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Inter-Market Analysis 

If you look at the U.S. yield curve (on a graph plot 'time' on the horizontal (X) axis and yield on the vertical (Y) axis. If interest rates rise with time then the yield curve slopes 'up' and is called 'positive'. If, on the other hand, short-term interest rates are higher than longer-term rates, the curve would slope downward and be termed 'negative') you will see a rather nasty 'U' shape. The low point for interest rates is rather rapidly sliding in- just recently the 5-year T-Note rep-resented the lowest yield while now it is the 2-year. As this trend continues we should eventually see Tbill yields below both, which is another way of suggesting that the Fed still has some work left to do.

Many, if not most, believe that in the process of pushing short-term interest rates lower the Fed will flood the financial system with liquidity and re-ignite the tech and telecom sectors. But...what about the Law of Unintended Consequences? Fed easing will certainly push asset prices higher but there is no guarantee that the Nasdaq is going to be the main beneficiary- which, of course, is ironic.

Below is a comparative chart of the S&P 500 Index (scaled upside down) and gold Futures. We ran this chart last week and commented that if there was 'one thing' that would shake the markets complacency it would be a moon shot by gold.

The chart shows that a correction/consolidation in the equity markets tends to go with strength in gold prices- and vice versa. The current S&P correction is the most substantial since the autumn of 1999 and we note that that correction DID NOT END until gold prices had reached peak and turned downward. In other words, it would be reasonable to look for gold price strength ahead of an equity market bottom.

Below is a comparative chart of the Dow Jones AIG Commodity Index and the ratio between the Philadelphia Gold and Silver Index (XAU) and the price of gold itself. The divergence here has long been one of the more perplexing aspects of this market cycle. However...think on this- the divergence on this chart began about the time the Fed began to RAISE interest rates in 1999 and is now in the process of closing just as the Fed CUTS interest rates. This chart argues that a reduction in short-term interest rates could have a rather monstrously positive impact on gold market psychology, which is the reason we can't stop thinking about the Law of Unintended Consequences today. In fact, this is one of the nicest set ups that we have ever seen.

Equity Markets

Below is a simple chart of the Nasdaq Composite Index with a trading channel, 50-day moving average, and 200-day moving average. We have spent quite a bit of time recently trying to show that the S&P 500 and 100 Indices are at, but not through, the chart levels that would indicate that the decline has come to an end. The Nasdaq, quite obviously, is in a similar sort of position. A break through the channel top coinciding with a solid close over the 50-day moving average would indicate an eventual assault on the 200-day moving average. While bullish, there is still no guarantee that this isn't merely the start of a long bottoming process between, say, 2300 and 3300. In the mean time, the fact that the major equity indices have struggled over the past two trading sessions certainly adds to our conviction that we have the channel drawn correctly.

Bond Markets

Unless you have a good reason to do otherwise, it is usually a good idea to trade with the trend instead of against it. Since the trend itself will often vary depending on which time frame you use, this is not always as simple as it should be.

If you go back ten or twenty years you will see that bond prices are trending higher. If you look at the progression of prices over the past twelve months you will also see that the trend is UP. However, if your time frame is a bit shorter...the trend is now down.

We show the U.S. T-Bond futures at bottom right. The T-Bonds pushed upward through November and December in a very nicely defined channel. By simply trading off of the channel tops and channel bottoms one could have done very well indeed. The trend finally broke on the Fed's surprise interest rate cut and a new channel has developed. The top of the channel cuts through around 104 10/32 with the channel bottom residing at 101.50. Those numbers are declining by about 6/32- 7/32 per day.

Bottom line- bond prices are currently in a declining trend that began when the Fed first cut interest rates. This trend will likely continue for the quarter or until such time as the Fed is ready to start raising interest rates once again.

One of the interesting things about the past few months is the fact that BOTH bond prices and the commodity cyclicals rose together yet...the DJII simply stayed flat. If one were to go back through past equity market cycles (and we have) it is usually apparent that the equity markets are strongest when these two sectors move up concurrently. We conclude two things from this. First, that there is still a substantial speculative premium in the equity markets and second, that it won't likely be removed until the Fed finds some reason to stop the furious growth of liquidity- which makes us think of the consequences of a rally in the price of gold once again.

Commodity Markets

We went positive on the gold mining sector back in November and have since reiterated that view with a second 'positive' opinion. The price of gold backed off substantially in December (to our annoyance). Did the trend change?

We show a comparative chart of gold futures and the stock price of Franco Nevada from the Toronto Stock Exchange. The chart shows something quite interesting, although not at all surprising. Franco Nevada's stock price rose nicely into December and then began to 'flag' sideways while the price of gold made marginal new lows. In other words...the shares were indicating that while a consolidation was in order the trend itself hadn't changed. If Franco Nevada pops up through $17 1/2 the game is once more afoot.

Inter-Market Relationships Analysis
Kevin Klombies Editor/Publisher
www.krk-imra.com

January 26, 2001