Currency/Commodity Markets
The chart below compares the euro futures with gold and crude oil futures.
The euro has trended quite closely with energy and metals prices in recent years so the basic point would be that U.S. dollar strength and euro weakness should go with an easing of commodity price pressures. In this example the euro going sub-1.45 (below the 50-day e.m.a. line) would suggest sub-90 crude oil and gold moving back towards the mid-700’s.
At right we show the Japanese yen futures and the ratio of the Nikkei 225 Index to the S&P 500 Index. Below right is a chart comparison between the ratio of crude oil prices to the CRB Index and the ratio of Asia ex-Japan stock prices to the Nikkei 225 Index.
We are combining both charts into one basic argument. The idea is that over the past few years the Japanese stock market has only outperformed the SPX during those periods of time when the yen was weaker. The conclusion would be that Japan’s export-oriented industries can only do better with a weaker yen.
The point, however, is that this has been a function of a trend that has included very strong oil prices and through the past few decades the yen has tended to weaken when oil prices are strong and rising. In other words the Nikkei’s reaction to yen strength of weakness remains a function of a trend towards higher energy prices that is inherently bearish for Japanese stocks.
The argument that we are circling is that in a strong commodity trend those markets that produce commodities will have strong currencies and strong equity markets. For Japan to return to relative strength so that the Nikkei rises with a strong yen the trend for crude oil prices has to finally turn negative.
Short-Term Views
At right we show a comparison between Freeport McMoRan (FCX), PetroChina (PTR), and the Chinese etf (FXI).
Over the weekend China announced yet another increase in banking reserve requirement ratios and will likely increase interest rates for the sixth time before the end of the year in an attempt to cool rising inflationary pressures. Given that the equity markets tend to lead real prices there is a risk that Chinese shares will decline.
The charts at right make two points. First, the trend for mining sector (FCX) is very similar to that of the broad Chinese market (PTR and FXI). Any break in Chinese stocks should go with weakness in the metals and miners.
Second, all three are tracing out potential ‘crash tops’. Risk will increase substantially if the November lows are broken.
Below right is a comparison between the ratio of the stock price of Coca Cola (KO) to the SPX and that of FCX to the SPX.
The point here is that over the past two weeks the markets have shifted back to the commodity sector and away from the more defensive consumers. As the FCX/SPX ratio has risen the KO/SPX ratio has declined. Our thought is that any kind of negative reaction to monetary tightening in China this week that extends to metals prices should be viewed as a positive for the large cap consumer names.
The big argument has been that the SPX should start to rise once the crude oil/TBond futures ratio peaks and turns lower. Bond price weakness into the end of last week was offset to some extent by Friday’s decline in crude oil prices but, as we showed on page 3, a stronger dollar and weaker euro appears still to be necessary if energy and metals prices are going to move more than marginally lower than present levels.
