The “Two-Year Lag”

11/28/2008 12:01 am EST


We are going to dig for some perspective to start off today's issue. The ongoing thesis has been that the trend for commodity prices lags behind the trend for Treasury prices by something close to two years. In other words, when bond prices turn higher-usually because of the sort of cyclical weakness that goes with falling commodity prices-it takes two years before the trend for commodities swings back to positive.

We are going to use yields instead of bond prices for today's comparison so the relationship becomes inverse. Rising yields precede a peak for commodity prices by two years, while falling yields tend to lead a bottom for commodity prices by the same length of time.

The first chart below shows the sum of three-month and ten-year US Treasury yields. We have combined short- and longer-term yields because in recent years most of the wilder swings have come from changes in short-term yields.

Below is also a chart of the CRB Index. The two charts have been shifted or offset by two years so that yields in 1999 are lined up with commodity prices in 2001.

The peak for yields in 2000 went very nicely with the bottom for the CRB Index in 2002. This was, in fact, a key argument that we were making at the start of the decade.

Yields reached a bottom in 2003 and began to rise in earnest in 2004, so our view was that by the spring of 2006, the trend for commodity prices should be turning negative. Much of the challenge posed by the markets over the past few years has come from the huge, and, in our view, counter-trend rally by the CRB Index from January of 2007 through June of 2008.

The collapse in commodity prices through the second half of 2008 has helped to bring the CRB Index back "on trend" once again. It has also managed to do considerable damage to the equity markets. Our point, however, is that much of what needed to happen has now happened, and as the days pass by we get closer and closer to a new positive trend for the CRB Index. In theory, this might not begin until the middle of 2009, but either way, we do expect that a year from now we will be firmly ensconced in a rising asset price trend that will do wonders for the health of the financial sector.

Equity/Bond Markets

Last Friday, we focused on the similarities between the current trend and that of early 1982. We are going to return to this argument today while adding in a few more details.

Below are two comparative views of the stock prices of Intel (INTC), Coca Cola (KO), and Canada's Bank of Montreal (BMO on Toronto and New York). The top chart is from 1981 into early 1983, while the lower chart is from the current time frame.

The argument is that the equity markets on a broad basis will not turn higher until the major financials start to trend upwards. Another argument is that if downward pressure on the broad market is focused on the commodity sector and banks, then ahead of the actual turn for the S&P 500 Index, we should start to see strength emerge in less-affected sectors. In other words, while the S&P 500 Index (and BMO) did not turn higher until late August of 1982, the stock prices of Intel and Coke actually began to rise months earlier. The pivot point-in February of 1982-followed the break to new lows by the BMO. Since that is exactly what happened last week (i.e. BMO broke support), our argument was that this could mark the start of a pivotal "split" within the equity markets similar to early 1982.

For the past year or two, we have argued that while we do not like gold, we had to admit that it was very cheap relative to copper. We have also argued that the ratio of gold to copper tends to rise with the long end of the Treasury market.

The chart below makes an interesting point. The chart shows the US 30-year T-bond futures and the ratio between gold and copper. Notice that for the first time since bond prices peaked in early 2003, the gold:copper ratio has risen to the upper extreme of its trading range. In other words, we can no longer argue that gold is cheap relative to copper now that the ratio has risen to 5:1. This also suggests that we could be approaching another peak in the long end of the Treasury market and a bottom for the equity markets.

By Kevin Klombie of

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