Commodity Charts Help with Stock Trading

By: Greg Silberman | Mon, Feb 18, 2008
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In our experience, for any serious move to get underway, the Bond, Commodity and Equity markets have to be aligned. That is about to happen shortly...

I've had the good fortune of meeting many Excellent Investors. Some were equity men and women, others were commodity and still others fixed income. I've also met a few who are a combination of all three but they are few in number!

Each discipline requires a slightly different way of viewing the world.  Bond men like rising unemployment and a weakening economy which push interest rates lower. Equity men like strong growth and low input costs. Commodity investors favor outright inflation. Needless to say they often disagree, but for any serious move to get underway they have to be somewhat aligned. Case in point is the fixed income and equity markets...

Chart 1 - S&P vs. Credit Spreads

The above chart shows the spread between investment grade bonds and Treasuries (blue) versus the S&P500 (red).

It is interesting to note the close correlation.

When the blue line is rising it implies that fixed income investors prefer riskier investment grade bonds to safer treasuries. This same risk appetite is evident in a rising S&P which closely mirrors the movement in credit spreads.

Framed in this context it is clear why the flight to Treasuries (blue line falling) coincided with a viscous sell-off in equities and why it is important for credit spreads to stop widening (blue line stops falling) before a sustained bottom can be put in the stock market.

Here's the way a commodity guy views the same scenario:

Chart 2 - Silver: Gold ratio vs. S&P500

For some reason unbeknown to us there seems to be a very strong correlation between the S&P (red) and the Silver: Gold ratio (blue). At first thought this correlation seems coincidental but on further analysis one would realize that Silver tends to be more economically sensitive than Gold. Silver has industrial uses as well as monetary and its price is subject to similar economic forces as say S&P companies. Gold on the other hand is counter-cyclical in that it performs best in worsening economic conditions. Hence the correlation may not be so difficult to understand after all.

During the recent sell-off in the stock market Silver vastly underperformed Gold (the chart fell). At current levels it takes 52 ounces of Silver to buy 1 ounce of Gold (the historic ratio is closer to 20). Aside from Silver being ridiculously cheap, the above chart also shows close correlation between the Silver: Gold ratio and the S&P -- recent strength in Silver versus Gold should bode well for the Stock Market.

The commodity and equity markets now look to be in synch (Dr Copper says shallow economic recession).

Someone should tell the Fixed Income boys that Corporate Investment Grade bonds may soon outperform treasuries due to credit upgrades (select large cap non-financial companies have exceptionally strong balance sheets).

Once credit spreads start to narrow, the stars will align for a decent sustainable rally in the Stock Market.

More commentary and stock picks follow for subscribers...

I am an investor and newsletter writer specializing in Junior Mining and Energy Stocks and small caps listed in the US, Canada and Australia.

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Author: Greg Silberman

Greg Silberman CA(SA), CFA

Greg Silberman

Profession: Research Analyst and Newsletter Editor
Company: Ritterband Investment Management LLC

Career Brief: Greg qualified as the youngest Chartered Accountant and Chartered Financial Analyst (CFA) in South Africa in 1998 at 25 years old. After completing his traineeship with Grant Thornton he moved to London where he worked for JP Morgan Chase in their Fixed Income Swaps Division. Sick of the grey skies and cold weather Greg relocated to Atlanta, Georgia where he spent the next 4 years freelancing as a management consultant. His targeted clients were fast growing mid size US based companies and he worked across many industries including credit cards, health insurance and energy trading. Greg has recently returned from Sydney Australia where he spent the last 2½ years working in Equity Derivative Structuring for Perpetual investments a major Australian Asset Management Company.

Greg has a passion for the markets and has been writing Greg's market newsletter for 2-years. A newsletter focused on metal and energy stocks and recently non-resource small caps listed in the US and Internationally.

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

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