by Kevin Klombies, Senior Analyst

Thursday, August 2, 2007

Chart Presentation: The Yield Curve and Copper

We start out today with three comparative charts of copper futures and the spread or difference between 10-year U.S. Treasury yields and 3-month Treasury yields.

When the yield curve is positively sloped it means that long-term interest rates are higher than short-term rates. This creates an incentive for money to move away from the safety of short-term in search of higher returns at the expense of increased risk. When the yield curve is flat or negatively sloped investors can eschew risk and pull money back into short-term TBills.

The twist is that while an inverted yield curve argues that investors should move away from ‘risk’ it is usually the acceptance of risk which creates the inverted yield curve in the first place. The charts at right argue that the low point for the yield spread was reached in 1995 and again in late 2000 at the peak for copper prices.

The current situation is shown below and once again the yield spread is low as copper prices are near the cycle top. Typically copper prices break lower which in turn helps to take the pressure off of interest rates. As short-term yields decline investors slowly start to push back towards longer-term investments as the cycle begins anew.




Equity/Bond Markets

Quickly… we have argued recently that the last bottom for the home builders late in the summer of 2006 went with the break below the 200-day e.m.a. lines by both Caterpillar (CAT) and Valero (VLO). VLO broke the line yesterday but CAT continues to hold near the highs. The two points that we wanted to make were that obviously the home builders were still negative through trading yesterday and we could also make the same basic argument for airlines like AMR. The stock price of AMR turned higher with the home builders last year and made new correction lows yesterday.

Quickly once again… the chart below right compares Anheuser Busch (BUD), the pharma etf (PPH), Coca Cola (KO), and IBM.

The argument has been that one after another stocks that were pressured lower in 2004 by the sharp rise in energy and metals prices are working back to 2004 levels. IBM has since broken well above that line and KO is doing a very nice job of holding in a weak market. The PPH and BUD have been knocked roughly 10% lower but if IBM’s path earlier this year proves to be a template they should work back to and through the resistance lines later this year.

We have included a long-term view of the ratio between crude oil and the TBonds along with the ratio between the stock prices of Schlumberger (SLB) and Coca Cola (KO). The idea is that from 1990 through 1998 the trend was weak oil and strong consumers and then from 1998 into 2007 the trend was the exact opposite. Now we are back to the original starting point as JNJ (below) works to set another bottom as the crude oil/TBonds ratio flirts with the highs of last year. Lower oil prices would obviously be a positive for the health care and consumer sectors.