20,000) so a comparable decline for these two currencies would take them from around 2.00 down to 1.00. It could happen.
We are going to do a chart-based comparison that may or may not be fair but, we believe, is firmly within the realm of the possible. In other words we are going to argue that ‘it could happen’.
We are going to continue- in a strange way- with the argument that we presented on today’s first page.
Below we show the sum of copper (in cents) and crude oil (in dollars multiplied by three times) and the Nikkei 225 Index from 1989 into 1991.
The point here is that the second break in the Nikkei in 1990 actually went with a very sharp rise in another asset class. Between July and the end of September in 1990 as the Nikkei tumbled the combination of copper and crude oil prices drove relentlessly higher.
Now… we are not arguing that the commodity currencies will break lower as commodity prices rise. To the extent that the third quarter of 1990 was an extraordinary time as Iraq invaded Kuwait it may make no sense to compare this time frame with any other. However, the point that we were trying to make is IF we get a second wave of capital outflows away from the commodity theme during the first half of 2009 THEN it is possible that one or more sectors will rise as a result. In 1990 it was copper and crude oil as money moved away from Japan while in 2009 it would have to be either a non-commodity or commodity-using sector.
We started off by including a snippet from a Bloomberg article which mentioned the weakness in crude oil prices. Below we show the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX) along with the Canadian dollar (CAD) futures. The very quick point here is that there is a definite relationship between relative strength in the oils (i.e. the XOI/SPX ratio) and the Cdn dollar. We are the start of a new quarter and year, the XOI/SPX ratio is back at the recent highs, crude oil prices have just declined by more than 12%, and the Cdn dollar has been on the rise since early December. It does make for a nice set up.
The problem for the equity markets is that nothing aside from the commodity cyclicals seems to have any strength which simply means that the stock markets tend to tumble when commodity prices weaken. What we would like to see is a positive reaction in a non-commodity sector to quarterly earnings so that money has something to do besides flee towards cash every time real asset prices begin to decline.
