by Kevin Klombies, Senior Analyst

Friday, May 25, 2007

Chart Presentation: May Days

In general the economy always appears ‘strong’ during May and June and by October and November it appears ‘weak’. The surprising strength in U.S. new home sales that was reported yesterday was a good example of this seasonal trend.

The charts below compare the S&P 500 Index (SPX), the sum of the Canadian and Australian dollar futures (CAD plus AUD), and the ratio between copper futures prices and the U.S. Dollar Index futures (DXY). The chart directly below shows the time frame from March through July in 2006 while below right is the time period from March of this year to the present day.

We did this comparison recently and have been including the charts on a daily basis in the back pages. The argument was that in May of last year as copper prices began to decline relative to the U.S. dollar the equity markets were pushing higher. Just as the two commodity currencies (CAD plus AUD) reached the channel top the equity markets broke rather sharply lower and the commodity currencies began to work lower.

The current situation is quite similar with the copper/dollar ratio already showing weakness this month even as the CAD and AUD work right back to the top of the trading channel. The SPX has been steadily working higher with much of the gains coming from commodity-oriented sectors.

The equity markets sell off in 2006 began with weakness in copper and the commodity currencies and ultimately ended when energy prices peaked in July. From May into July the health care theme- including the biotechs- performed quite nicely.



Equity/Bond Markets

We mentioned yesterday that our view was that we should remain equity markets positive at least into the summer but we have to admit that there is certainly a healthy amount of short-term risk- especially if energy prices disconnect from metals prices for a few months.

We have shown and argued that the cyclical trend is still positive so the idea is that when one cyclical sector starts to weaken another will start to strengthen. The chart at right shows the sum of copper and gold futures along with the sum of the share prices of Cisco and Nortel.

The telecom trend turned higher in early August 2006 as crude oil prices turned lower. It then peaked in February as metals prices swung higher. Our argument here is that the weaker the trend for gold and copper the greater the likelihood of a rally in the techs and telecoms.

At times we really feel like we are on the wrong side of the trend but when we step back and consider what ‘the trend’ is we are somewhat heartened. At bottom right we show the pharma etf (PPH) and the stock price of Anheuser Busch (BUD) along with the product of the CRB Index (commodity prices) multiplied by the Canadian dollar futures.

We have argued that ‘the trend’ is negative for commodity prices and positive for the non-commodity sectors. Within the context of the trading channels drawn on the charts it really does appear that we on the right side of this.

The Canadian equity market weakened relative to the U.S. equity market yesterday as the CRB Index turned lower. Notice that the Cdn/U.S. equity ratio has basically been ‘channel top’ this month which means that it is difficult to sustain any kind of strength in commodity prices. We will continue with this thought on the next page.