by Kevin Klombies, Senior Analyst

Thursday, July 24, 2008

Chart Presentation: Trend Thoughts

With the markets fairly active of late we are going to revert to a reasonably long-term perspective today. For one reason or another the more volatile the daily action the more likely we are to get ‘macro’ with our work.

Below we show a chart comparison between copper futures and corn futures from 1994 through into 1999.

The argument is and has been over the years that the grains rally once copper prices reach a peak. Each cycle is somewhat unique but in general the time to look for rising grains prices is after a strong rally for base metals. Once copper prices topped out at the start of 1995 the focus shifted over to corn futures.

The final peak for corn futures prices should occur around the time that copper futures are ready to break lower. In other words through 1995 and into 1996 copper prices traded roughly sideways as corn prices rose parabolically and then as corn prices reached a peak in mid-1996 it marked the end of the rally for commodity prices in general.

We have argued that the trend for commodities is similar to that of Asian growth so once corn and copper prices turned lower in 1996 the trend turned from positive to negative for the Asian equity markets. The Hang Seng Index actually moved to new highs into the summer of 1997 before ‘crashing’ but the point is that money began to move away from Asian growth in 1996 and continued to do so through the Asian crisis in the autumn of 1998. By early 1999 the trend reversed once again with Asian growth improving as commodity prices began to recover.

Where are we now in the cycle? Copper prices peaked in mid-2006 which initiated the rotation into the grains. The peak in grains prices went with what appears to be the final rally for copper prices and now the commodity markets are starting to break lower. Our view is that the U.S. dollar should do better as money starts to move away from the Asian, Latin, and emerging markets.

A year or two from now we expect to read that China is having trouble defending the yuan and eventually it will be forced into a devaluation. At present everyone knows that China’s currency has to rise but our sense is that it will instead move substantially below today’s levels.



Equity/Bond Markets

Below we show Coca Cola (KO) and copper futures from 1994 into 1999.

We have been fixating over KO of late because it seemed important to us in terms of the longer-term trend.

The charts have been shifted or offset by six months to support our argument that while KO and copper prices tend to move in opposite directions the stock price of KO tends to lead by about six months.

The trend for KO turned positive in mid-1994 fully six months before copper prices reached a peak. Once copper prices peaked grains prices started to rally so, in a sense, we should try to remember years from now to look for strength in the grains around two quarters after KO’s share price begins to push higher.

Below we show KO and copper prices- offset once again by six months- from 2005 forward.

KO began to trend higher at the start of 2006 with copper prices peaking close to the middle of the year which, in turn, turned the trend for corn futures prices positive.

The problem has been that KO’s share price peaked in January so if KO leads copper by six months and KO has been declining for six months then it is possible that instead of KO rising and copper prices falling… the markets are setting the stage for yet another rally for copper prices. In other words if the January highs for KO were to mark the end of the positive trend then by mid-year copper prices should be set to break to new highs. Our view has been that KO should resolve higher but our convictions were tested each time KO moved to new lows.

The correction for KO through the first half of this year went with a rally in copper prices and stronger trend for ‘commodity cyclical’ versus ‘consumer. In other words as copper prices pushed upwards the ratio between Caterpillar (CAT) and Pepsi (PEP) rose as well. We are going to touch on this again on page 5 but the point is that all of our views and arguments would look much better with copper prices nicely below 3.60.