by Kevin Klombies, Senior Analyst

Wednesday, March 12, 2008

Chart Presentation: Relatively Normal

You are going to hear and read over the coming months that the ‘Fed is pushing on a string’ and that it is a ‘jobless recovery’. How do we know this? Because these are the same comments made each and every time the Fed tries to stimulate economic growth and they are based on the lagged impact of an expansionary monetary policy on economic activity. Our view is that every time the Fed has attempted to slow the economy they have done so and every time the Fed has attempted to kick start the economy they have been successful.

The equity markets rallied sharply yesterday on the news that the Fed was essentially going to trade illiquid mortgage-backed securities for liquid Treasuries. As far as plans go this one made sense to us. We also noted that while the markets were forecasting a 100% chance of a funds rate cut next week to 2.25% following Monday’s trading the odds declined yesterday to virtually a coin toss between 2.5% and 2.25%. The time to be long the equity markets is when the markets stop forecasting the need for sharply lower short-term yields and yesterday’s action improved conditions markedly.

For as unique as the current cycle may be there are pieces of it that are almost identical to past cycles so we start off today with a chart of copper futures and the ratio between wheat futures and the CRB Index.

As we have pointed out in the past the window for a grains rally tends to open when copper prices peak and then close following the last broad commodity rally that pushes copper prices back towards the highs. The wheat/CRB Index ratio skyrocketed between 1995 and mid-1996 as copper price traded basically flat beneath the early 1995 highs and the same thing has happened during the current cycle as copper has traded below roughly 4.00 since the spring of 2006.

The chart below compares copper futures with the stock price of Coca Cola (KO).

The point here is that KO tends to turn higher around the time copper prices finally peak so this chart not only makes the case that the cycle is progressing in a relatively normal fashion but also shows why the equity markets have been stressed of late. If copper prices were to explode to the upside then we would expect KO to break lower but as of today KO has done little more than pull back to support at the 200-day e.m.a. line to await the eventual price roll over for copper futures.



Equity/Bond Markets

We have a number of peculiar views with respect to the markets and, we would guess, one or two of them actually make sense. Whether the charts and explanations that we are going to show on this page today should be included in this category is still open to debate but… we soldier on nonetheless.

Below is a stacked chart of three markets. We start on the bottom with Boston Scientific (BSX), move on to Canadian gas producer Rider Resources (RRZ but it was actually taken over about a week ago so this is for illustrative purposes only), and gold futures.

We tend to believe that the markets work through a series of cycles. On the other hand most people seem to feel that trends must be extrapolated so that prices will either rise forever or fall through eternity depending on the direction of the trend over the past few months.

When the Fed started to cut interest rates in January of 2000 the trend for BSX turned positive and it remained that way until the Fed finally began to raise interest rates in the spring of 2004. As BSX turned lower the markets shifted over to the resource sector because, after all, strong commodity prices were the ‘driver’ behind rising yields.

From mid-2004 through 2005 the markets loved the natural gas story until, of course, it was discovered (surprise, surprise) that the gas market was the subject of some rather intense speculation and/or manipulation (as usual- we fully expect all kinds of revelations with respect to Asian trading in copper futures over the next number of months). The Fed stopped raising interest rates in mid-2006 after the markets shifted focus over to gold prices.

Our quick point is that for a time the trends pushing BSX and then natural gas appeared bullet-proof and investors were only too happy to chase prices ever higher because, after all, these were long-term trends instead of intermediate-term cycles. As the booms turned into busts a new never-ending trend would develop and as the rotation progressed we find gold prices pushing 1000. We read that gold prices are going to a gazillion and they would have to if today’s prices are going to be justified but… we would be not at all surprised to find in early 2010 that gold prices were trading in the 400’s.

Anyway… we also tend to believe that when sectors diverge from the long-term trend they make rather spectacular rises or declines in order to return to that trend. To explain we show a long-term chart comparison between Phelps Dodge (taken out by FCX in 2007) and Anheuser Busch (BUD).

Some will argue that it is a new dawn and a new day and that China’s voracious demand for metals will last forever. We argued years ago that this decade would be about ‘all things China’ but we never intended this to mean that China’s impact on the markets would only be positive.

The point is that between 1997 and 2002 PD fell far below ‘trend’ and to return to trend a number of things had to happen including a sharp decline in the dollar and a huge rise in copper prices. At present almost no one likes BUD- and for some very good reasons- but back in 2002 and 2003 absolutely no one liked the mining stocks either. We were told that copper inventories were too large for prices to ever rise just as we were told years later that the ‘mountain of corn’ would depress grains prices forever. How BUD will ever return ‘on trend’ is beyond even our imaginations but that is how the markets tend to work.