Today's Trends: Canary in A Coal Mine

In past cycles a drop in the transports has signaled the end of a rally for crude. After rallying approximately 25% in 2010, the Dow Jones Transportation Average has entered territory not seen since 2008. Should this Monday's 52-week high of 5219.8 turn out to be an inflection point for the index, then any meaningful reversal of course could again signal lower prices in crude. We note that we are of the opinion that the economic recovery underway will continue to push the transports higher, for at least another quarter or so, but thought it prudent to make our readers aware of what institutional investors may soon be anticipating.

Over the last two cycles, a retreat in transport prices has been followed by a significant decline in spot WTI prices. In July 2006, the transports signaled the end of the rally nearly one month ahead of a correction in crude prices. Subsequent to faltering transports, crude oil prices fell 20%+ over the following three months. A similar occurrence took place during the summer of 2008 with transportation stocks peaking in early June and crude finding its peak in early July. Then WTI crude prices fell 30% over the following three months and proceeded to bottom out 79% below the peak, before the calendar year had even ended.

The circumstances differ significantly this time considering that we are in the midst of a global economic recovery. However, growing excess spare capacity due to ramping production in emerging nations coupled with worldwide energy demand that is well below peak levels are two factors that give us a reason to pause and consider whether or not the momentum for commodities, particularly oil, is waning. We suggest keeping a close eye on the transports as the proverbial "canary in the coal mine" in preparation of rotating out of the energy sector ahead of what historically has signaled grief for the industry.


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