by Kevin Klombies, Senior Analyst

Friday, May 2, 2008

Chart Presentation: Paid

May 1 (Bloomberg) — Commodities fell the most in six weeks as a rally in the dollar eroded demand for energy, metals, crops and livestock as alternative investments.

We have argued time and time again that the strong commodity theme was being driven by the weaker dollar. Our problem was that the relationship was really supposed to be coincident instead of causal which simply means that in more normal times the two trends- strong commodities and a weaker dollar- would coexist without feeding off of one another. That the computer-modelers and momentum-followers would link these trends so tightly to the extent that a minor rise or decline in the dollar could affect the ability of people to afford to eat says much about the markets’ propensity towards excess.

At top right we have included a chart comparison between the CRB Index and the ratio between the Canadian and U.S. equity markets. When commodity prices are stronger the Canadian equity market outperforms and when commodity prices are weaker the U.S. market tends to do better.

Try as we might it is still almost impossible to argue that the commodity trend is now ‘done’. It might well be but the CRB Index chart shows that prices have declined to or just below the 50-day e.m.a. line on five previous occasions since last October with each dip leading right into another ramp higher. The Cdn/U.S. equity ratio may be off the recent highs but most certainly has not broken even the most minor of trend lines.

The chart at bottom right compares the Canadian dollar (CAD) futures with the ratio between the Canadian and Japanese ishares (EWC/EWJ).

In a weaker commodity trend the Japanese stock market should handily outperform the Cdn market but our point here is that the EWC/EWJ ratio is no closer to its 200-day e.m.a. line than it was last August, December, January, and March. The Canadian dollar continues to trade back and forth around its moving average lines while holding above what appears to be key support around the .9650- .9700 level. Yesterday was a good day for our thesis but not quite to the point where we are able to take a deep breath and mark this one as paid.



Equity/Bond Markets

We were negative on the home builders through much of last year but started to turn more positive during the final months of 2007. Every now and then we would comment that the home builders deserved a look once calendar year 2007 came to a close because ‘money’ tends to look for something new to do at the start of a new year.

At right we show a comparison between Nippon Tel (NTT) and U.S. home builder Beazer (BZR).

It isn’t that we are negative on the home builders at present but more that we can think of better things to do than chase fallen angels. Our explanation is based on the 2-year decline in NTT between 2000 and 2001 and the similar 2-year decline in BZR through 2006 and 2007. The argument is that ‘not going down is not really the same thing as going up’. In other words if you think of a trend change in terms of ‘angles’ a sharply declining price trend can simply lead to a prolonged flat trend- which is what the tech and telecom sectors did in large part from 2002 into 2008.

At bottom right we show NTT once again along with the U.S. Dollar Index (DXY) futures.

Our view is that a major trend change will shift focus from consumer to capital spending themes and this will be marked by strength in the dollar and weakness in energy prices. Instead of bottom fishing in a sector like the home builders we would prefer to focus on those groups that have been trading sideways for the past six or so years as the dollar has declined.

Below we show a comparison between Boston Scientific (BSX) and the ratio between Exxon Mobil (XOM) and BSX.

In late 1993 and again at the end of 2000 the XOM/BSX ratio reached a peak before turning lower for the next three or so years. All this means is that once the ratio finally loses touch with support around the 200-day e.m.a. line BSX should outperform Exxon for at least a few years. Yesterday was encouraging without being conclusive however.