Some times knowing where you are depends, at least in part, in having some idea where you came from. Or something like that.
We are going to run through one perspective of how the markets worked through the sequence that culminated in the collapse in asset prices last year. At right we show a chart of, from bottom to top, heating oil futures, lumber futures, the stock price of Canadian forest products company Canfor (CFP on Toronto), U.S. home builder Beazer (BZR), Citigroup (C), and nickel futures.
In the spring of 2004 we started to argue that the Fed was holding short-term interest rates too low for too long and that the markets would force rates higher through strength in energy prices. The chart shows that heating oil (as well as crude oil) futures prices finally broke to new all-time highs in the first half of 2004 which served to push interest rates upwards.
One of the first markets to turn lower in response to rising yields was lumber followed close to a year later by the forest product stocks. Twelve months after the forestry sector had swung into a bear market the U.S. home builders reached a peak and started to decline only to followed another year later by the major U.S. financials. By mid-2007 nickel prices reached a top with copper and energy prices finally breaking lower during the second half of 2008.
If one were to look back at a cycle dominated towards the end by weakness in U.S. home prices which created incredible pressure on the financials it is fairly easy to see- in hindsight, of course- how the cycle evolved. Energy price strength pushed interest rates upwards leading to a declining trend in lumber and then the forest products sector. In the midst of a speculative real estate market one of the key components- lumber- was declining in price. The negative trend jumped from lumber and the forest products to home builders and from there to the financials and base metals. Eventually the rolling asset price recession worked all the way through to copper and crude oil.
The point? Strangely enough the point is that while most seem intent of jumping back into the markets that broke to the down side last- base metals and energy- we tend to believe that we should focus on those sectors that turned down first. In other words… lumber. If the correction began with lumber then it makes some sense to believe that the recovery might begin with lumber. This is one of the reasons we will often show lumber-related charts on the back pages.
Belowwe have included a comparative view of the U.S. 30-year T-Bond futures and the ratio between gold and copper futures.
The basic point here is that anything above 5:1 for the gold/copper ratio is an extreme. It represents, we believe, a reflection of the markets’ concern about financial and sovereign debt default. Goldman Sachs’ commented last week that based on currency relationships gold prices are likely fair value somewhere closer to 710 which means that anything above that level is likely a reflection of the same state of risk aversion that drove the TBond futures to new highs above 125.
A second view is shown below using the ratio between Japan’s Mitsubishi UFJ (MTU) and the gold etf (GLD) compared to 3-month euribor futures.
The bottom line is that the downtrend for financials versus gold began in late 2005 when short-term European interest rates began to rise. The end of the squeeze would then require higher euribor futures prices which, of course, have already come to pass. The point? One of the best ways to ‘see’ that the crisis has truly come to an end should be through rising bank/gold ratios which are, of course, still near the absolute lows.
There are any number of major issues that have yet to be resolved and one of them is shown below. The chart compares the sum of the Canadian (CAD) and Australian (AUD) dollar futures with the ratio between crude oil and the CRB Index.
The point is that some markets have already corrected all the way back to late-2001 levels while others remain roughly half way between the 2008 highs and the 2001 lows. Either the CAD plus AUD has bottomed suggesting that oil prices have declined as low as they are going to go against general commodity prices or the next shoe to fall will be a second period of intense weakness for currencies against both the dollar and the yen.