Technical Investing Themes: MacroTrends, USDX, Oil, Gold, S&P500, etc.
I will try to tackle a broad market sweep of all of the sectors that I usually look at. I tend to be a sector investor and not so much a stock investor. Obviously this is an ambitious post. I will not be covering everything nor will I be doing any sector justice from an analysis viewpoint. I make no claims about being an expert, just an interested (and perhaps enthusiastic) investor/trader who is trying to make sense of the complicated workings in the market.
I very much like to look at weekly charts for trending purposes, daily charts for (general) timing, and then 30-min / 5-min charts for very specific timing. For this post I will stick with weekly and daily charts.
Treasuries and the US Dollar:
We cannot begin a discussion about US markets or assets denominated in Federal Reserve Notes (a.k.a the US Dollar) without discussing US monetary policy. Obviously the big news recently is that the Fed has announced a [sarcasm](public)[/sarcasm] Quantitative Easing (QE) policy. This basically boils down to the Fed creating money out of thin air to buy Treasury bonds (vs. the Treasury selling bonds to foreign entities, which of course it is still doing). This gives the Treasury new funds to spawn new programs to buy toxic assets from banks, gives the Fed the ability to buy Fannie/Freddie toxic assets directly, etc. Whether or not this is “good” or “bad” will not be discussed here. What will be discussed is the impact of this newly created money.
BTW, if you would like to read a humorous description of QE and how it is being implemented, check out this post: Quantitative Easing Explained.
There are many gears in the “Inflation Transmission” and the Fed just kicked it into a higher one. I have very little doubt that this is the beginning of many similar actions. Now does this mean inflation happens automatically and immediately? No. There are still short term deflationary forces at work. But I have become convinced for a long time that this is a Deflation Scare. And we have to be very careful about how inflation and deflation is defined. Please see several of my recent posts (as binv271828) about both inflation and deflation:
- Steve Saville: Market Value, Money and Credit
- John Mauldin: The Endgame
My opinion (obviously all of this is) is that behind the backdrop of declining asset prices (what almost everybody calls deflation, even though in and of itself, it is not) money supply has been growing substantially. It is in fact politically desirable to spur inflation to fight "deflation". It is desirable for Congress, the Treasury and the Fed to be seen as doing "something / anything". Inflation just got kicked into a higher gear, but based on Saville’s arguments and historical correlation, there is a lag between the increase in True Money Supply and everyday asset prices. So by the time that increase is actually felt by the public the Fed and Treasury will have already massively overcorrected. Essentially this next leg of inflation (as experienced through rising consumer prices) will be largely hidden from the public. But this expansion will eventually lead to higher prices (at least it always has historically).
What does this mean for treasuries?
Obviously treasury prices jumped on the “rumor” and as the “news” culminated in a less-than-stellar auction the price quickly dropped back into family. 30-year bond prices are shown above but 7-year bond prices reacted similarly.
Treasury Bond Bubble:
I personally believe we are in a Bond Bubble. If you look at a chart of long bond prices for the last 28 years (since 1981) the prices have been in a rising channel. This means (average) yields have also been dropping for 28 years. In December 30-year bond yield dropped to 2.6% (it is currently back up to 3.6%). So do I think long term bond investors will settle for these yields with the biggest inflation gun unleashed by the Fed to date? No …
…, But the answer is yes for now. I do not think the bond bubble will burst yet because the Fed is essentially putting a floor under the prices. Now this is good for short term bond prices, but this is very bad long term. This action is not stimulating aggregate demand from investors. This is sending an artificial signal to the market. At the same time, this will allow the Chinese and Japanese to sell back long term dated Treasuries (essentially to the Fed) and exchange them for commodities (which they are stockpiling). So while the Fed is pegging the yields artificially low (trying to keep interest rates low for the rest of the economy to try and spur consumer spending) I think there are many investors over the next several months / year who will unload. This bubble will stay inflated, probably longer than most will suspect. Bond prices may even rise once more. But once these highly inflationary actions (creating money out of think air to buy Treasuries and maintain low yields) are seen for what they are and the inflation works its way into the system in terms of rising prices (for goods and services), I think bond prices will collapse and yields go the only way they can: up. Because US government debt is NOT low-risk and at some point bond investors will demand higher interest to hold it.
Timeframe for bond bubble bursting: ???. I am watching for “deflation” signs to reach a crisis. Inflation discussions are still in the noise. After the Fed announces several more Treasury purchases, and inflation becomes more discussed, then I think conditions will be ripe for a bond bubble collapse. Maybe 1-2 years.
US Dollar (via the USDX):
Also on the same news talked about above, the dollar has been tanking recently. However, based on the fact that currency devaluation wars are happening among all the central banks (Bank of England revving its engine after the Fed kicked it up a gear, ECB not far behind) I don’t think the drop will be an “orderly” one, nor do I think it will drop like a rock. But I think the general uptrend (bear market rally) is over. The dollar rally was fundamentally driven by hedge fund deleveraging, and the fact that overseas dollar investments / yen carry trade investments must be repatriated into dollars.
But the new QE policy by the Fed by definition is reducing the value of every other dollar already in existence. And I also believe this first QE installment will NOT be the last. So like I said above, while the USD may not drop to new lows immediately, I believe it has been dealt a deathblow.
See the weekly chart for the general trend (and what I am identifying as a blow-off top). The daily chart is showing a rally off of oversold conditions. I think this “rally” has the look of a bearish pennant. I think the USDX will eventually make a last gasp rally, but if it does, it will probably originate from a bounce off of the 200 day MA, and not from current levels.
However, I think the weaker dollar is one of the contributing factors to the current stock market rally we find ourselves in, and this current bear decline in the dollar is generally conducive to perpetuating the current rally. More on that later. If you wanted to play on the direction of the dollar directly, you could buy UUP or UDN, depending on your preference/opinion.
However, a weak dollar also makes other assets prices in USD rise, namely Gold and Commodities.
I will not go on a spiel about why gold is the most important monetary protection against fiat currency devaluation, or why gold is a currency and not a commodity, or that there is manipulation in the gold market (TMFSinchiruna has a great post here). These are my opinions and they have been documented and debated elsewhere. But what is factual is that gold does trade ‘like a currency’ and often moves in an inverse relationship to the US Dollar.
So lets look at some gold charts:
First we need to look at the long term picture (several year horizon):
Gold is still in a secular bull market. There are many arguments that gold is overvalued (based on Gold/Silver ratio and Gold/Oil ratio, etc.). I have heard them and I don’t buy them, especially based on the Gold/Oil ratio (argument). The GOR is high because the denominator (Oil) has gone AWOL (to paraphrase Menicious Moldbug). $35 oil is about as realistic as the $147 was 6 months ago (read: not very). So of course the GOR is skewed. GOR ($920 gold/$54 oil) now is 17 (vs. 25 at the peak last year, and vs. a mean value of ~10 during the last 30 years). Oil is in the midst of a serious correction. What is the “fair value”? Tough to say. But I would tend to think that it is much higher that its current price of $54/bbl and much higher still once all of this new inflation filters down. So whether you consider gold overvalued or not is based on common ratios, realize that these ratios are currently skewed based on the current economic crisis. Coming up with a long term “fair value” is not easy.
Shorter horizon (months – couple of years):
Okay, so lets look at some charts to see if they give us any indication of what is happening in the near term.
- Last year, underwent a test of the bull market support line and bounced off convincingly
- Responded convincingly higher to QE announcement
- Lots of bad economic data and it has not topped previous high last year
- Possible head and shoulders formation on daily chart
My take/recommendation (for what its worth):
Gold is an early and direct responder to inflation. The Fed has stated it will fight deflation at any cost (read: massive inflation). Gold responded directly to the recent Fed QE announcement. My supposition is that there will be many such announcements in the coming months / years.
For my long term account: I am buying gold (and silver) on all pullbacks (mostly through CEF). I have a lot of Gold and Silver Miner (GSM) long positions.
For my trading account: I current have no GSM or Precious Metal (PM) positions.
If you are long gold as silver but you think there will be a pullback: hedge with a small short position
If you are bearish on gold and silver: Stay out of the GSM and PM market. But I would really urge you not to go naked short. I know that everyone has their own timeframes and risk tolerance. But I believe that gold is the one (or at least the main) legitimate bull market that exists right now, and I think as inflation hits the system gold will go much higher and do so quickly and unexpectedly. I am not trying to scare or be the crazy guy with the tin foil (or gold foil as the case may be) hat, I am just communicating my opinions.
I believe that oil has bottomed and is now in a new uptrend. I have written several posts on the subject: Update on Oil, Gold and the USDX, Short Term Oil - Update 2 (Intraday), Short Term Oil – Update, and Short Term Oil. There is a lot of good discussion in the comments of these posts.
Oil has definitely formed a bottom (at least of for this cycle of monthly declines and retracements) and is in a new uptrend. The long term historical support that was identified has held. Oil has been on a new uptrend that is several weeks strong at this point. The weekly MACD has triggered up, but it is not in positive territory yet. However it looks very strong to me.
The daily chart looks overbought and oil is running into its first real resistance zone around $50-55. I bet we will get some kind of pullback from this level. I am waiting to time my next oil purchase until I see how far we pullback. I will write another post as the pullback occurs to evaluate its progress.
So what are some reasonable targets for oil in the coming weeks and months? Now that the bottom has been established (at least of for this cycle of monthly declines and retracements), lets looks at where we were. Oil topped out at ~147 and bottomed ~35. Doing just a 38% retracement (which I think is very possible) puts oil around $77/bbl. That is what I am targeting and where I plan to start selling. All kinds of things can happen between now ($50) and then ($77), but that is a loose gameplan and I will adjust mine as the chart unfolds.
What are my real life oil picks? For the short-term (weeks/couple of months) are: USO, USL, DXO, and UCO. Right now I am very bullish on the commodity and I am neutral/bearish on the producers. In the previous 4 oil posts mentioned above, several of us have been having discussions on oil supply and how profitable oil companies are with oil in the: $35-50 range, $50-75 range, >$75 range.
My "forecasts" for oil are:
Short term (next couple of days to 2 weeks): Oil is overbought in daily terms. It is hitting a resistance zone between $50-55/bbl. I expect a pullback and the most likely test point will be the 50 day-MA
Intermediate term (2 weeks - 3 months): Oil on a weekly chart looks very strong, made a solid bottom, and is now in a new uptrend. 38% retracement from top (147) to bottom (35) is likely. Which means my target is $77 oil.
Mid/Long term (3 months - 2 years): ??? Who knows. This is anybodys guess.
Very Long term (>2 years): Oil will be at much higher levels. Maybe 100/bbl, maybe higher. I think the inflation cat is way out of the bag. Oil (and all commodities) will trade much higher.
I think oil has a good shot of getting back up to $75 in the next few months. But will it stay up there for this year? I don't know. The state of the economy says no, inflationary pressures say maybe.
So this is why I am very bullish on oil as a commodity (since it is an inflation hedge) and much less so than the producers. Many of the rig operators are not making money with oil this low. And while I see oil going to $75 in the next few months, they supply/demand situation is too cloudy now to say whether it will stay there this year.
From a very long term standpoint I am bullish on COP and STO, not only because they are (reasonably) efficient producers but also because they are (partial) green/alternative energy plays (they have both made good green and alternative energy investments). BP is sort of in the same boat, (reasonably efficient, partial green). But rig operators, drillers and oil-sands projects I am not at all bullish on right now. I think several will go bankrupt in the next few years (all will probably drop in value). And when inflation starts to become front page news, I think a lot of the survivors will be priced very reasonably.
... Broad market Equities and conclusions in comments section ...