by Kevin Klombies, Senior Analyst

Thursday, March 27, 2008

Chart Presentation: Rubber and Road

We generally try to stay fairly ‘macro’ in the first page of the IMRA but it is time, we suspect, to tighten things up just a bit. Our sense is that the markets are rapidly approaching a decision point of some significance so ‘long-term’ might well be measured in weeks instead of years.

For quite a number of months we have been arguing that the change in trend should include a ‘pivot’ in terms of relative strength similar in some respects to the spring of 2000. Below we can see that the Nasdaq reached a high in March of that year as financials such as Canada’s Bank of Montreal (BMO) reached a low. When the Nasdaq finally moved above 5000 the stock price of BMO was at a bottom but after a 10% correction in the Nasdaq we can see that the recovery rally in tech and telecom back to 5000 occurred even as BMO continued to push upwards.

For the current trend we have replaced the Nasdaq with crude oil futures and are using Fannie Mae instead of the Bank of Montreal. We show this comparison below.

The short-term argument that we presented at the start of the week was that crude oil futures may well take another run at the 110 level. Similar to the 2000 Nasdaq oil prices have recently declined by close to 10% before finding support at the 50-day e.m.a. line. Concurrent with this decline we find that the share price of FNM has gapped skyward.

This is where the ‘rubber meets the road’. The set up that we are looking for includes a short-term period of strength for commodity prices without much damage being done to the financials. Ideally stocks like FNM and Citigroup (page 2) actually push on to new highs over the next week or so to indicate that the commodity trend has come to an end even as buyers rush forward in an attempt to catch the next break out for crude oil. It makes for a lovely set up… although the jury is obviously still out with regard to how the financials are going to fare into next week.



Equity/Bond Markets

The rally in crude oil prices yesterday came at the appropriate time even though it is hard to get used to 4-point price gains on news of little significance. Of course gasoline inventories are declining. At the highest levels since 1993 they had almost nowhere to go but down and since refiners are working at mere 82% of capacity the reduction in gasoline refining means a reduction in the demand for crude oil.

In any event the charts at below compare the stock price of Wells Fargo (WFC) with the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX). The XOI/SPX ratio trends with energy prices and at the bear market lows for the SPX in 1990 (chart at right) the oils had reached a relative strength peak.

We have argued that WFC should be ready to rise above its 200-day e.m.a. line when the XOI/SPX ratio is ready to break down through its moving average line. Fair enough. The problem is that each time WFC spikes up over its moving average line… oil prices surge upwards to elevate the XOI/SPX ratio. In reality yesterday’s action was little different that early February (marked on the chart below right). The problem is that in early February oil prices turned higher from around 86 and didn’t stop until 110- 111 was reached. If history repeats crude oil is due to climb to 125.

The key, as mentioned on page 1, is how the financials handle the pressure. Below we show a chart of Citigroup. Notice that at the start of February it was just below its 50-day e.m.a. line- similar to its position earlier this week. C bottomed at 24 in January, close to 18 in February, and if this cycle continues may well see 12-13 into May. On the other hand if C manages to break out above 25 then trend has reversed which would argue for much lower crude oil prices.