by Kevin Klombies, Senior Analyst

Tuesday, November 20, 2007

Chart Presentation: Metals

The chart at right compares the Chinese equity market (Shanghai SE Composite Index) with the spread or difference between copper futures prices (in cents) and crude oil futures (in dollars and multiplied by three times). The rally in Chinese shares went with the sharp rise in copper prices relative to crude oil that began in late 2005. Our view is that the spread will continue to decline as copper prices fall back towards or even through 2.00.

The chart below right shows the gold/copper ratio. Our antipathy towards gold has been predicated on our rather overwhelmingly negative view on copper. To the extent that copper prices hold or rise, however, the ratio causes significant upward pressure on gold prices.

Below is a comparison between aluminum futures and gold futures. Gold has found support repeatedly at the 200-day e.m.a. line so 700 is a reasonable short-term down side target.

Aluminum, on the other hand, has broken below this moving average line which has turned from support into resistance. Risk below 700 for gold prices will increase rather substantially if aluminum prices fail to hold at the recent lows around 1.05.



Equity/Bond Markets

At right are two comparative charts featuring the pharma etf (PPH) and the ratio between equity (S&P 500 Index) and commodity (DJ AIG Commodity Index) prices.

We did this one yesterday but we thought we would take another run at it. The premise is that at the peak for energy and metals prices we get lower interest rates and as interest rates decline the price of financial assets (stocks and bonds) will rise relative to commodity prices.

In any event the chart at top right shows the relationship between March and August of 2006. Downward pressure on the equity markets began in March and ran into mid-July and as the equity/commodity ratio began to lift the pharma sector responded by moving broadly higher. Yesterday’s observation was that the start of crude oil price weakness in early August lagged behind this recovery by about four weeks.

This year (chart below right) the ratio began to decline in July before making a bottom in early November. In terms of both time and ‘slope’ the ratio corrected in a manner almost identical to 2006. The only thing missing- so far- is a bullish response from the pharma sector that would carry the PPH up and away from the 200-day e.m.a. line.

The point yesterday was that if history were to repeat almost exactly we could still see upward pressure on crude oil prices for another two weeks.

However… from another perspective we can also argue that crude oil futures prices ‘should’ have turned lower more than a month ago. The charts below compare the SUM of the share prices of Caterpillar (CAT) and Valero (VLO) from 2006 and 2007. Last year copper prices peaked in May with oil prices turning lower in August. These two ‘commodity events’ went with the double top in the CAT+VLO combination. This year copper prices peaked in July and oil prices should have turned lower in October. Our point, by the way, is that the recovery in the non-commodity cyclicals began during the first half of September last year after the sum of CAT and VLO broke below the moving average line and the June lows. Very close to where things stand at present.