by Kevin Klombies, Senior Analyst

Wednesday, June 11, 2008

Chart Presentation: The Unwind

From our point of view yesterday may well have marked DAY 1 of the ‘Great Commodity Markets Unwind’.

One of the problems or challenges that comes from comparing the current markets cycle to a previous time period is that history never repeats exactly. There are broad similarities, of course, but always with enough differences to hide the fact that the markets move through broad cycles instead of never ending trends.

Today we will start with a premise and then build upon it to construct a rather fascinating (if one is inclined to find chart-based theses interesting) forecast for the balance of the year.

The premise is that energy and metals prices, the commodity currencies, and the Asian equity markets reflect the same basic trend. In other words they trend higher together and they trend lower together. At the peak for Asian growth we will see the highs for currencies like the Canadian and Australian dollar as well as the peak for energy and metals prices while at the bottom for Asian growth we will see currency and commodity price lows.

On (too) many occasions in the past we have linked the turning or pivot point for the Asian growth/commodity theme with the trend for the stock price of Wal Mart. At top right we return to this argument by showing a comparison between WMT and the sum of the Canadian (CAD) and Australian (AUD) futures.

At the start of 1997 the stock price of WMT turned upwards and with the benefit of hind sight our argument is that this marked the start of a 2-year negative trend for Asian growth. As WMT began to rise the commodity currencies started to decline relative to the U.S. dollar.

However… as the chart at right of the CAD plus AUD futures and Hong Kong’s Hang Seng Index shows… the markets did not go quietly through 1997. The trend for the Hang Seng was obviously negative but that didn’t stop it from ballooning higher into August and then abruptly ‘crashing’ to come back to the negative trend line.

The premise once again is that energy and metals prices, the commodity currencies, and the Asian equity markets move together. In 1997 the Hang Seng diverged from the trend for 7 to 8 months before finally collapsing back ‘on trend’.



Equity/Bond Markets

Below we show the sum of the CAD and AUD futures along with the chart of WMT.

The argument is that around the end of October last year the market’s trend changed. As WMT pivoted higher it marked the start of a negative trend for Asian growth that would go with weakness in the commodity currencies and a negative trend for metals and energy prices.

The problem was and is that crude oil prices didn’t get the memo.

If strength in WMT marks the start of a trend change that is supposed to go with falling oil prices but oil prices continue to rise… then doesn’t this seem somewhat similar to what the Hang Seng Index did during much of 1997?

At top right we show the Hang Seng Index from 1997 while below right we have included a chart of crude oil futures from the current time frame.

The negative Asian growth/commodity trend began at the start of January in 1997 and appears to have begun once again around the end of October last year. We will use these two points in time to line up the charts.

The Hang Seng Index corrected lower for the first three months of 1997 before driving to new highs into August. Crude oil prices in the current cycle corrected for three months and then shot to new highs.

Through the initial three month correction in 1997 the Hang Seng created a downward sloping trend line that marked the ‘trend’ that it would eventually return to. Crude oil futures, on the other hand, worked through a flatter correction that may only point to a return to the 85 level later this year although we could quite easily justify something closer to 65- 70 if pressed.