the link

Stocks & Commodities V. 10:5 (208-211): The Link Between Bonds And Commodities by John J. Murphy

The Link Between Bonds And Commodities by John J. Murphy

Like a set of tumbling dominoes, intermarket analysis is based on the theory that one instrument affected will in turn affect another. Technical pioneer John Murphy, best known for his trailblazing work in technical analysis and intermarket analysis, explains how that interrelationship between bonds and commodities works.

Intermarket analysis adds another layer to the work of the technician by considering activity in related markets. Whereas traditional technical analysis treats each market separately, intermarket technical analysis suggests that important directional clues can be obtained in one market by studying what is happening in related markets. The stock market and the U.S. dollar, for example, are influenced by the direction of interest rates. The direction of interest rates, in turn, is influenced by the direction of commodity prices, and so on.

Commodity prices and bond prices usually trend in opposite directions; bond yields trend in the same direction as commodities. Thus, commodities and bonds should be viewed together. Analysis of either sector is incomplete without analysis of the other. Figure 1 shows the Commodity Research Bureau (CRB) Futures Price Index, a basket of 21 commodities, and bond yields generally trended in the same direction from 1988 to February 1992. At year-end 1991, the drop in bond yields to new lows was not confirmed by the CRB Index, which held above its mid-1991 trough; that divergence was followed by a rebound in both measures.

Analysts should follow several commodity indices to ensure that the correct inflation message is being sent. Another index that is useful for this purpose is the Journal of Commerce Index of 18 raw industrial prices.

Article Text 1Copyright (c) Technical Analysis Inc.

Copyright (c) Technical Analysis Inc.

FIGURE 1. Bond yields and the CRB Index generally trended in the same direction frommid-1988 to early 1992.

FIGURE 2. A strong visual correlation can be seen between bond yields and the CRBIndustrial Futures Index (copper, cotton, crude oil, lumber, platinum, silver) from mid-1990 to early 1992.

Stocks & Commodities V. 10:5 (208-211): The Link Between Bonds And Commodities by John J. Murphy

INDUSTRIAL AND AGRICULTURAL

Since the CRB Index includes many agricultural commodities, industrial commodity prices should be tracked as well. Figure 2 shows the strong correlation between bond yields and the CRB Industrial Futures Index from mid-1990 to early 1992. (That commodity sub-index includes copper, cotton, crude oil, lumber, platinum and silver.) Figure 2 shows bond yields and industrial commodities peaking in unison in 1990, rebounding together during the first half of 1991, falling together during the second half of 1991, and rebounding as one into February 1992. As 1992 began, bond yields rebounded from 7.40% to 8.00%. A glance at the commodity markets suggests that the rebound in commodity prices had a lot to do with the uptick in bond yields as 1992 began.

Figure 3 compares the prices of Treasury bond futures with four of the industrial commodities included in the CRB Industrial Futures Index during December 1991 and January 1992. The downturn in bond prices that began in early January 1992 coincided with upturns in copper, crude oil and platinum. Lumber prices turned up well before the other commodities and preceded the downturn in bonds. Since lumber is tied to housing, which is usually the first sector of the economy to turn up during a recession, an upturn in lumber is usually an early warning of an upturn in other commodities and of a downturn in bond prices.

Analysts should follow several commodity indices to ensure that the correct inflation message is being sent. Another index that is useful for this purpose is the Journal of Commerce Index of 18 raw industrial prices. Certain individual commodities such as crude oil also have an important influence on the bond market.

John Murphy is president of JJM Technical Advisors Inc., and publishes the monthly "Futures Trends and lntermarket Analysis." He is also the technical analyst for CNBC/FNN.

REFERENCESJJM Technical Advisors Inc., 297-101 Kinderkamack Road, Suite 148, Oradell, NJ 07649.Murphy, John [1986]. Technical Analysis of the Futures Markets, New York Institute of Finance.___ [1991]. Intermarket Technical Analysis, John Wiley & Sons.

Figures 2Copyright (c) Technical Analysis Inc.

Copyright (c) Technical Analysis Inc.

FIGURE 3. The downturn in Treasury bond futures in January 1992 coincided withupturns in copper, crude oil and platinum. Lumber, which usually leads other commodi-ties, was the first to turn up.

Stocks & Commodities V. 10:5 (208-211): SIDEBAR: UNDERSTANDING STANDARD MATHEMATICAL SYMBOLS

UNDERSTANDING STANDARD MATHEMATICAL SYMBOLSIt is inevitable that today's technician will encounter steps to calculating an indicator that uses standard mathematical symbols that appear to be beyond simple arithmetic. In reality, these symbols are simply shorthand notation for no more than basic arithmetic. The following is a guide and interpretation to mathematical symbols commonly seen in STOCKS & COMMODITIES.

By convention, the first few lowercase letters of the Roman alphabet (a, b, c) are used to denote constant terms or coefficients. A constant is simply a value that does not change. For example, if a formula states that a = 1.5, then whenever you see the in the formula you know that you can substitute 1.5. A coefficient is a factor in a product. If you see bx in a formula, then you know that the variable x is multiplied by the coefficient b. Variables are typically denoted by the last few letters of the Roman alphabet (x, y and z). A variable can be any observed value such as today's closing price of the stock market. Statistics will use capital letters of the alphabet (X, Y and Z) as variables.A subscript is used with the variable to define a list of differing values from the same set of values. A set of values could be the last month's daily closing prices of a stock. The daily closing price of a stock could be assigned the variables x1, x2, x3, x4, x5 ... xi for each individual day. The notation for the subscript value is identified by the letter i. Sometimes, a formula will instruct to use a specific quantity of observed values for example, the last five days' closing prices. The notation for the number of variables is the letter n. In the previous example, therefore, n = 5.

A formula may require you to add together a series of variables that is, the last five days' closing prices. The formula could be stated as xl + x2 + x3 + x4 + x5. Instead of this lengthy style, the Greek letter (epsilon) is used, meaning "to sum." If a specific number of variables is to be summed, the notation includes a counter, n.

xii=1

5n=Here, the letter i indicates to start with the first x (number 1) and the letter n = 5 indicates to count up to a total of five x's and to sum the x's. In simple English, the instructions are to add xl + x2 + x3 + x4 + x5 together.

A number of technical indicators and statistical formulas use an average of the observations or variables in the calculations. Another name for the average is the mean. The mean is identified by a line over the variable such as x

_

. The steps to calculate the average or mean of a series of prices is to first decide on the number of periods to be averaged for example, a five-day average. Sum the five days' prices and then divide by 5. The following is the formula for a five-day average:

x =n

xii

n=1

1

5

=

In the above example, the variable xi represents a single day's closing price. This variable could represent


Stocks & Commodities V. 10:5 (208-211): SIDEBAR: UNDERSTANDING STANDARD MATHEMATICAL SYMBOLS

something other than one set value. A variable could be something more complicated. Let's say you wanted to calculate the difference between two values xi and yi and then square this difference and finally sum a series of these squared differences. Our set of values are xl =12, x2 =22, x3=25 and yl=10, y2=15, y3=20. The formula to do this would look like this:

( )x - yi ii=

n=2

1

3Here, we will subtract the first y from the first x (l2 10), which equals 2; the next step is to square 2, which equals 4. The next step is to subtract the second y from the second x (22 15), which equals 7; squaring 7 equals 49. The last difference is subtracting the third y from the third x (25 20), which equals 5; squaring 5 equals 25. The last step is to sum the squared differences (4 + 49 + 25), which equals 78.While some of the formulas may appear to be complicated, the notation is usually just a shortcut to present a series of steps that involves no more than simple arithmetic.

Editor


the link

Documents