by Kevin Klombies, Senior Analyst

Tuesday, August 28, 2007

Chart Presentation: The Commodity Pivot

The Nasdaq Composite Index rose above 2000 towards the end of November in 1998 and managed to surpass the 5000 level close to 15 months later in March of 2000. The Shanghai Composite Index, on the other hand, moved through 2000 last November and in roughly 9 months has eclipsed 5000.

We have included three charts of the CRB Index. The top chart shows 1986 through 1988, the middle chart is from 1996 through 1998, while the lower chart start at the beginning of 2006.

We are trying to make the point that in the second quarter of 1986 and the second quarter of 1996 the trend or direction for the CRB Index changed. In 1986 it bottomed and turned upwards while in 1996 it peaked and turned lower.

We mention this because this directional change for commodity prices appears to have preceded an equity markets ‘event’ by close to a year and a half. When commodity prices turned higher in 1986 it led in due course into the U.S. stock market ‘crash’ in the autumn of 1987 while the down turn for commodity prices in 1996 preceded the collapse in the Hong Kong stock market in 1997.

The idea is that a downward trend for commodity prices goes with falling interest rates while an upward trend will go with rising interest rates. What likely caused the ‘crash’ in 1987 was the combination of strong commodity prices and relentlessly rising interest rates.

One interesting feature of the 1987 and 1997 CRB Index charts is that the actual trend wasn’t that clear before the equity market ‘event’. In other words while the CRB Index had bottomed in the spring of 1986 it didn’t really surge higher until AFTER the stock market ‘crash’ and while the CRB Index peaked in 1996 real weakness didn’t show up until after the Hang Seng lost roughly 45% of its value between August and October.

Our point is that if we use the CRB Index (or the DJ AIG Commodity Index) as our measure of the trend for commodity prices (as opposed to any of the spot commodity indices) a peak was reached in the spring of 2006. This makes the current situation similar to 1997 because the trend for commodity prices is lower instead of higher and, if history is any guide, suggests that the focus of equity markets risk this autumn should be outside of the U.S. and likely concentrated in regions like Asia.




Equity/Bond Markets

We showed that the CRB Index turned lower in the second quarter of 2006 and that this was similar to the 1996 time frame that led into the Hang Seng’s decline in 1997.

We show two comparative charts of Coca Cola (KO) and Inco (N). At one time Inco was one of the Dow 30 stocks but in March of 1987 it and Owens Corning Glass were replaced by Coca Cola and Boeing. So… even though Inco no longer exists as a separate company after being bought out this year by CVRD it does share history with Coke.

Through much of 1987 the stock prices of KO and N rose in tandem as the equity markets pushed higher. After the stock market collapsed, however, the trend for the CRB Index (higher) set the trend within the equity markets with KO falling and N rising.

The opposite outcome occurred in 1997 as the break in Hong Kong followed weakness in Inco. After the equity market ‘event’ the negative trend for the CRB Index asserted itself within the equity markets leading to higher prices of KO and lower prices of nickel producer Inco.

Our thought is that if we get some sort of equity markets problem this autumn it will likely be focused outside of the U.S. and following its initial break we should get a sense of whether the CRB Index is going to continue to decline (better for Coke) or turn upwards once again (better for the miners).

Below is a comparison between Canada’s WestJet (WJA on Toronto) and China Southern Airlines (ZNH).

From 2000 through May of this year the charts were virtually identical. WJA rose just over 400% from the low in 2000 to the early 2004 peak and ZNH rose just over 400% over the same time frame. The charts were so similar that we have included an overlaid view on page 7.

From May into August this year ZNH has risen from close to 25 up to roughly 56. This is comparable to WJA closer to 40 instead of in the 17’s. Why the divergence? We suspect that it has less to do with value than it has to do with momentum and liquidity.