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Intermarket Analysis
 The BIG Picture:
In this issue of Investor Notes we will review the intermarket relationships between four sectors; currencies, bonds, equities and commodities. Knowing how these sectors relate to one another will provide perspective on where we are within the asset class cycle.
To set the stage for our analysis here are some of the most important intermarket relationships:
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The U.S. dollar and commodities trend in the opposite direction so a falling dollar is bullish for commodities and a rising dollar is bearish for commodities.
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Commodities generally trend in the opposite direction of bonds. Therefore, commodities and yields trend together.
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Bonds and stocks generally trend together and opposite yields except in a deflationary environment.
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With the basics covered, let’s begin our analysis. According to John Murphy in his book Intermarket Technical Analysis, “The dollar has an important influence on the direction of interest rates. The direction of interest rates has a delayed impact on the direction of the dollar. The result is a circular relationship between the two. A falling U.S. Dollar will eventually have a bearish impact on financial assets in favor of tangible assets. Rising commodity prices will, in time, become bearish for stocks. Falling commodity prices usually precede an upturn in equities.” And so goes the cycle, around and around. There are periods when these relationships decouple but eventually they get back on track.
The Asset Class Cycle (Table 1) outlines the full relationship between the four sectors. Traditionally, gold acts as a leading indicator for the CRB Index hence the reason for its inclusion.
| Table 1: Asset Class Cycle |
| The cycle progression listed below is long-term by nature taking, in some cases, months or years to move from stage to stage. The bold line represents approximately where we are in the progression. |
| 1. Rising interest rates pull the dollar higher. |
| 2. Gold peaks. |
| 3. The CRB Index peaks. |
| 4. Interest rates peak; bonds bottom. |
| 5. Stocks bottom. |
| 6. Falling interest rates pull the dollar lower. |
| 7. Gold bottoms. |
| 8. The CRB Index bottoms. |
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| 9. Interest rates turn up; bonds peak. |
| 10. Stocks peak. |
. . . repeat the progression . . . |
Source: Intermarket Technical Analysis by John Murphy
>>> Click for Murphy's review of the 80's from an intermarket analysis perspective.
Where are we now (11/12/04)?
The U.S. Dollar continues to fall (Chart A). Both gold (not shown) and the CRB Index (Chart B) have bottomed and are now on the rise. Earlier this year the Fed began to raise interest rates which has led bonds and notes (Chart C) to stall. Equities (Chart D) may not have peaked as of yet but the clock is ticking. Conclusion: Commodities look good.
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