This section will begin with a comparison of the CRB Index and Treasury bonds. As stated many times before, the inverse relationship of commodity prices to bond prices is the most consistent and the most important link in intermarket analysis. The use of ratio analysis is another useful way to monitor this relationship. Ratio charts provide chartists with another indicator to analyze and are a valuable supplement to overlay charts. Traditional technical analysis, including support and resistance levels, trendlines, moving averages, and the like, can be applied directly to the ratio lines. These ratio lines will often provide early warnings that the relationship between the two markets in question is changing.
Figures 12.1 to 12.3 compare the CRB Index to Treasury bonds during the fiveyear period from the end of 1985 to the beginning of 1990. All of the figures are divided into two charts. The upper charts provide an overlay comparison of the CRB Index to Treasury bonds. The bottom chart in each figure is a relative ratio chart of the CRB Index divided by Treasury bond futures prices. As explained in Chapter 11, the relative ratio indicator is a ratio of any two entities over a selected period of time with a starting value of 100. By utilizing a starting value of 100, it is possible to measure relative percentage performance on a more objective basis.
Figure 12.1 shows the entire five-year period. The ratio chart on the bottom was dropping sharply as 1986 began. A disinflationary period such as that of the early 1980s will be characterized by falling commodity prices and rising bond prices. Hence, the result will be a falling CRB/bond ratio. When the ratio is falling, as was the case until 1986 and again from the middle of 1988 to the middle of 1989, inflation is moderating and bond prices will outperform commodities. When the ratio is rising (from the 1986 low to the 1988 peak and again at the end of 1989), inflation pressures are building, and commodities will outperform bonds. As a rule, a rising CRB/bond ratio also means higher interest rates.
The trendlines applied to the ratio chart in Figure 12.1 show how well this type of chart lends itself to traditional chart analysis. Trendlines can be used for longer-range trend analysis (see the down trendline break at the 1986 bottom and the breaking of the two-year up trendline at the start of 1989). Trendline analysis can also be utilized over shorter time periods, such as the up trendline break in the fall of 1987 and the breaking of the down trendline in the spring of 1988.
The real message of this chart, however, lies in the simple recognition that there are periods of time when bonds are the better place to be, and there are times when commodities are the preferred choice. During the entire five-year period shown in Figure 12.1, bonds outperformed the CRB Index by almost 30 percent. However, from 1986 until the middle of 1988, commodities outperformed bonds (solely on a relative price basis) by about 30 percent.
Figure 12.2 shows the relative action from the mid-1988 peak in the ratio to March of 1990. During that year and a half period, bonds outperformed the CRB Index by about 20 percent. However, in the final six months, from August of 1989 into March of 1990, the CRB Index outperformed bonds by approximately 12 percent.
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