TSX TrendWatch Weekly

Another week and more of that sinking feeling. The S&P/TSX Composite Index declined almost 3%, with a year-to-date result of -33%.  From the high point of that index in 2007, we’re down over 50%.

Fortunately, those of us who follow the markets closely and exit when the time is right are far better off than those folks who have blindly put their RSP money into broad-based mutual funds.  They’ve lost half of their retirement money or more in the past 15 months or so.

The S&P/TSX Venture Index  dropped a whopping -12% last week, bringing its year-to-date figure to -70%.

The major US indexes were down -5% to -9% over the week, with year-to-date numbers that are worse than ours (excepting Venture).

There really isn’t any point in commenting on the sector breakdown or individual stocks; but, as usual, you’ll find all the latest weekly numbers in the DATA & CHARTS workbook.

One minor flicker of hope is that the endpoint of our chart above is now at 8%… off the all-time low of 2%.

If you’re a short seller or trying to pick the bottom (neither of which we recommend), you should keep an eye on this chart.  The rest of us will too, but will stay on the sidelines until we break above 50%.

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NEW VIDEOS:    We’ve added two new videos to that VIDEOS page at the web site… another interview with Jim Rogers (uploaded October 22, 2008), and a more in-depth interview with Noam Chomsky, one of the world’s greatest intellectuals. Chomsky tracks the development of the current crisis from the 70’s and argues persuasively that the current state of affairs is due to American anti-democratic practices when it comes to the financial system (uploaded October 21, 2008).

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COMMENTARY ON THE LOONIE & THE PRICE OF OIL:      As someone close to his investments, I like to say that “when the going gets tough, the tough do research!” That’s one reason I’ve recommended taking this unpleasant interval as a time to read and re-assess your overall approach to investing. We can all learn from previous mistakes.I like to spend to time on my little number-crunching excercises that turn up results I can’t find in our blinkered, hype-oriented financial press. This week I had a look at the loonie and the price of oil.The media almost always treat them as totally separate items to track independently. The value of the Canadian dollar is discussed relative to maufacturing and more specifically imports and exports… and the price of oil is discussed in terms of supply and demand, major events like hurricanes and OPEC quotas.It’s hard to believe that they could be related…  or is it?Interest rates are probably the biggest single factor that moves a currency, but there are other influences.  For instance, the commodity currencies… Canadian dollar (CAD), Australian dollar (AUD), New Zealand dollar (NZD) and South African Rand (ZAR) …are considered to be substantially influenced by the price of commodities, since natural resources are a major part of those economies. And, most major commodities are priced in US dollars.

So, using the price of oil as my “commodity index”, I went back 5 or 6 years and had a look.

The USDCAD pair was at a high of 1.6121 in January 2002 (1 $US buys that many $Cdn). That’s the correct number to use if you’re a currency trader, although all of the Canadian media prefer to report it backwards. By using the inverse, that means CADUSD was at 62 (1 $Cdn buys 62 cents American). Buying US goods at that time was painfully expensive.

CADUSD traded sideways for most of that year until mid November, when it started to rise, so that seemed to be a good starting point for this exercise.

The chart below tracks the Canadian dollar vs the price of oil in Canadian dollars to make the comparison more meaningful.

To make this less of an apples and oranges comparison, I expressed the respective sets of data in terms of cumulative %-change in price. The left scale tracks oil. The right scale tracks the exchange rate. Such dual-scale charts can be misleading, but I did my best to adjust them appropriately.

You’ll see that both measures moved together like clockwork, with the %-range in the oil price moves being roughly triple that of CADUSD moves. They’ve even came crashing down together over the past few weeks.

To verify how tight this relationship is, I carried out a statistical regression analysis, and came up with R=.97  …about as closely tied together as one could expect in a piece of financial research.  The R-squared value is about .93, which means that 93% in the variability of one of these variables can be accounted for by the other. Just 7% remains to be accounted for by other factors.

So, what does this tell us?

Well, I’ve stared at the chart long and hard and can’t see that the exchange rate leads the price of oil or vice versa, so we can’t hope that a change in one will help us predict the other on a consistent basis. The topping out of CADUSD a few weeks before the top in the price of oil is interesting, but not typical of what has happened in the rest of the chart.

What may be happening is that those independent factors (like interest rates for the CADUSD, or OPEC quotas for oil prices) will nudge one or the other out of alignment… but we can’t really anticipate which and when. But what we can expect is that when one is pushed out of alignment, the overall pattern will likely return. In that sense, for some small periods of time, one will lead the other. A surprise move up in oil prices will pull the Canadian dollar higher shortly afterwards, or a larger than expected interest rate cut will bring the dollar down and oil will follow shortly afterwards.

This is still somewhat theoretical, so I’ll be testing this going forward.

As for the impact on equities, resource stocks usually lead the prices of the commodities they produce until they get over extended. Unfortunately, one needs to add the expression “all other things being equal”.  All other things being equal doesn’t apply right now, since all stocks are being painted with the same brush.

So, once again it’s a matter of waiting until something closer to normal emerges. An equity investor could watch for signs that the S&P/TSX Energy sector is recovering a bit faster than the overall market.  If oil prices start to follow that improvement, this might confirm a turnaround.

Otherwise, there are probably some profits still be be made in the currency markets if you have the risk tolerance; and the time to watch this slow, close dance between the Canadian dollar and the price of crude.