by Kevin Klombies, Senior Analyst

Thursday, January 10, 2008

Chart Presentation: Touch

We spent our two week absence from the IMRA on the beaches of Mexico south of Cancun thinking deep thoughts, completing the open water scuba diving certification, and doing our best to not follow the news or the markets. We left the lap top at the office and when we simply had to access the internet we did so using an Apple iPod ‘touch’.

The ‘touch’ is a very nice piece of technology and we are especially fond of it because it helped save our sanity on the six hour plane ride home. We were able to watch 7 episodes of the sitcom ‘Corner Gas’ and a movie that we had loaded onto it ahead of time and this was enough of a distraction to keep us from throttling the very badly behaved children of apparently unconcerned parents who might very well have been reenacting their favorite mixed martial arts sequences in the seats behind us.

Our point today has something to do with technology. Comcast’s new 10-times faster than high speed internet which will allow for a 4-minute download of a high def movie, Matsushita’s new internet-enabled plasma TVs, wireless connections that will significantly reduce the demand for copper wiring, General Motors push to introduce the Chevy Volt by late 2010 which, if successful, would lead to a significant decline in gasoline consumption and, we imagine, to far fewer visits to the convenience stores tied to gas stations.

The chart at right compares the ratio of the gold miners (XAU) to the S&P 500 Index (SPX) to the ratio of the Nasdaq 100 Index (NDX) to the SPX from late 1992 forward.

The recent surge in gold prices and the swing back to strength by the gold miners has gone with a sharp decline in the tech sector. The intermarket argument is that these two cyclical growth sectors- mining and tech- tend to take turns so once the golds peak on a relative basis we should be ready to turn back towards the broad tech theme.

It may be that the reason the commodity sector has been so strong for such an extended period of time has something to do with the amount of excess capacity in tech and telecom developed into 2000. Now that bandwidth is being gobbled up by video sharing sites such as U-Tube we expect that there will soon be a need for capital to push back towards ‘tech’ to finance the next stage of development. However, this trend will only start in earnest after metals prices and the miners start to lose relative strength.


Equity/Bond Markets

One of our arguments of late has been that the equity markets go down with Caterpillar and up with the pharma sector. We have a few additional comments with regard to this on today’s third page but for now we wanted to take a rather large step backwards and show this relationship over a longer time frame.

At right is a comparison between the S&P 500 Index and the ratio between the pharma etf (PPH) and the stock price of CAT.

The SPX rose through the 1500 level in 2000 based on strength in sectors like pharma and then spent the next seven years trying to get back to this level based on strength in the basic materials and commodity-sensitive sectors.

The point is that the 2000 top for the SPX marked the relative strength peak for PPH versus CAT while the return to the highs in 2007 likely went with the cycle bottom for the ratio.

New trends often begin when they make the least amount of sense and that could certainly be true for the drug stocks this year. Senator Clinton just won the New Hampshire primary and has made it clear that if elected President she would take aim at the large oil companies and the major drug makers. On the other hand the baby boomers are getting older and health care as a broad theme makes very good sense. If they could just introduce a drug that would cure all the ailments that come from sitting for very long periods of time in front of a computer screen we would be more than pleased.

The chart at bottom right compares the Canadian dollar (CAD) futures with the CRB Index and the ratio between Caterpillar and Coca Cola (CAT/KO).

The Cdn dollar ended down close to a full cent yesterday at .9893. If we were to run a trend line up under the closing lows since early 2007 it would cut through around .9850 so the trend is certainly getting a good test this month.

The CAT/KO ratio tends to trend with commodity prices which in turn trend with the commodity currencies. We often use Wal Mart’s stock as a surrogate for the flip side of the commodity trend and WMT managed to close just a bit higher in trading yesterday.

In any event when the financials went into crisis last summer downward pressure began to form on interest rates and as interest rates declined the markets began to bid up the price of ‘real’ assets through rising commodity futures. This sent the Cdn dollar into the stratosphere as the CRB Index moved upwards.

The problem is that by the middle of last year the cyclical stocks that tend to go with rising commodity prices started to weaken as the equity markets began to focus on stable or non-cyclical growth. On the one hand investors (and we use that term loosely here) were buying momentum in the commodity markets while on the other hand they were selling cyclical shares and buying defensive growth. Early in 2008 we find the CAT/KO ratio at the lowest levels since 2005 even as the CRB Index flirts with new highs.

This divergence did occur back in 2000 so we will show how that worked in tomorrow’s issue.