Our focus is usually on attempting to provide answers with respect to markets trends but there are times when we wonder whether knowing the correct questions to ask might be even more important. One question that springs to mind is... what in the heck is ‘the trend’?

Below is a chart comparison that we have used on a few occasions in recent weeks. It shows the Canadian dollar futures, crude oil futures, and the ratio between crude oil futures and the CRB Index.

The argument begins with the assertion that all three of these charts represent the same basic trend. The Canadian dollar rises with energy prices and is especially strong when the ratio between crude oil and the CRB Index is pushing higher.

From a macro perspective we hold the view that the Cdn dollar is ‘fair’ around .80. The actual number might be closer to .78 but for now .80 is likely close enough.

There are long periods of time when the Cdn dollar trades well below .80. These reflect time frames when the markets are trading off of a ‘weak energy’ theme. Conversely the Cdn dollar can and has traded well above .80 as a reflection of a ‘strong energy’ theme.

In a perfect world one goes positive on the energy sector when the Cdn dollar is trading somewhere close to .60. The problem with this is that when the currency is this low absolutely no one outside of the oil patch has the slightest interest in the oil and gas stocks. Even so... if you can catch the theme as the Cdn dollar begins to rise towards and then through .80... vast profits will accrue.

So... returning to our original question... what in the heck is ‘the trend’? We struggle with this at times because on the one hand we recognize that the best time to go long the energy sector was 8 or 9 years ago. On the other hand any time the Cdn dollar is trading in the vicinity of parity with the U.S. dollar it reflects a positive energy theme. In other words owning the oil and gas stocks when the Cdn dollar was in the .60’s might have made sense in the long run but until the currency began to trend higher it was a losing proposition. Selling the energy sector when the Cdn currency is close to dollar parity might make long-term sense even though in the here and now it simply won’t work until the currency actually begins to trend to the down side.

Equity/Bond Markets

The above argument was that the current trading level of the Cdn dollar reflects a markets theme that is overly energy-centric. If the energy stocks are unloved and neglected when the Cdn dollar is close to .60 then the sector is viewed as excessively important when the CAD is close to parity.

The problem is that there is a vast difference between the Cdn dollar being ‘high’ and the Cdn dollar actually trending lower. Until the Cdn dollar actually starts the march back to or below .80 ‘the trend’ is going to continue to focus on energy prices.

First up is a comparison between the sum of the Canadian and Australian dollar futures and the S&P 500 Index. Both the CAD and AUD are commodity currencies although the CAD tends to trend with North American growth while the AUD is more closely tied to Asia.

We burned the entire first page today as we attempted to lay the foundation for a point. Whether we were in any way successful remains to be seen.

Once again... there is a difference between the Cdn dollar declining because the markets are ready to shift away from the energy theme and the Cdn dollar declining when the markets are still focused on the energy theme.

In the first instance the equity markets can rise on a weaker Cdn dollar simply because the energy theme is becoming irrelevant. We suspect that when this happens it will simply mean that there are better opportunities for long-term growth in other sectors.

In the second instance each time the Cdn dollar moves lower it reflects capital moving away from risk and towards safety which means that the Cdn dollar tends to weaken with the stock market.

The chart shows that the CAD plus AUD is still trending very closely with the S&P 500 Index. The trend remains energy-centric and will remain that way until the markets discover another sector or theme that is entering a growth cycle.

Below is a comparison between IBM, Wal Mart , and the product of the U.S. 30-year T-Bond futures times gold futures.

The cash to asset ratio for the S&P 500 Index companies remains near 30-year highs. This is another way of suggesting that major companies aren’t sure where to find long-term growth either. If companies are sitting on cash instead of raising capital for expansion or development then it little wonder that the U.S. dollar has been weaker.

The chart suggests  that under the cover of a decade-long period of consolidation for large cap names such as IBM and Wal Mart the markets have shifted focus over to themes that include higher bond and gold prices. Our thought is that one way to tell when the trend is ready to shift away from falling interest rates and rising gold prices will be through a break to new highs for stocks such as IBM. We will keep a close eye on it as we move through the balance of this year.