by Kevin Klombies, Senior Analyst

Tuesday, January 29, 2008

Chart Presentation: Setup

We start off today with a chart comparison that we have shown on a number of occasions in the past. The chart below compares, from top to bottom, the stock price of Wal Mart (WMT), crude oil futures, and two moving average lines (100-day and 200-day e.m.a.) for the cross rate between the Japanese yen and the Australian dollar.

The yen/AUD tends to move inversely to the trend for commodity prices. When commodity prices are strong the currencies of countries such as Canada, Australia, and New Zealand tend to appreciate while the yen weakens. Conversely when the commodity trend is weaker the yen does better while the Aussie dollar declines.

We use the moving average lines for two reasons. First, to smooth out the daily fluctuations and second, because the lines tend to ‘cross’ at major trend change points and then continue in a new direction for several years.

Crude oil prices reached a peak at the start of 1997 so this serves as the starting point for our intermarket argument.

When oil prices peaked the stock price of WMT began to trend higher. For the next three years WMT’s stock price rose while crude oil prices remained below the previous price peak. Whether oil prices were declining- as they were through 1998- or rising- which was most certainly the case during 1999- the key was that they remained BELOW the cycle peak set at the start of 1997.

The forex markets confirmed the trend change in early 1997 by swinging the yen higher against the AUD. Once this trend changed it remained positive for the yen for the next four years.

We (obviously) do not know for certain whether $100 is going to be the cycle high for crude oil but the markets are behaving in a manner that suggests that it could or should be. WMT has tested the 50 level while the JPY/AUD cross rate has improved to the point where the moving average lines have converged. It makes for a very nice set up but when all is said and done the entire argument rests on premise that oil prices have peaked for the cycle. Wal Mart above 50- 52 would be encouraging while continued strength in the yen vis-a-vis the Aussie dollar would also help bolster our conviction.


Equity/Bond Markets

The chart below compares the stock price of Anheuser Busch (BUD) with the S&P 500 Index (SPX).

On page 1 we suggested that we could be one little bout of crude oil price weakness away from a major multi-year trend change so any argument based on recent relationships has to be at least somewhat suspect. Still… we soldier on.

Both BUD and the SPX bottomed at the start of March last year and then made a second bottom in mid-August. In theory if the equity markets are making proportional bottoms in terms of ‘time’ then the next low would be reached by the end of January. Since this is the third time that BUD has declined back to or below 48 with the previous two instances marking the lows for the SPX… a bullish view going forward seems to make a certain amount of sense.

Below and below right are two charts of General Motors (GM) and the ratio between the CRB Index and crude oil futures. The chart below covers the time frame from late 2003 forward while the chart below right runs from late 1989 into early 1995.

The CRB Index/crude oil ratio is important for a number of reasons. From our point of view it determines the base trend for the autos and airlines. When the ratio is falling it means that oil prices are stronger than general commodity prices and this goes with a negative trend for stocks like GM, Ford, and the general airline group.

We showed this comparison yesterday but wanted to make our point once again. The ratio has to bottom and turn higher before the autos will turn positive but it took a full two years- from the autumn of 1990 through the autumn of 1992- until GM actually kicked into gear. One or two other things had to happen as well so we will attempt to show how this worked later this week.