by Kevin Klombies, Senior Analyst

Friday, June 22, 2007

Chart Presentation: The CAD

When a market or security ‘drives’ upwards as hard as the Canadian dollar did this year we argue that it is coming back ‘on trend’. Relentless day-after-day price adjustments reflect a market that has been pushed well away from its underlying trend and is swinging back to it. Being on the right side of one of these swings is golden but being on the wrong side- as we were with the Canadian dollar- is definitely not an enjoyable experience.

The basic point is that a market that ‘drives’ is coming back ‘on trend’. Fair enough. The next point is that regardless of what you think should be happening the market serves as the final and ultimate arbiter. We can argue that the market is wrong but that makes about as much sense as arguing with gravity after stepping off of a ledge. It might make for a spirited debate but it won’t change the outcome.

However… we have been known to argue with the widely accepted consensus view and we have a history of arguing with both the markets and common sense so we thought we would return to a chart-based perspective that we introduced several years ago.

The chart compares the Canadian dollar futures, crude oil futures, and the spread or difference between short-term U.S. and short-term Canadian debt futures (3-month eurodollars minus 3-month Canadian Bankers Acceptance futures).

When the debt price spread is above ‘0’ it means the Cdn yields are higher than U.S. yields and when the spread is below ‘0’ it means that U.S. yields are higher than Cdn yields. A level of, say, -1 would imply that 3-month U.S. yields are 1% higher than Cdn yields.

The idea is and was that when the spread reaches a bottom- as it did in 1997 and again through 2000- then the Canadian dollar is at a peak, crude oil prices are making a top, and over time U.S. yields will slowly decline relative to Cdn yields. Our argument was that the Cdn dollar and crude oil prices have been working through a very extended ‘top’ that began back in 2005 and the trend for both would remain negative until the debt price spread returns to or through the ‘0’ line.


Equity/Bond Markets

In general commodity prices rise when the U.S. dollar is declining and vice versa. On this page we show two comparisons based on the ratio of the CRB Index to the U.S. Dollar Index. When the ratio is rising it means that commodity prices are strong and the dollar is weak and when the ratio is declining it shows that the trend is positive for the dollar and negative for commodity prices.

From time to time we argue that there are some interesting ‘decade’ trends on the go. We have shown, for example, that there were stock market ‘crashes’ in both 1987 and 1997 so we will be inclined towards caution later this summer.

The CRB/DXY ratio peaked in May of 1996 as the stock price of chip maker Intel (INTC) began to rise. The ratio peaked once again in May of 2006 around the time that the trend for INTC turned positive once again.

The first top for INTC was reached in August 1997 leading into a year-long correction that ended after the 1998 Asian crisis. From late 1998 into 2000 the trend was extremely positive for the tech sector.

Below we show the stock price of DaimlerChrysler (DCX) and the CRB/DXY ratio from 1994 through 1999 and again from 2004 forward.

The ratio began to ‘top’ towards the end of 1994 and as it worked up towards the highs into 1995 the stock price of DCX began to lift. As the ratio turned lower in 1996 DCX pushed well away from the rising support line only to peak in July 1997. As the Hong Kong market collapsed DCX moved back to support before pushing to new highs into 1998. The peak for DCX in the summer of 1997 was made around the time that the CRB/DXY ratio broke to through its support line. If history were to repeat then DaimlerChrysler would remain positive until the ratio broke below the lows reached this past January.