Aug. 11 — Canada’s dollar dropped to the lowest level in almost three weeks as commodities and stocks tumbled a day after the Federal Reserve said the recovery in the U.S., the nation’s largest trading partner, will be slower.

Aug. 11 — Treasury 10-year notes rose, pushing the yield to a 16-month low, as stocks tumbled a day after the Federal Reserve said the U.S. recovery is slowing.

One of the problems that we have faced over the past few months is the apparent divergence between two trends that typically run in the same direction- the commodity currencies and long-term Treasury yields. We have attempted to show this issue from a number of perspectives to at least make the point that one side or the other appears to be ‘wrong’. After yesterday’s trading we have the sense that, as usual, it is never a good idea to argue with the bond market.

Below is a comparison between the sum of the Canadian and Australian dollar futures and U.S. 10-year Treasury yields from March of 2008 through January of 2009. Below right we show the same chart comparison for the current time period.

Our initial point a week or two back was that during the third quarter of 2008 long-term Treasury yields refused to decline even as commodity prices and the commodity currencies buckled. By the fourth quarter of 2008 the sum of the CAD and AUD reached support around 1.4 while 10-year yields fell to just above 2.0%.

The downward trend for yields this year began in January. As 10-year yields decline ever close to 2.0% the issue of just how low the commodity currencies might get captures our attention. The point is that if yields return to test the lows set in late 2008 then it is possible- perhaps even likely- that the currencies will return to test their bear market lows.

Obviously the sum of the CAD and AUD remains far above 1.40 but after swinging lower over the past few days first support around 1.80 appears... reachable. If this level is taken out then the prospect of the currencies breaking lower in a manner similar to yields in November of 2008 appears possible.

Equity/Bond Markets

We are going to show the same two charts today that we included in yesterday’s issue. At right is a comparison between the S&P 500 Index and the U.S. 30-year T-Bond futures from 1987 while below right is a chart of the SPX and 30-year Treasury YIELDS from 2010.

Our point, we suppose, is that this chart comparison worked perfectly for us back around the end of June and until is stops working we are inclined to stick with it.

The argument once again was that when 30-year yields reach bottom- as they did at the end of the second quarter- the equity markets should pivot higher. The comparison between the current situation and 1987 was so compelling that our sense was that while we might eventually see new lows for 30-year yields... this wouldn’t take place until some time closer to the end of September. In other words... we had a solid quarter of breathing room before we had to seriously contemplate a bearish equity markets resolution.

In terms of the chart the basic point is that while 2-year, 5-year, and 10-year yields have now reached new lows... 30-year yields are still above support. Not a long ways above support but still above support. The initial reaction by the SPX to lower yields looks a bit too much like August of 1987 to did in too deeply but for the time being a tenuous case can still be made for higher prices ahead.

Gold prices rose marginally yesterday. Below we show the SPX and the ratio between gold futures and the CRB Index.

The argument has been that on the two occasions that the gold/CRB Index rose to 5:1 the equity made a key low shorter thereafter. This happened in March of 2009 and again at the end of June this year. If we connect the two closing lows and take the stance that the gold/CRB Index has not moved above 5:1 then support for the SPX on a closing basis would be expected to cut through around 1060. This level will rise somewhat over time given the positive slope of the trend line.