Nifty : Crude way?

We all know Crude Oil Prices are very much a guide to where Indian Markets are headed. The conventional wisdom says that higher crude prices are bad for commodity importers like India and China. But this is not always the case and we all now know that both these prices behave in all sorts of correlation.

Ideally I believe in a typical economic cycle :

1. Both go up together (coming out to recession, easy money injected, all markets go higher)

2. Next price of crude go higher which pulls Nifty lower (concerns of Inflation and threat to growth due to it, while money from equities shift to commodities)

3. Then we see Nifty go higher because crude is going lower (concerns of demand slowdown pulls commodities lower, relief rally exhibited by equities)

4. Finally both go lower together (realization that growth has gone "for ever", there is wealth destruction, all markets slide)

The chart above show Nifty and Crude Oil from April to September 2008. I have marked the four phases in the chart. Though this pattern will not always be found, this small duration speaks a lot in terms of how price of crude governs Nifty. These were the times when every small movement of crude was tracked by Nifty traders and it looked like the only aspect that matters. In a larger time frames as well, I expect this kind of relationship to exist.

The idea of this post is to identify the phase we are in currently. The above chart shows the YTD comparison. We see a fall in Nifty from start of Jan to mid Feb while crude is range bound. Then suddenly there is a surge in both. Nifty has corrected since early April highs and looks like crude has just started that correction, with a 10% correction in a single day.

So are we in Phase I, when Nifty and crude rally and corrections are together with a small lag? Phase 3, when falling crude will provide impetus to equities? Or, Phase 4, when all assets will come tumbling down together?

The least likely possibility is 4, for it we need a major systemic breakdown in action (something like Lehmann collapse?). Though I believe the system had always been broke, we still do not have the price action confirmation.

Next likely Phase for me would be 1, when we see Nifty and crude rising and falling together. But the Nifty has been falling since Nov last year and crude has made a top as recently as May.

Most likely scenario is we being in Phase 3, when a correction in crude will give much needed relief to bullish traders. The equities are near a support zone of 5300-5500 and commodities are falling, rate hike has been done with, mood is extremely sour and analysts on TV predicting 5000, looks like we are well in track to go 6000. Or are we in Phase 4 :P !!