LOWER OIL AND HIGHER AIRLINES ARE GOOD FOR THE MARKET -- HIGHER CHINESE RATES HURTS COMMODITIES, BUT MIGHT NOT BE BAD FOR GOLD
OIL VS. THE AIRLINES ... I've been asked a lot lately to explain why the transports continue to climb in the face of rising oil prices. Historically, the transports are adversely affected by higher energy costs. This time it has been different at least for some transportation stocks. Ironically, the shortage of oil has contributed to the strength in ocean freight, rails, and truckers who have to move it around the world and the country. The need to ship oil and other imports arriving from Asia have put a tremendous strain on the global transportation sector, which has been able to pass higher energy costs on to their customers. Not so with airlines. The airlines have maintained their inverse relationship to crude. Charts 1 and 2 make that point very graphically. The two charts show that the airlines fall when oil is rising, and rise when oil is falling. The three main turning points are shown by arrows and circles. The collapse in oil from $40 in March 2003 (after the start of the second Iraq war) caused a sharp upturn in the Airline Index (see first green circle). Airlines peaked during the fourth quarter of 2003 just as oil prices started their yearlong climb (red circle). The sharp drop in oil this month has coincided with another sharp upturn in the airlines (second green circle). In fact, the sharp jump in airline stocks on Tuesday preceded by one day a 5% plunge in the price of crude. From a sector rotation standpoint, some money coming out of oil should move into the airlines. But there's a bigger point having to do with the business cycle.
Chart 1
Chart 2
AIRLINE AND OIL TURNS ARE TYPICAL AT BOTTOMS... Near the start of 2004, I wrote that leadership by energy stocks has traditionally been bad for the stock market and the economy. That has proven to be the case through most of this year. I've written a lot recently about the need for technology leadership at a market bottom. Page 110 of my book on Intermarket Analysis shows how market sectors perform at different stages of the business cycle. Energy leadership usually occurs at the end of an upturn as happened earlier this year. At a bottom, the two groups that usually turn up first are technology and transports. Technology has already turned up. If we use the airlines as a proxy for the transportation sector, they turned up this week. Why an upturn in the transports is good for the market and the economy is because it usually accompanies a drop in oil. That pretty much describes what happened this week.
CHINESE MOVE TO RAISE RATES HURTS SOME COMMODITIES -- BUT NOT GOLD... The Chinese suprised everyone today by raising interest rates for the first time in nine years to slow their economy (which is growing at 9%) and contain a 5% inflation rate. That had the effect of pushing industrial commodity prices like aluminum, copper, and steel lower and contributed to more selling of oil. That explains why energy and basic material stocks were among the day's weakest sectors. That pushed the CRB Index down more than 2 points. More importantly, today's decline pushed the CRB below its March peak and raises the possibility of an intermediate top in commodity prices. A glance at the Commodity Channel Index (CCI) shows it dropped below the zero line, which implies more selling ahead. I don't believe that this is the end of the major commodity boom. But it could be interrupted for the time being. Although initially the dollar rose and gold fell on the news, those trends were later reversed.
Chart 3
GOLD TESTING YEARLY HIGH WHILE DOLLAR TESTS LOW... Earlier in the week I showed gold testing its 2004 high near $430 and expressed the view that the presence of that previous peak (combined with an overbought CCI reading) allowed for some short-term weakness in bullion. The Dollar Index (Chart 5) is the exact mirror image of gold. The Dollar Index is testing its early 2004 low near 85. There again, I wouldn't be surprised to see an attempted recovery off that previous low (especially with an oversold CCI). That's especially true if the fourth quarter stock rally continues (as I expect it will). That would most likely cause some selling of bonds (which would push yields higher), boost the dollar, and cause some profit-taking in gold. I would view any significant pullback in gold and gold stocks, however, as another buying opportunity. I also suggested earlier this week that I expected gold stocks to start doing better than oil stocks.
Chart 4
Chart 5
WATCH OUT FOR A HIGHER YUAN... The fact that gold bounced today (about 80 cents) and the dollar sold off tells us that the Chinese move may not be that bad for gold or good for the dollar. It's believed that today's Chinese move to raise rates to combat inflation is the start of a process to allow the Chinese currency (the yuan) to gradually increase in value. In an update that I wrote early last week (October 19, 2004) I suggested that there could be some negative side-effects to that process. A higher yuan would weaken the dollar even further. A weaker dollar would boost gold. And, if the Chinese stop buying Treasuries with all of the dollars they've been buying to keep the yuan from rising, U.S. interest rates could start to rise. That could hurt the U.S. stock market and the economy. And, as I wrote in that earlier piece, the main beneficiary of those dangerous side-effects should be gold. That probably explains why gold escaped today's commodity selling and why the dollar couldn't hold its earlier gains.
