by Kevin Klombies, Senior Analyst

Thursday, April 3, 2008

Chart Presentation: The Time

April 3 (Bloomberg): Valero Energy Corp., the largest U.S. refiner, said last week that output from its catalytic cracking units, the primary gasoline-making devices at its 15 U.S. refineries, has been reduced to 73 percent because of “uneconomic” margins.

Crude oil prices spiked 3.63 higher yesterday as gasoline inventories declined more than expected while crude oil inventories rose more than expected. We have argued that the ratio of the price of crude oil to gasoline is much ‘too high’ and that this will either be resolved through lower crude oil prices or rising gasoline prices.

We read from time to time that without the speculative premium crude oil prices could well be ‘fair’ between 50 and 55. Our view is that this is the time- perhaps long past the time, actually- for something to be done about that. Either open the Strategic Petroleum Reserve, place limits on the long-only commodity index funds, or face the very real prospect of gasoline prices rising by as much as 40% from current levels into May.

At right are two comparisons based on the share price of Wells Fargo (WFC) and the ratio between the Amex Oil Index (XOI) and the S&P 500 Index (SPX). The top chart is from 1990- 91 while the lower chart is from the present time frame.

The S&P 500 Index bottomed in early October in 1990 just after the peak for crude oil prices and the highs for the oils (XOI) relative to the broad market (SPX). The chart detail that we have been focusing on over the past few months has to do with the way WFC finally moved up above its 200-day e.m.a. line at the end of November concurrent with the break below the moving average line by the XOI/SPX ratio.

Our argument has been that WFC should be ready in the current cycle to move above its 200-day e.m.a. line when the energy trend has weakened to the point where the XOI/SPX ratio falls below its moving average line. Notice on the chart at right how WFC keeps spiking up through the moving average line and then is beaten back down again as oil prices strengthen.

Time and time again the XOI/SPX ratio has held just above the moving average lines with oil prices snapping dramatically higher to keep the energy trend positive. Time and time again the banks surge higher and then fade lower. Such was the case this week as Tuesday’s stock market strength led directly into yet another rally for crude oil.




Equity/Bond Markets

Over the years we have argued that we will know that Japan has escaped from deflation when Japanese 10-year yields rise above 2.0%. That level has been tested on occasion but as of yesterday were back to 1.375%. From 1994 forward the Nikkei has tended to rise as yields move upwards and decline as yields move lower. From 1998 forward the U.S. equity markets have followed the same trend.

On a relatively short-term basis we have suggested that the Japanese 10-year (JGB) bond futures have to decline below 137 to show that the banks are ready to recover on a sustained basis. At right we show the JGBs scaled upside down along with the chart of Japan’s Mitsubishi UFJ (MTU). We used to include Bear Stearns in this comparison but it seems somewhat less than relevant to do so now.

In any event… the banks and brokers rallied nicely following UBS’s biting of the proverbial bullet but, in all too typical fashion, crude oil prices snapped higher the next day. We would like to see the JGBs down through 137 so that the argument can be made that this rally has some traction but that will obviously take more time.

Quickly… we like the Japanese equity market for a number of reasons but the best reason not to like it is that it has been an underperfoming pig for a very long period of time. At bottom right we show the ratio between the Nikkei 225 Index and the S&P 500 Index from the early 1980’s to the present day to put this into perspective. However… the CRB Index peaked in November of 1980 and bottomed 18 1/4 years later in February of 1999. The Nikkei peaked 18 1/4 years ago so one might argue that its levels today are similar to commodity prices in early 1999.

The chart below compares Genentech (DNA) with the ratio between commodity prices (CRB Index) and equity prices (SPX). If, as, or when the CRB/SPX reaches a final peak it will mark a similar set up to that of the spring of 2003. Notice that following the ratio’s peak in 2003 the biotechs began to push higher so the better action in both DNA and the Biotech etf (BBH) over the past quarter has most certainly had our attention.