by Kevin Klombies, Senior Analyst

Monday, June 9, 2008

Chart Presentation: Second Half

Even though we have included a comparison between crude oil futures prices and the Nasdaq Composite Index into the first quarter of 2000 on a number of occasions (page 7 today) we found Friday’s oil price action somewhat disconcerting. One of our ongoing page 5 arguments- based on the relationship between the stock price of Potash Corp. and crude oil futures- indicated on Thursday that higher oil prices were due but we really expected something a bit less dramatic.

At top right we show a comparison between oil refiner Valero (VLO) through the first half of 2007 and Canadian natural gas producer Duvernay (DDV on Toronto) from the current time period.

Through the first half of 2007 the trend was based largely on rising energy prices with a particular emphasis on the refiners based on the fear of a shortage of gasoline. A year later VLO’s stock price has fallen all the way back below the lows set in January of 2007.

Through the first half of 2008 the trend has been based largely on rising energy prices with a particular emphasis on the natural gas producers. Our point is that- strangely enough- the rising trend for VLO began around mid-January and came to an end in mid-July while the rising trend for DDV began- somewhat conveniently- in mid-January as well.

What bothers us is the way the trends are always based on the threat of a supply shortage, run almost exactly from quarter to quarter, and then end with multi-billion dollar losses similar to Amaranth.

In any event… VLO’s stock price rose into the end of the first half of 2007 and then the markets shifted over to more of a gold-based theme. Below right we show gold futures and the spread between the U.S. 30-year T-Bond futures and the U.S. Dollar Index (DXY).

In early June of 2007 the spread between the TBond and the dollar began to widen and by late summer the price of gold began to lift off of the 200-day e.m.a. line. Towards the end of last week the bond market had begun to rise in price following a couple of attempts to push 10-year yields above 4.0% while the dollar moved lower. We would like to think that the markets have a bit more imagination than this and won’t follow a first half energy theme with a second half gold theme two years in a row but… perhaps we are giving hedge fund managers too much credit.




Equity/Bond Markets

One of our recurring arguments has been that once oil prices finally reach the top of the mountain and turn lower we should see price increases in stocks such as Wells Fargo and Carnival Cruise Lines. Obviously through the end of last week oil prices had yet to find a true peak.

We often argue that the markets work in what we term ‘offsets’. An extremely powerful trend will tend to have an offsetting trend in another market. A simple example would be the negative trend for the airlines that began back in 1999 as crude oil prices began to rise.

Below right we show a chart of General Electric (GE) and U.S. home builder Hovnanian (HOV) from 2000 into early 2002.

The idea is that when GE peaked in the autumn of 2000 and then turned lower the share prices of the home builders began to rise in response to falling interest rates. At that time- a year before the 9/11 terrorist attacks- it was not intuitively obvious that a collapse in the Nasdaq was going to create an offsetting boom in the real estate market.

We could have used the stock price of General Electric once again but we have chosen to show Hong Kong’s Hang Seng Index below. When the Asian stock markets began to decline last autumn commodity prices started to rise along with stocks such as Wal Mart (WMT) and Japan’s Matsushita (MC).

Our thought is that the Asian equity markets theme appears similar in 2008 to the stock prices of companies involved in the capital spending theme back in 2001. Now we have to look for the offsets and then try to understand what it is that the markets are saying about the way trends will emerge over the next few years.