THE RATE OF CHANGE IN THE PRICE OF OIL IS MORE IMPORTANT THAN THE ACTUAL PRICE

As mentioned in today's update, history shows that equity markets usually decline if the price of oil rises by more than 80% in one year. It has therefore been very interesting to observe that consumer behavior did not change much as oil rose over the psychological level of $100 per barrel. However, now that the price of oil has risen over $120 per barrel, it is having a significant impact for businesses and finally changing the driving habits of consumers. An 80% increase from the average price last June is $121 per barrel. This validates the premise that an 80% increase in one year causes problems in the economy and equity markets. Major changes in prices over a short time always make it very difficult for businesses to adjust.

Bear markets started in 1981, 1987, and 2000 when the price of oil increased more than 80% after equities had long up trends. That is not the case now. In 1991, oil spike for only a few months after Iraq invaded Kuwait, which resulted in a 20% decline for equities that was reversed a few months later. In 1974, the US was already in a severe recession caused by wave and price controls to combat inflation, problems in the Vietnam War and Nixon/Watergate scandal, and a 260% rise in oil prices. The SP 500 declined 10% in the first 10 months of 1973 but the TSX was still near all-time highs. In the year following October 1973, the SP 500 fell another 44% while the TSX lost 36% to bottom in October 1974. Of all the previous occasions, the situation now seems closest to the environment in 1974.

It will be very important to see how oil, equities, and the trend charts react in the weeks ahead.

WHIRLWIND OF VOLATILITY SEEMS TO OBLITERATE TRENDS WHILE OIL SKYROCKETS AND US FINANCIALS BREAK PREVIOUS LOWS. WHILE HIGH OIL PRICES ARE A SERIOUS THREAT TO EQUITIES, MOST OTHER DATA SUGGESTS THIS IS MERELY A PERIOD OF CONSOLIDATION BEFORE A VERY STRONG RISE.

Oil and gold fall as the Bernanke speaks and the US$ rises. Then Trichet from the European Central Bank (ECB) speaks and they move sharply in the other direction. The DJIA rises 214 points on Thursdaly and falls 394 points on Friday as the biggest jump in unemployment in 20 years cause investors to fret and send the battered US financials to yet another new low. Why not throw in the biggest rise in ever in oil for one day to make matters even worse? What on earth does it mean for investors?

Very simply, I believe it means that many assets are consolidating after moves since the mid-March lows in US equities. Since Mar. 17, 2008 the SP 500 rose 13%, the TSX rose 20%, gold fell more than 10%, commodities from copper to rice peaked, and oil rose 35%. Almost nothing goes straight up or down, so it is very normal for trends to reverse course or consolidate recent moves. Random volatility during a consolidating phase is not unusual. Typically, consolidations/corrections like this last six to seven weeks. Since US equities peaked on May 19, we could continue to see up and down action until the end of June.

The huge rise in the price of oil is a real concern for investors. In Stephen Leeb's book, The Oil Factor (2004), he shows that equity markets decline if the price of oil rises more than 80% in one year. This means that stock markets and the economy could be hurt if the price of oil remains above #121 in June and $135 in July. He states that equities improve when the increase is reduced to only 20% for a year. A 20% increase from last year's levels would be approximately $81 for June and $90 for July. Even though it seems like oil is destined to rise to $150 according to the media, nothing can be ruled out at this stage of market activity.

Offsetting the concerns about energy prices is the pessimistic sentiment created by all the bad news. While such negative unemployment figures seem ominous, past history shows that US equities just about always perform extremely well after such a negative move - a gain of 30% in 12 months for the DJIA on average since 1950 according to JP Morgan. A healthy level of pessimism, very low consumer confidence and statistics showing that the markets are as oversold as they were before strong rises (such as October 2005 and July 2006), indicates that the risk is likely much lower than it might seem, and that the upside potential when this period is over, could be much better than it might seem. Hang on for the ride! I will continue to do my best to try to make sense of what seems unexplainable in the weeks ahead.

Bonds - Bond prices have also been volatile. The long-term oscillator and bond prices appear to be making a double bottom.

Commodities - The short-term oscillators for gold and oil turned up last week. The long-term oscillator for gold is positive and indicating topping action for oil (as it has for weeks now). The indicators are the same for the respective gold and energy equities too.

Currencies - According to the long-term oscillators, the CAD$ seems to have peaked versus the USD$, the USD$ seems to be strong compared to the euro and the euro is stronger than the yen.

Catch the trend.

The short-term oscillators for the US markets are oversold and are forming a double bottom like they did at market lows in August and November 2007 and January and March of this year.

The long-term oscillators for US equities are still declining from overbought levels. These need to turn up to indicate that the corrective phase is over. They do not normally drop to oversold levels so soon after a market low.

The long-term trend chart for the SP 500 has turned red or negative once again, while the TSX is still very green. Stay in Canada.

The short-term oscillator for the Volatility Index is showing a double top like it did when the markets bottomed in August and November 2007 and January and March of this year. You can see that this is happening with the Index at much lower levels (25 on the right scale) now compared to other peaks (35).

The long-term oscillator for the Volatility Index is rising and needs to turn down to suggest that this corrective phase is over.

The short-term oscillator for the TSX turned up last week along with the oscillators for gold, gold stocks, oil and oil stocks suggesting that they should rise for a week or so. The TSX cannot rise very long if the US markets are declining.

The long-term oscillator for the TSX is a little lower with the TSX higher. This looks similar to the indicator for oil. If oil falls, the TSX could decline until the US markets turn around. Continue to stay with Canadian investments as has been recommended to my clients since May 2002. If oil prices rise, the TSX usually benefits. If they fall and the US markets rise, the TSX will usually benefit too.

The long-term oscillator for bonds is likely creating a double bottom, which is fairly rare. Usually these oscillators create deep V bottoms as you can see. Nonetheless, bond prices have not been very volatile since this first turned up May 19. (Ten year US bond yields are 3.99% now versus 3.84% on May 19.)

The short-term oscillator for oil turned up last week at $125 per barrel forecasting this recent rise. The short-term indicators are usually accurate for at least three to five days or so.

Similar to the TSX, the long-term oscillator for oil reached a lower high when the oil price moved to a higher high. This is usually a sign of weakness.

The change in the currency oscillators this week is that it seems like the CAD$ peaked compared to the US$. It would not be unusual for the CAD$ to stay in a trading range for a year or so since it had a rise of historical proportions against the US$ 2007.

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