You often hear or read about the term “rotation” when different market sectors take turns exhibiting relative strength. In a bullish situation, this tends to occur when one major group runs up to a peak and then begins to flatten out as the flow of capital that has been pushing prices higher turns its attention to another seemingly unrelated sector.
In the past, grains often have been the beneficiary of strong rising trends for energy and metals prices with the bulk of the upward or bullish move for grain prices taking place after the energy and metals sectors had risen near a cycle peak. Take a look at 1995, for example, a time frame that is very similar in a number of important ways to 2005.
YEN & FREIGHT
“Carrying the load” compares Japanese yen futures with the Baltic Dry index (formerly called the Baltic Freight index) and sets an interesting stage for analyzing the flow of cash from one market to another. The Baltic Dry index is an index that measures the cost of shipping dry cargo by ocean freight. In general, it tends to reflect supply and demand conditions that represent the health of global trade.
The chart shows the Japanese yen moves higher and lower with ocean shipping rates. When the Baltic Dry index is rising, so is the yen and vice versa. During the first half of 1995, the yen and Baltic Dry index made important cyclical price peaks before turning lower and continuing to decline into 1998. Between 1995 and 1998, the pace of Asian growth reached a major cycle peak, then began to slow with sharp stock market losses in Hong Kong during 1997, leading to a series of currency-related crises that swept through Southeast Asia in the middle of 1998.
The initial setup, or premise, is that a major peak or top in both ocean shipping rates and the Japanese yen should correspond in a general way with a peak in Asian growth.
CLUES FOR CORN
“Domino effect” builds on this notion by examining what else was occurring within the markets during the spring of 1995 as Asian growth topped out. The copper plus crude oil combination is made up of copper priced in cents ($1.50 per pound would show up as 150) and crude oil multiplied by three ($50 per barrel shows up as 150), giving copper and crude oil an approximate equal weighting.
Three-month Eurodollar futures represent the cost of short-term U.S. debt. When Eurodollar futures are trading at 95, this implies that 90-day interest rates are close to 5%. When Eurodollar prices decline to, say, 93, this implies short-term yields are now 7%. Through 1994 and into the spring of 1995, the Japanese yen was rising along with shipping rates as the combination of energy and metals prices moved higher. Concurrent with this, short-term U.S. yields were on the rise while corn prices were moving lower.
In the spring of 1995, the markets began to make an important rotation. The dollar started to trend upward as currencies like the yen turned lower. Ocean shipping rates began to decline and the combination of energy and metals prices (crude oil and copper) reached a cycle peak. As energy and metals prices topped out, the chart shows corn prices began to turn higher at the same time that U.S. short-term interest rates finally began to move downward.
A longer-term view actually suggests corn futures prices started rising as far back as 1992 with a first peak in early 1994 followed by a major consolidation and then a second rise to an even higher peak in 1996 following the peak in ocean shipping rates, the Japanese yen, metals, energy and short-term U.S. interest rates. Put another way, key cyclical commodity sectors (metals and energy) exhibited considerable strength into the first half of 1995 as short-term interest rates increased. At the same time corn prices were consolidating before beginning the last and strongest leg of a rising trend that traced its origins back to 1992.
1995 & 2005
Notice on “Carrying the load” the yen and freight rate markets made three simultaneous peaks since the early 1990s. In addition to the peak during the first half of 1995, there was a second peak ahead of the collapse in cyclical growth that marked the start of the bear market in major stock indexes such as the Nasdaq Composite in late 2000 and a third instance of a concurrent peak and downturn during 2005.
The decline in both the yen and ocean freight rates during the first half of 2005 suggests Asian growth has once again reached a high for this cycle and is now on the wane. “Another shift under way?” compares corn futures prices, the combination of copper and crude oil futures prices and short-term U.S. debt prices from the autumn of 2003 into the summer of 2005. Crude oil and copper prices clearly have been stronger as U.S. short-term yields have moved higher. At the same time, corn prices, which began to rise during 2002, reached a price peak in early 2004 and have since appeared to be moving through a protracted consolidation.
Similar to the intermarket action in 1995, in 2005 the U.S. dollar strengthened and the yen has turned lower, ocean shipping rates are now declining, indicating a potential peak in Asian growth, and short-term U.S. debt prices have been moving lower as energy and metals prices have risen and grain prices are consolidating.
The big-picture point is that the broader intermarket action between the currency, fixed-income and commodity markets is similar in a number of key ways in the early stages of one the best bull markets for grain prices in recent memory. The major difference between 2005 and 1995 is that there has yet to be a clear peak in copper and crude oil prices and a clear bottom in U.S. short-term debt prices. On a seasonal basis, grain prices tend to peak during the summer. What made the grain price rally during 1995-96 so extraordinary was the way grain prices rose to a summer top, then consolidated briefly and continued higher.
Over the longer-term, the various markets have created an intermarket setup similar to 1995-96 that argues for potentially much higher grain prices into 2006. However, to confirm this signal, corn futures would have to break and remain above the high of $2.73 per bushel recorded on July 18, 2005, concurrent with a flat to lower trend for metals and energy prices.
Through the shorter-term, this view allows traders to lean towards the long or bullish side whenever a trading signal such as a moving average crossover generates a buy signal before moving back to a flat position on sell signals. This would especially be true if corn futures prices manage to move back up and through the highs set during the summer of 2005.
This approach weds the longer-term benefits of intermarket analysis with short-term technical trading signals. It provides the background or basis for a trading stance and the trigger to make it work effectively.
Kevin Klombies has been active in financial markets since 1979. He is a market analyst for www.TradingEducation.com and manager of a private investment partnership based in Calgary, Canada.