by Kevin Klombies, Senior Analyst

Friday, July 11, 2008

Chart Presentation: MTU/GLD

July 10 (Bloomberg) — Japan’s wholesale inflation rate rose to a 27-year high in June as companies raised prices to counter record oil and commodity costs. Producer prices climbed 5.6 percent from a year earlier, after a revised 4.8 percent gain in May, the Bank of Japan said in Tokyo today.

Strange days indeed. Japanese producer prices rise 5.6% year-over-year and 10-year Japanese bond yields decline from 1.61% to 1.575%. Perhaps we are missing something here…

At top right we show a chart comparison between the ratio of the share price of Japan’s largest bank (Mitsubishi UFJ- MTU) and the gold etf (GLD) and short-term European debt futures prices. A declining trend for 3-month euribor futures prices indicates a rising trend for short-term European interest rates.

At present one of the dominant trends within the markets is ‘weak financials and strong commodities’. In other words the ratio of MTU to GLD is moving lower. We have argued that this trend began in earnest way back in late 2005 when short-term European interest rates began to rise and it makes sense to assume that the trend will continue as long as the ECB is inclined to push rates higher in an attempt to cool inflationary pressures.

The chart argues that downward pressure on the financials began in late 2005 so, in a sense, the collapse of many of the U.S. banks and brokers in 2007 represented prices coming back ‘on trend’. We suggested yesterday that the markets remained locked within a ‘circle’ as rising commodity prices increased inflationary pressures and European interest rates which pushed the euro higher and dollar lower leading to higher commodity prices. Our thought was that the best way for this circle to be broken was through a dramatic decline in commodity prices.

At bottom right we have included a chart of the S&P 500 Index from 2000 through 2003. The simple point is that in terms of ‘time’ the negative trend for the financials relative to gold prices has run on for about as long as the equity bear market from 2000 into the spring of 2003. Ideally what we are seeing this year as the MTU/GLD ratio shows signs of flattening out is something similar to the series of lows in the SPX from the second half of 2002 into March of 2003.



Equity/Bond Markets

We generally have a reason for our views even if the reasons aren’t always glaringly obvious. Quite often a particular view or opinion will come about as a result of us jumping from market to market. To explain we start at right with a chart comparison of the Shanghai Composite Index and the stock price of Las Vegas Sands (LVS).

In the past we have pointed out the strong similarity between the trends for the Chinese equity market and that of LVS. Since LVS is involved in Macao, China casinos the relationship makes some sense.

LVS made new lows yesterday while the Shanghai Comp. has been on the bounce back towards 3000. This very minor divergence sets the stage for the next part of the argument.

The chart at bottom compares Wal Mart (WMT) with the Shanghai Comp. The argument is that WMT turned higher and began to outperform the S&P 500 Index around the same time prices turned bearish in Asia. In other words WMT has been going up as the Shanghai Comp. has been going down.

WMT has so far failed to push through 60 and as prices have started to weaken somewhat we can see that Chinese shares have begun to strengthen. However, if LVS is ‘right’ then the Shanghai Comp. should move to new lows which in turn would lead to WMT moving on to new recovery highs.

Below we show the Shanghai Comp. along with a chart of the sum of two U.S. home builders- DR Horton (DHI) and Hovnanian (HOV). The charts represent two different periods of time so the idea is that the Chinese equity market is in the early stages of a negative trend that could run through into 2010. In a perfect world this index would reach its next intermediate-term bottom in October which would go with a peak for WMT. Putting this all together we realize that WMT is struggling below 60 but our positive view is based on the idea that the Asian equity markets are still in down trends as suggested by new lows for LVS and the argument that similar to the MTU/GLD ratio on page 1 when a major trend has reached a peak and turned negative it has tended to remain negative for at least two years.