by Kevin Klombies, Senior Analyst

Monday, June 18, 2007

Chart Presentation: Wal Mart

We start off today with a comparison between the sum or combination of copper and crude oil futures prices, the Fed funds target rate, and the U.S. 2-year T-Note futures.

The idea here is that the peak for bond prices in 2003 went with the low point for the Fed funds rate. As copper and crude oil prices began to rise into 2004 upward pressure was placed in yields which eventually led to an increase in the Fed funds rate from 1% to 5.25% and a downward trend for 2-year T-Note futures.

We have argued that the cycle should work the same way in reverse with weakness in energy and metals prices leading to a peak in the Fed funds rate and a bottom for bond prices. We have also argued on many occasions that once copper and crude oil price reached a top- as was the case in mid-2006- the equity markets should ‘drive’ in relentless fashion for a least the next twelve months.

The argument makes reasonable sense given the steady ascent in the equity markets since last summer although the recent rally in commodity prices does create some measure of stress. If the thesis was based on the idea that interest rates would peak with commodity prices then obviously we are going to have to develop an alternate thesis if commodity prices rise to new highs with bond prices breaking to new lows.

The problem is that one pays a very high price for certainty. The markets tend to shift trends when it makes the least amount of sense so we are always on the look out for price action that goes against the general consensus view.

At bottom we have included a comparison between the U.S. 2-year T-Note futures and the stock price of Wal Mart (WMT).

We often argue that WMT trends with the U.S. dollar and bond prices and inversely to energy prices. At the moment we all know that energy prices are high and rising due in large part to a series of unplanned and seemingly inexplicable U.S. refinery shut downs. It may be that WMT’s recent price surge will fade away once again but the chart suggests the potential for a near-term bottom for bond prices that would be confirmed or at least indicated if WMT were to steady out and rise to new recovery highs. Our point is that there are many reasons for WMT to slump back below the moving average lines but if the rally continues then the message would be that energy prices and interest rates are once again ready to turn lower.



Equity/Bond Markets

The chart compares the U.S. 10-year T-Note futures with the ratio of copper futures to the CRB Index.

The copper/CRB ratio tends to peak at the bottom for long-term Treasury pries. In other words when copper prices are strong and rising the offset will be a rising trend for interest rates.

The bottom for bond prices in both 1989 and 1995 went with the peak for the copper/CRB Index ratio.

If we examine the recent trend we can see that bond prices have been working through a potential bottom ever since May of last year when the ratio reached a peak. The bottom line is that we can make a very positive case for bond prices right here and right now if and only if copper prices start to weaken relative to general commodity prices.

As we stated on today’s first page there is a very high price to be paid for certainty. By the time it becomes clear and evident that copper prices actually are declining many other markets will have adjusted prices accordingly.

The chart below shows copper futures and the ratio between the stock price of Intel (INTC) and the S&P 500 Index (SPX). Last week INTC was upgraded in part because the long price and market share war with AMD was coming to an end. Our view is that the market will only be interested in pushing INTC sustainably higher if the metals price trend is ready to turn negative. In other words the more positive the reaction to news for INTC the greater the odds that the copper prices are not going to new highs any time soon.

Below we show the ratio between Japanese and U.S. 10-year bond futures. As drawn the ratio has risen to the very upper edge of a declining channel. Our view is that it is possible for long-term Japanese interest rate to rise even as U.S. yields decline if the channel represents ‘the trend’. Put another way with the JGBs in the 131’s and the T-Notes in the 104’s we would expect to see prices move towards convergence through the balance of the decade.