by Kevin Klombies, Senior Analyst TraderPlanet.com

Thursday, June 14, 2007

Chart Presentation: The Yield Spread

As you dig deeper and deeper into the markets you often find more questions than answers. Today’s Chart Presentation is one such example.

We show three chart comparisons between copper futures prices and the spread or difference between 10-year and 3-month Treasury yields. The 10-year minus 3-month spread is generally considered to be the best measure of the slope of the yield curve.

The chart shows the time frame through the lows for the yield spread in 1995 while the chart at bottom feature the yield spread’s reversal at the end of 2000. In both instances when the yield spread finally turned higher it marked the beginning of weaker copper prices.

The yield spread is currently rising at a furious pace so the historical examples would argue that this is the start of declining metals prices. The caveat- and it is a large one- is that the yield spread is rising on higher long-term yields instead of falling short-term yields. However, because we tend to believe that significant trend changes occur when they make the least amount of intuitive sense our conclusion is that we should believe the yield spread and look for weaker metals prices into 2008.

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Equity/Bond Markets

We show crude oil futures and the ratio between the oils (XOI) and the airlines (XAL).

The XOI/XAL ratio swings higher and lower with crude oil prices and at present it is so ‘high’ that it makes sense to look for weakness in energy prices. The problem is that the ratio continues to make new highs which makes the very succinct point that the trend for crude oil is still positive.

The strength in the oils might best be described as pervasive. The ratio of the Amex Oil Index (XOI) to the S&P 500 Index (SPX)- chart below right- fairly defines the trend for commodity prices and it has simply refused to turn lower. As it grinds upwards it holds the trend for the CRB Index positive which, we suspect, is why we are getting such wild swings in any commodity (like wheat and corn yesterday) with bullish fundamentals.

The chart below compares the stock price of IBM, the pharma etf (PPH), Coca Cola (KO), and Anheuser Busch (BUD).

The first point is that we have argued that stocks that were driven lower by stronger commodity prices and rising interest rates in 2004 are swinging back to 2004 levels. Notice that IBM, the PPH, KO, and BUD are back to the trading range of early 2004.

The second point is… what happens next? We noticed that IBM dropped sharply early in the year after touching 100 and at present KO and the PPH are attempting to swing higher after making similar sell offs. We would like to see at least one of these stocks extend upwards so that we have some sense that there is still more to come.

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