03 April 2011

Nifty : Can Crude help Identify the Top?

Its always nice to see ratio charts, I prefer them because they give better insights when most of the markets are either going up together or coming down. Ratio charts can warn us beforehand about a forthcoming turn of events. Lets see the chart below, I could get only 3 year chart from usual chart stores, so I prepared one by downloading some data.

The chart above is a weekly closing ratio of Nifty and Crude Oil since 1997. As one can see the ratio generally has been bound between 40 and 80. Another thing which I have pointed out is that the ratio once crossing 60 tends to touch the other end.  In 2000 it crossed 60 and remained below it till 2006. I don't need to describe the chart, you get an idea.

So what does this oscillation from lower end to upper end means. Once the ratio moves to the higher end, Nifty becomes costlier when compared to the most important commodity, the fuel of economy. Similarly when the ratio is closer to lower end, we can consider it to be relatively cheaper.

Another interesting thing to note (refer exhibit 2) is that when the ratio moves below 60 (2000 & 2008) it almost marks the top of the bull market. Even the minor peaks (during 2003 to 2008) are marked by the ratio turning lower after making a local high.

So why does this happen, is there any reason for it?
What I can make out from it is that, Nifty as long as its in the "relatively costlier" zone looks to be in a momentum period. Investors tend to ignore the rising crude prices (Nifty rallies more than crude), till we reach the inflection point. After crude reaches the Inflection Point and rises further, fear of Inflation and slowdown in economy due to higher crude prices start making investors nervous and pulls Nifty lower. This sudden shift in sentiment, turns this ratio over its head. There is good amount of time when this inverse co-relation continues, money from commodity importer countries will keep flowing out and will get into commodity funds.

So is the latest fall in this ratio a sign of a bull market top in Nifty, or can we have this rally in Nifty along with the rally in crude. Fundamentally, all these markets have been driven by liquidity. Its just a matter of which side of  the balance the weight is more. I feel the 2008 scenario is going to be played again, when Nifty will top earlier than crude and once crude has topped, we will see "deflationary" collapse in both.


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