Chart Presentation: Reverse Engineering

Our recent argument has been that as we enter a new quarter the euro has reached a critical decision point. After working through aconsolidation the euro is set to accelerate to the upside or fail to the down side. We have argued that commodity prices in general and gold prices in particular tend to trend with the major European currenciesso the fate of the broader commodity trend hangs in the balance.

We are going to ‘reverse engineer’ our argument today by working somewhat backwards. At right we show a chart of oil refiner Valero (VLO) and gold miner Barrick (ABX).

The charts are shifted in time by six months so that January of 2007 for VLO is lined up above July of 2007 for ABX.

Today’s argument comes in part from the comparison that we showed yesterday (and have included on page 4) of AMR, Valero, Barrick, and Canadian natural gas producer Duvernay. On occasion in the past we have substituted Chesapeake (CHK) for Duvernay to show the general natural gas theme.

The idea is that over the past few years the equity markets have shifted from theme to theme about twice per year. The first half of the year belonged to the energy theme while the second half of the year focused on either the non-energy sectors or, as was the case last year, the gold miners.

The comparative chart shows that once AMR turned lower it continued to trend to the down side for the next 18 months while VLO has been in a negative trend for the past 12 months.

We have offset the charts at right to make the point that Barrick in mid-2008 could be in a similar position as Valero at the end of December last year. Notice that through the end of last year VLO’s stock price rallied fairly sharply only to reverse back to the down side early in January.

If gold prices trend with the euro and Barrick trends with gold prices then what happens next for the euro and U.S. dollar should be important for the gold miners. If Barrick were to follow the path of both AMR and VLO then it would remain in a negative trend for the next six to twelve months. From an intermarket point of view this suggests that the euro has at least the potential to surprise to the down side.

Over the last few weeks we have been focusing on the potential for a major trend change that should extend through the second half of this year. The problem is that trend changes often do not show up in earnest until some time later in the month.

Below is a comparative chart showing Genentech (DNA) and the ratio between Mitsubishi UFJ (MTU) and the gold etf (GLD).

The idea is that the trend for biotechs like DNA is very similar to the trend of the ratio between Japan’s major banks and gold prices. If the biotechs are going to strengthen this quarter then this generally goes with a stronger U.S. dollar and weaker gold prices. DNA above the 82 level would argue for a better trend for thefinancials relative to gold prices.

Below we show the stock price of Boston Scientific (BSX) and the ratio between Apple (AAPL) and Genentech (DNA).

One of our arguments of late has been that both Apple and RIMM are closely tied to the commodity trend that has pushed crude oil prices higher. BSX, on the other hand, tends to do better once energy prices have turned lower. The ratio of AAPL to DNA tends to reflect the energy/health care tug of war so strength in DNA or weakness in AAPL should be a positive for BSX.

Quickly… the chart at bottom right shows the U.S. 30-year T-Bond futures and two moving averages for the sum of the Fed funds target rate (currently 2%) and 3-month eurodollar futures prices. When the sum rises above ‘100’ it tends to mark the highs for bond prices so we used this chart earlier this year to argue that the TBonds at or above 120 were at a peak. The problem is that the sum has fallen very rapidly to levels that have in the past been associated with major bond price lows so of late we have been considerably more positive on long-term Treasury prices.