Dollar and Gold Market Update - A Look at the History of Dollar Countertrend Rallies and the RSI

We're going to start today's post a little differently by looking at our record--the good and the bad--as it applies to this move in the dollar and gold so as to set the stage for the purpose of this post on what to look for in a dollar turn based on its actions in the last 10 years of the bear market.

Note that we started talking about a need for gold to sell off technically, on November 4 with a need to consolidate near the 1100 number, or possibly as low as 1070.  Of course, this call was early, but now that we're working around that number, it seems to make sense, right?  By November 5, we were talking about sell signals on gold and the need to take profits.  By November 10, we were discussing the long term (primary) trend and warning that gold needed a correction in the short term, and that if it didn't correct then, there would be an intermediate term correction of a higher than normal magnitude coming.  By November 18, we discussed how gold was moving euphorically even as the euro did not confirm the move by failing to break 1.50 against the dollar.  By November 20, we were looking at the bullish and bearish cases on the euro to determine what direction things were going, and commenting on the ECB talking the euro down.  On November 25, we discussed that either gold was frothy or the dollar was about to take a nosedive--confirming we believed that gold was big time frothy.  On December 4, we discussed the gold correction underway but did not believe the dollar would break its 50 day moving average (should have trusted our own advice more on that one).  We also incorrectly believed that the euro would find support earlier than it has, but that was before all of the Greek default talk.  On December 7, we postulated that this could be a currency intervention (we still tend to believe that given the magnitude of the moves).  On December 11, we looked at key currency support levels, which frankly, haven't held as well as we'd believed it would.  We also commented on gold moving into the range for traders, which is still the case, noting that the 1100 area was solid with a possible breakdown as low as 1070.  Again, going back to the beginning of November that a consolidation must take place at 1100 or so.  Fast forward a month or so and here we are.  During that month, it was certainly concerning that we may have blown some calls, but in the end, the charts don't lie.  In summary, we've been right on in knowing there had to be a gold consolidation, and by proxy the US dollar must have at least "stood still," but we underestimated both the gold buying euphoria and the level of the dollar move up.  That's something we hope to correct today.

This brings up one key area in the realm of traders vs. investors.  Investors, which are simply traders with longer time horizons from our perspective, should be focused on the primary trend and should not be concerned with getting the absolute bottom of a move--just a good value.  The reason, of course, is that the closer one tries to call a bottom or top, the more likely the call is wrong.  A trader needs to not only get a trend right, but he must get it right in many different time horizons and get it right repeatedly in order to profit.  Essentially, his risk is higher as he has to enter and exit more trades, and thus get more decisions right.  It's a trickier game, but knowing the techniques can help make even long term investors make better decisions.

Let's get into it.  This was originally going to be part of our gold report since the dollar and gold are so tightly linked.  The problem, however, is that we can't seem to get the gold report out the door.  So instead, we'll summarize the dollar section here, and as we near a bottom, we'll follow up with the key gold analysis.

First, a history of the dollar in chart form since the beginning of the bear market.

This is a daily chart, and as such, it's quite crowded.  It's obvious, however, that the general trend (primary) since late 2001 is down (coinciding roughly with the bottom in the gold price). That trend should hold until fundamentally, the US gets its fiscal house in order--or the currency goes bust--whichever comes first.

That primary trend is made up of oscillations of small, medium, and large sizes.  That is, nothing goes straight up or down, so during the primary trend there are periods where there is a countertrend of various periods--months, weeks, and days, if you will.

Then next few charts will make this more evident.  First, the long term trend--down.  Again, this is driven by fundamentals.

Within any long term trend, there are countertrends.  We're going to use the term "longer term" to imply the smaller periods (trends, waves, whatever you want to call them) that make up the primary trend.  In other parlance, it would be called the secondary trend or countertrend (whenever it goes against the primary trend).  In essence, it's not the long term, fundamentally driven move, but instead it is the "next size down" series of moves that make up the long term trend.  The rallies that go against the primary trend are the secondary or counter trend rallies.

The following are what we'll term "intermediate term" moves.  Colors changed from blue to red to make it easier to see...  Basically, just as the long term trend is made up of smaller periods we're terming the "longer term," so then is the longer term made up of yet smaller moves called "intermediate term" periods.  All of these periods are also commonly referred to as "waves," but we're avoiding that term because it is often used by a specific school of technical analysis called "Elliott Wave Theory."  We don't want to create confusion as if we're referring to their technique.

Of course the intermediate term moves are made up of short term moves.  In a 10 year chart, there are simply too many to point out.  But you probably get the idea by now.

Note that we're really trying to break this down to be more granular and specific than most.  In most cases, analysts refer to the short term, intermediate term, and long term.  However, each analyst has a slightly different definition of what that means.  For our purposes, we're let the fundamentals drive the long term.  The monthly charts confirm the long term and help define the longer term.  The weekly charts define the intermediate term (with input from the monthly charts), and the short term will be defined by the daily charts (with input from the weekly charts).  Sound confusing?  It will become clearer as we move along. 

Our primary means of investing is to invest in accordance with the long term trend, but to avoid the secondary (longer term) counter trend rallies by either changing assets or, in some cases, shorting the primary trend.  We anticipated that the dollar would hit a longer term rally (a counter trend rally lasting several months that would be sharp and damaging to gold prices, in particular) in late Q1/2010 or early Q2/2010.  There are several fundamental factors for that time period as well as technical indicators that have been trending to "go off" around that period since this March.  However, we *may* be on the cusp of that longer term countertrend rally now.  The key in watching the dollar is to determine if we are, indeed, entering a significant countertrend move, or if this move is more of an intermediate or short term move.

To summarize our position in the dollar and gold markets, at this stage, we believe we're seeing an intermediate term move--one that will last maybe 4-6 weeks, of which 2.5 are already behind us.  Initially, we believed we'd be seeing a move of a couple of weeks at most, but we've understimated the weakness in the euro, and are still under the belief that we are probably witnessing a currency intervention timed for near the end of the year when gold prices were strongly overbought and the dollar was under significant pressure.  Why?  There are several factors, in fact, but perhaps the most important was is that this market has been trading very technically for a long time now, probably due to the dramatic rise in the computer-based trading instead of long term fundamental investing (hence the dollar vs. all assets in the world has been a theme even when the fundamentals don't support that in all cases).  Given that, then we can look at one very important piece of information--the dollar has never had a major (longer term/secondary/counter trend) rally when it was not oversold on at least the daily and weekly charts, and at times the monthly charts.  Never.  Not once.  Yet this time, all of the activity began occurring when the dollar was not oversold, but gold was overbought.  Combine that with data from the Exchange Stabilization Fund, the time of the year (holiday season), the negative dollar press everywhere, the ECB talking the euro down and the dollar up, the Bank of Japan talking the yen down and the dollar up, the positive press on gold, etc and you have a formula for the perfect time to intervene and manage market perception going into Bernanke's confirmation when there were signs all over that the trend from March was slowing.  Coincidence?  Only if you believe that we have free markets....

Nevertheless, here's a fact (and the number one reason to include technical analysis in your investing)...though markets are manipulated, that manipulation *must* show up in the price of assets.  There is no way, as an example, for central banks to beat the price of gold down without the price being affected.  While this seems ridiculously obvious, the point is that since we're using price-based analysis, then as the price moves, we should be able to determine the price movement will have on investors, resulting in additional future price movements.  That's the purpose of technical analysis and the reason that fundamentals alone, while they are the most critical aspect of investing, are not enough to navigate manipulated markets.
 
Another important note is deserved here.  No long term trend can develop without longer term trends that develop.  No longer term move can occur without intermediate term moves that become longer move.  No intermediate term move can develop without short term moves.  Everything starts at the daily, short term level and may or may not expand.  Given this condition, calling bottoms and tops obviously becomes a fool's game because the implication is that on any given day, you must know whether or not a given market move is going to be a long term play or not.  It's just not possible.  Our goal, when trading, is simply to determine if trends are changing, and if so, what the duration of that trend may be.  Then move into it once it has actually become a trend.  We'll never get 100% of a trend's move, but we're happy to take 80% of a trend with much lower risk, getting in after it's established and getting out before the herd.

With all of that said and the stage set, then let's look at how well the RSI has forecast the dollar moves in the short, intermediate, longer, and long term and what the history of these moves tells us that could be used to improve our odds of looking into the future.

 The first chart is a 10 year long monthly dollar chart.  There are areas outlined in either red or blue.  The blue outlines denote what we call "longer term" or countertrend moves.

 Notice how those blue boxes outline the countertrend moves so obvious on the chart we posted way above, just copied here for convenience.

In 10 years, there have been two countertrend periods, and both were forecast by the RSI.  Take a look at the monthly chart again.  Notice that the RSI was oversold (below 30) for an extended period of time before both rallies occurred.

There are two red boxes on those charts as well.  They correspond to intermediate term rallies.  You could say they were "false positives" that a longer term rally was coming.  Note that those intermediate term rallies never really moved the RSI from bordering an oversold condition, so in the end, it took a longer term countertrend rally to move the oscillator to the 50 mark (which is an important level on the RSI that separates bear markets from bull markets).  Note that in our latest period, the RSI is not oversold at all.  The trend from March would have put the RSI into oversold in late Q1 or Q2/2010, which was part of the purpose of our thesis about the gold price moving up until that period in time (as the dollar weakened).  Note on this chart that since the dollar entered its bear market in 2001 (which occurred when it topped and was technically confirmed in 2002 when the monthly RSI fell below 50), the RSI has not risen for any substantial amount of time above 50--only briefly and barely during the first major countertrend rally and again when the credit crisis (last rally) fueled the countertrend rally.  We've discussed this issue in the Looking Back at Signs of the Credit Crisis essay and our recent Global Health update.  In short, without credit stress, we do not believe that any countertrend dollar rally can substantially break above 50 on the monthly RSI for any reasonable period of time.  Thus, that 50 mark takes on a different meaning--without an exogenous event fueling a dollar move, any break above 50 for a substantial period is a good technical confirmation of a primary trend change to a dollar bull market due to a change in fundamentals (ie, the US gets its fiscal house in order).  We're not holding our collective breath on that one any time soon.



If we look at the RSI's performance on a weekly dollar chart over the same 10 years, we get a sense of the intermediate term rally picture.  We pick out about 19 intermediate term rallies for the dollar in the last 10 years (counting the current one).  If you used the RSI alone to forecast those rallies when the RSI was oversold only (as shown below), you'd have forecasted 11 of them (58%).  You would have forecasted 100% of rallies of at least 5% magnitude in size.

If you would have used the RSI at every oversold and turn at 50, you'd have forecasted 13 of 19 (68%) and every rally of at least 3%.  That's pretty good for one indicator.  Note that this recent dollar rally was also forecast as the RSI just touched the 30 level on the weekly chart.  That corresponded to the period when we first made the gold call that it was becoming overbought at 1100.

Note that the weekly and monthly charts were both oversold when the two longer term, countertrend rallies occurred.  

Now, this doesn't mean that the RSI is the Holy Grail of technical analysis.  It is very good, though, and the dollar has been particularly predictable with it.  Gold tends to need the slow stochastic, stock markets tend to need an advance/decline, etc.  There is no single indicator that forecasts everything, and they tend to be best as confirming indicators relative to chart patterns.  However, the point here is that the RSI alone can help predict the dollar market, which in turn helps predict stocks, gold, energy and other asset markets.

If we simply take the weekly dollar chart above and examine each of the 10 marked periods on daily charts, you will get a further sense of the magnitude and duration of the dollar moves.  We will leave the close examination to the reader, but here they are in chronological order.  Notice again that these are daily charts, and so you will see the short term moves in greater detail that make up the intermediate term moves.

The first intermediate term move was approximately two months long and made up of three short term countertrend moves of 13, 7, and 8 trading days.  (For those familiar with Elliott Wave Theory, you'll see this  patterns throughout the rest of the discussion).

These next two rallies occurred in a short period of time, so we've combined the view on one chart.  The first rally was a very steep short term rally (of "medium" or intermediate size) of 8 trading days.  Arguably, you could consider the second short term rally to be part of the first intermediate term rally, but since a new low was not set, we have not included it as such.

The second rally was an intermediate term rally of four short term countertrend rallies of 9, 9, 3, and 13 days, respectively.

The fourth rally was made up of 3 short term rallies of 10, 21, and 7 trading days, respectively.  It lasted 4 months.  Obviously, there is some judgment as to how to break up the short term rallies.  This is the most simplistic viewpoint, and 21 trading days is at the far extreme of what we'd term "short term."  In addition, 4 months is about as long term as an intermediate term trend can be.  This one bordered "longer term" in duration and magnitude.  There are no clear cut lines, but about 10% and 6 months would be the maximum "intermediate term" trend in our book.

This next intermediate term rally ("Rally Number 5") became the first longer term countertrend move, lasting 6 months and running to 13%.  Arguably, this is a secondary countertrend move mad up of three intermediate term moves.  Refer back to the monthly chart to see its overall size (which stands out on the monthly chart) and the weekly chart (to see the four distinctive intermediate trend moves, each made up of short term countertrend rallies, as seen below).

The next intermediate term rally was made up of three short term rallies.

The next three occurred close together and are on the same chart.  Notice that in this period, the monthly RSI was still staying in the oversold range, and the weekly RSI was hugging the oversold level (much as occurred prior to the first longer term rally).  These rallies never really removed the oversold condition on the dollar.

The last dollar rally was a throwover from the prior three.  Add in a little credit crisis, and look out!  A 25% move over 6 months that went from a consolidation, to an intermediate term rally, to a longer term rally.

Thus, in 10 years, we have two longer term, counter trend rallies which were predicted by both the weekly and monthly RSI, nineteen countertrend rallies of which all of consequence were predicted by the RSI, and more short term rallies we care to count, many of which were predicted by the RSI and most of which were, frankly, inconsequential (look at the first 10 year daily chart we posted to get a better sense of it).

What can this data tell us about this current rally?  First, the dollar was NOT oversold on the monthly charts and had only "tapped" the oversold line on the weekly charts when the rally began.  History says that this will not be a longer term rally, implying that the dollar move will be less than 10% and four months or less in duration.  The dollar has already moved more than a short term move would imply.  With confidence, we can state this will be an intermediate term dollar move.  Using the same exercise we went through and a similar one using gold as a proxy to determine when the dollar rallies end, we can conclude this move is probably over halfway done.  The euro charts appear to confirm this activity, though it's possible more downside in the euro remains.

We have a high degree of confidence that, since this is an intermediate term rally without a monthly oversold RSI or a credit crisis situation, that we will have turn no later than when the weekly RSI just peaks over the 50 line and the daily RSI gets to just below the 70 line.  We're just about there on both charts, meaning this run is just about over by historical measures.  The implication is that we'll see gold bottom and turn up first as a forecast that the dollar is soon to turn over.  In closing out the discussion around the gold price, we take you back to the December 4 forecast, and the final chart.

That initial forecast stands that gold has likely bottomed in the 1100 range, but there's a chance that we could have a breakdown to 1070.  If that occurs, back up the truck because someone gave you the best discount you'll likely ever see again.

For the record, a similar analysis of the gold market shows that any time the 14 day slow stochastic reaches oversold, it's a good time to buy gold.  We'll leave that investigation to the inquisitive readers.

Read more...

On the Gold Market, Fundamentals, Technicals and Sell-Offs

After last week's call on a gold pullback, we've gotten several questions asking how that could be so.  Thus, we've opted to explain a little about timing gold and the dollar in the short, intermediate, and long term.

Keep in mind that we're looking at only a short term consolidation, with the possibility of an intermediate term consolidation in the near future.  For most people, they shouldn't be concerned unless they need to buy more gold, at which point reading short and intermediate term lows is valuable as a buying point.

Over the long term, keep in mind that fundamentals are the most important factor.  As long as the nations of the world run with fiat currencies coinciding with global banking crises, the central banks of the world will create more currency.  This is a net increase in supply since there is a winner for every derivative contract loser.  The result is a devaluing of currency.  Given that the primary country in need of devaluation to reconcile its debts is the United States, and the US dollar is the world's reserve currency, then all countries will try to devalue relative to the dollar to stay competitive for as long as the dollar maintains its reserve currency status.

The fundamental result is that paper currencies will all weaken relative to hard assets, notably gold (and oil being a close second).

Thus, the first question that is necessary to ask is "when will it all be over and time to get out of gold?"  First, the fundamentals need to change so that the competitive devaluation of currencies globally ends.  That implies that either the US needs to get its financial house in order (which is not happening at this time) and/or the dollar needs to be removed from its position as reserve currency (there are many discussions about that going on).  It will probably take many more years.  It is even possible that, given the extreme devaluation of currencies, that this will be truly devastating--like nothing we've seen in our lifetimes.  This is one reason we advocate a strong position in physical bullion and not simply ownership of "paper gold."  Gold will not make you rich, but it will preserve your purchasing power in times of extreme stress--and the stress is far from over.  This is simply an intermission.

From a charting perspective, we look at cycles, historical precedent, and technical analysis for answers.  One of the best long term indicators of when the worst should be over is the DJIA:Gold ratio:

We call these market periods where there is extreme financial distress and gold begins to outperform everything "gold superbulls."

At some point, that ratio should approach 1, meaning that 1 ounce of gold is worth the same as the DJIA.  In fact, however, if you really examine the linear trendline connecting the bottom of each period, you get a ratio of 0.53, or roughly translated, an ounce of gold will buy the DJIA twice over.  Will it get that extreme?  That's a question of how the fundamentals develop, but given present course, it's not out of the question.  Also, given that during periods of extreme central bank money printing during secular bear markets, the DJIA tends to bottom at a much higher level than it would otherwise (due to inflation), and the duration of the secular bear market cycle is longer than it would be otherwise.  Presently, we are well on track for a very high gold price, a very long bear market, dramatic devaluation of all currencies--especially US dollars, Japanese yen, and British pounds--and ultimately, a very high DJIA.  We'd give you the numbers for gold, the US dollar, inflation rates, and the DJIA that we derived, but you'd just shake your head in disbelief or sit in the corner and cry...

The lesson here is that gold is a buy and hold--especially the physical stuff.  For those more inclined to trade, the short and intermediate term moves can be valuable, but being caught without physical could be financially crippling (talk to the Argentinians or Icelanders).  In our opinion, in September we began the second leg of this gold superbull which will be very strong and last a long time.

Thus far in this market, the USDX has really governed the gold moves.  However, gold has broken out in all currencies.  The one pseudo-exception has been the Australian dollar.  Gold in Aussie terms based from June to November and recently broke out.  Although it has consolidated a bit since, we expect the trend to continue very soon of gold rising in Australian dollars.

Thus far, we know that gold is in a long term bull.  We have some common sense about the fundamental picture and some technical indicators to support knowing when the gold bull will end.  We know that gold is generally rising in all currencies and it appears to be entering its second leg up in the long term bull market.  Note that while the USDX generally commands the gold price, which is because of its reserve currency status.  Gold may ultimately rise due to inflation, and not simply because of a weakening dollar (in currency flow terms).  Please make sure you've read our discussion on Inflation, Floating Exchange Rates, and Competitive Devaluation for more information on our position on this topic.

The moral of the story here is, again, gold should be a core position moving forward.  We use the indicators to find good entry points in the intermediate and short term.  If you already have a good physical position, then trading paper gold--in the form of ETFs, mutual funds, or gold stocks--can be a good play.  Note that we'd never bet against (that is, short) gold in this environment since it will be unpredictable and its upside strength must be respected.  It's simply too risky to bet against gold (just ask an honest deflationist).  Worst case, on a trade, we'd move to cash and wait for a consolidation if we expected a large sell-off (see more below).

That brings us to the intermediate and short term charts, and our prediction last Thursday.  Keep in mind that this prediction was about a short term move with a possible intermediate term move.

First, the short term:

Here we see the daily gold chart, plotted against the dollar.  We can see the breakout from the triangle in September that set this rally period off.  Readers should already know about the intermediate-to-longer term bullish inverse head and shoulders that should take gold to 1300 or more in this move.  You can see the neckline of that pattern in the chart above, with the purple dotted line.  Since the triangle breakout, note the channel pattern where gold rises quickly, hits resistance, and the RSI and slow stochastic indicators BOTH go into overbought.  Gold then trends sideways for a couple of weeks, corrects to the previous resistance line (about 4% in these recent cases), and then takes off to the upside again.  Since the RSI and slow stochastic were entering overbought territory and 1100 marked the near top end of the channel, it made sense that we were due for a correction--in this case, perhaps to 1070--the previous resistance zone.

But what about the dollar?  Don't we always look at the dollar, too?

Yes, of course....

Note that while the US dollar has resumed its downtrend (as predicted), it is at the low end of its support zone.  In support of this view has been the EURUSD cross, which is struggling again with the 1.50 level.

This level WILL give way at some point, pushing the dollar lower and gold higher (gold's rise yesterday was due to the dollar falling more abruptly than expected...), but given the importance of this level, we expect the struggle to continue a bit longer and give gold time to correct.  We expect gold will lead to the upside and forecast the 1.50 break.

But wait...that's not all...  Didn't we mention something about a *possible* intermediate term consolidation?  We got a lot of questions on this, especially in light of Marc Faber's market commentary on Friday:

INTERNATIONAL. Marc Faber the Swiss fund manager and Gloom Boom & Doom editor said he has some short-term concerns about commodity prices including gold. He is also reluctant to invest in bonds.

In the latest issue of the Gloom Boom & Doom, Faber writes: "Since we had in 2008 the third best annual return (41%) in the last 35 years and since each time high returns were followed by negative returns I would be, regardless of the economic outlook, very reluctant to invest in long term government and also in corporate bonds.

Faber says he is more negative about US bonds under a further deterioration of the economy than under a recovery, adding that 'inevitable' further economic weakness 'will lead to further fiscal stimulus packages and necessitate further money printing'.

He believes the latest GPP growth figures are a result of massive government interventions into the free market which inevitably resulted in extremely volatile economic and financial conditions.

As a result assets are over-stretched: equities are too high, the euro is over-bought the dollar is over-sold. Even gold may be due for a short term correction, he says.

"I should also mention some concerns (for now of short-term nature) I have about commodity prices including gold. A large number of commodities including oil, the CRB Index, and gold broke out on the upside in early October," Faber said.

"I would regard a failure to hold above the “upside breakout points” in the period directly ahead with great caution. In the case of gold a decline below US$1,000 would likely lead to further more meaningful weakness, possibly down to between US$800 and US$900," Faber added.

Faber has been reiterating, in various recent interviews, the notion of over-stretched assets and a possible short-term dollar turnaround.

Speaking in a Bloomberg interview from Istanbul on Tuesday, Faber said: "Maybe the dollar has made a turn, it can easily rebound by 10%”.

“It may have started already since the asset markets started to go down 10 days ago.”

“I don’t think that the dollar will be a strong currency, but you can have periods like in 2008 that the liquidity tightens”.

“If you have the private sector withdrawing credit and the government throwing credit at the system you can get a lot of volatility,” Faber said, adding he would be careful to buy equities now as “we are in a correction period.”

For more information, please visit www.GloomBoomDoom.com

While we agree with Marc Faber's commentary on government and bonds, and are cautious about large consolidations in this environment, we believe he's a bit premature.  We believe there's still more upside before a major gold consolidation (see below) and equity consolidation.  Of course, the USDX drives all right now, and if the EURUSD cannot rally above 1.50 once gold has consolidated, then that should be a concern.  Unless that condition becomes prevalent, we believe our thesis on the big dollar/gold move to be correct.  For the record, we would consider any large gold sell off after a major dollar bottom to be an intermediate term move, and this is one reason we have considered owning paper gold in this particular case (we will be taking paper profits and buying more physical gold after the move).  The long term trend is intact.

As we have discussed several times, the USDX controls everything else--the whole world of assets is being traded against the dollar.  We have a proprietary indicator we call the "Window of Opportunity" indicator for the dollar.  Essentially, this foreshadows major intermediate and long term changes in trend for the dollar.  It has been particularly accurate for forecasting when the dollar will fall and about 60% accurate for dollar rises, including the March 2008 rise and the March 2009 fall.

Something similar can be done with looking at different RSI and stochastics over various trading periods (daily, weekly, monthly).  While going through that analysis is a thesis in and of itself, let's just point out a few things of interest.

Below are three charts.  Each chart is a 10 year view of the gold bull market.  The first chart is a monthly, the second is a weekly, and the final is a daily. 

 

 

The gold market, and all markets for that matter, are dotted with short term, intermediate term, and longer term sell-offs (just like we showed on the short term chart).  We use the term "longer term" to differentiate from long term in the multi-year, megatrend sense like a during a secular bull or bear market.  We are essentially talking about corrections in this case.  These sell-offs are small, medium, and large in magnitude (like that fancy categorization?).  All of the medium and large magnitude sell-offs have been forecast with the combination of the RSI and slow stochastic.  Over the last 10 years, since the bull market began, we have had two large magnitude sell-offs, approximately two years apart (circled).  In both cases, the monthly, daily, and weekly charts have all forecast these moves with the 16 period RSI and 14,3 period slow stochastic showing overbought.  In both cases, the monthly RSI was overbought for at least a couple of months before the correction occurred.  (Side note, in the last correction, the TED was elevated dramatically as this sell-off was the sell-off of the credit crisis).  If these conditions were not present, the gold sell-off was only "medium," meaning no more than about a 10% correction.  If you look at the charts above, you will see that the daily and weekly charts are overbought, though the weekly is "just barely" overbought.  The monthly "still has room."  Thus, we believe we are due for a short term correction (small) and possibly an intermediate term correction (medium) of up to 10%.  The larger, longer term correction is not YET in the cards....

What this means to us is that our "dollar to 72, gold to 1300" thesis is alive and well.  Within the next 6 months or so, we expect to see the dollar bottom, a major consolidation of assets, and gold to sell off for an intermediate term correction of about 25%, ala what Marc Faber mentioned.  But we're not there yet--at least by historical measures.  We do, however, concede the possibility in the shorter term of a gold sell-off taking the price back toward 1025, which would be a medium level sell-off.  For the time being, we believe that the neckline will serve as the primary support level.  Once gold completes its longer term pattern, then that support line will not be as important.

There you have it.  If there are any questions or clarifications, or if you'd like to get in on our free mailing alert list, email us.

Soon, we'll be providing a more in-depth energy discussion by popular demand.

Read more...

Review and Dollar Update: Countertrend Conundrum, or Destined Demise?

A brief recap for the new readers.  Our key thesis is that we're in secular bear market in stocks and a secular bull in commodities, and that those markets are behaving exactly in line with the movements of the US dollar.  All of our Technical articles are based on this premise, and we use a variety of in-house models to determine what is likely to occur next in this process, that are based on a combination of economic theories, fundamental analysis, historical precedents and cyclical behaviors.  Of course, we use short term technical indicators to determine if we're on the right track in the short and intermediate term.  The long term is generally a known, the short term is a gamble, and the intermediate term gives us the main trend that we work with to ensure that our model is behaving.  In essence, the model (or actually models) are projections of what could happen, the intermediate term indicators tell us if the model is working or something else needs to be taken into account, and the short term technical analysis points to what is likely to occur in the intermediate term (short term trends may evolve into intermediate and long term trends....).  We encourage you to read the Education section for more details on the models and our methodology.


Central to navigating the waters is the action of the US dollar.  Thus, the dollar is the primary focus of most of our analysis as the leading indicator of what will occur in other asset markets.  Most all assets are moving inversely to the dollar's actions, as measured on the US dollar index (and our own internal variant, charted several times below).  In the big picture, we believe the US dollar, and perhaps all fiat currencies, are in major trouble during the course of this secular bear market.  This is primarily because the entire global monetary system is based on a promise to promise to pay with promises.  It is, in essence, based on nothing but goodwill, which is likely to be in increasingly short supply moving forward.  At the same time, the consumption engine of the world--the US consumer--is tapped out creating major recessions in many parts of the world and likely depressions in the US, and most likely Europe.  We stand on the edge of a major shift in global sentiment with the possibility of a rising Asia and sinking West.  This is history in the making, and we're going to show you something you should watch carefully.

Market fundamentals are poor, but we have rising markets as the US dollar falls.  At some point, this trend will have to stop, but until then, a falling dollar generally means rising asset prices, and increasing global monetary inflation is sure to buoy prices across the board over time.

The global risk level is high right now, and likely to get higher as the US dollar falls.

Big Picture - USDX
Let's see where we are.  First, we'll slice and dice the history of the USDX.  The black, dotted line is the one we're concerned with and is our own "smoothed" version of the USDX from inception to present.  It closely tracks the "Major Currencies" and "G-10" data.

Next, note the red downward, linear trendline (derived mathematically, not drawn by hand).  That's the linear trendline of the USDX since 1971, which is the best graphical description of the dollar losing purchasing power (you will note that most all fiat currencies follow this general trend to one degree or another).

Note that there is a cyclical behavior to the dollar (as with most things)...

 

You can see the substantial, almost parabolic rise of the "credit crisis" of 2008/2009 show up on the chart.  Note that credit crisis afforded the dollar the opportunity to "touch" the trendline, and then fall back below it.  Also note how long the dollar tends to stay below the linear trendline--in each case, the dollar was below trend for approximately 10 years, from 1972 - 1982, 1987 - 1997, and most recently, late 2003 - present.  Conversely, the dollar stays above the linear trendline for 5-6 years.  Assuming we stay on trend, the dollar should rise above trendline in late 2013 or early 2014.  That begs the question, when should we look for a bottom in the dollar in a typical period such as this?

Note the dotted green line that is a 6th degree polynomial trend for the USDX.  Note that although it is trending down, it has a cyclical nature to it where it rises above the trendline and then falls below it.  This polynomial trendline should tell us when the dollar will bottom and begin to turn up--if this secular bear is like the others.

Note that in the above chart, we extrapolated the linear trendline and created a horizontal trendline that is tangent to the lowest point of the polynomial trendline back in 1974 (the lower red trendline).  This, what we call the "Must Hold" trendline, is the furthest point of deviation on the polynomial trendline from the linear trendline.  Note that it nicely marks the lowest points in the dollar trend through the past 38+ years of the floating currency paradigm.  Any break below this trendline has been very, very temporary in the past (note that this is a daily chart).

Here's a closer look at this trendline on the USDX and some key cyclical points to keep an eye on.

 

In the chart above, we have some projections for a "healthy" secular bear period.  If the dollar is to continue in its long term, cyclical trend, it should rise back above the long term linear trendline (top red line) in late 2013 (where the USDX value will be approximately 82), or perhaps as late as early to mid 2014 (the cycle period is stretching over time).  It should bottom in early to mid 2012 at around 68 on the USDX.  That implies that we should see a gradual slide from 76 to 68 between October 2009 and May 2012, or 10.5% over 31 months.  Note that the current rate of decline is much, much faster than this, which is a warning in and of itself.  To correct this pattern and "stay on track" for a "typical" secular bear, we should expect another rally or two in the dollar over the next 3 years that are sharp and dramatic.  Otherwise, the risk of a dollar crash becomes substantial.

Why is this information important?  Because we simply always need to evaluate whether we're in a "typical" secular bear or if this is something different.  Fundamentally, most countries around the world are inflating their currencies away, and this has historically ALWAYS led to hyperinflation and currency destruction.  But the magnitude of the dollar bear market that we've seen so far is not out of alignment for a "typical" secular bear market, though we may be getting close to that danger zone.  As long as we remain within the trend projections above, we're in a "normal" down cycle for the dollar.  If we break those trends, notably we break the lower "must hold" trendline, then dollar holders likely have a very, very serious situation on their hands.

To reemphasize the accuracy, note how the dollar bottomed at the "must hold" trendline in early 2008.  This led to a vicious "credit crisis" rally, in which the dollar hit the 38-year, long term trendline and fell again.  These trendlines certainly seem to have a substantial track record and should be respected.  Conversely, if we break down below the typical behavior, that should be regarded as a MAJOR red flag.  Thirty-eight year old trends that suddenly end probably end badly....

So this leads us to the short and intermediate term trends that should tell us where we're going.

Intermediate and Short Term Dollar
What we typically call "long term" in our technical analysis, at least relative to the 38-year old trends we just reviewed, could better be called "intermediate term" in this case.

Here is an 18 month view of the USDX weekly chart, just prior to the credit crisis and just after.   Note that on a weekly chart, we are approaching oversold(but not there yet).  The last time that the dollar was oversold on the weekly chart, it bottomed for a few months and then rallied strongly (back to the 38-year trendline).  Note that the rate of decline on the RSI has increased since the second top in March (which, by no coincidence, was the beginning of the stock market rally).  The 200 week and 50 week moving averages are on a path to have a negative crossover, also known as a death cross, at the 82 level.  We are oversold on other, faster oscillators.  It is possible for the dollar to move down lower over the next few months, but we are probably due for a rally of significant size at that point (see our October 8 update).  If we do not see a significant rally, remember that things crash when they're oversold, not overbought...

Even shorter term, things are looking bearish--or is it a bear trap?

On this daily chart, the slow stochastic is clearly oversold, though the RSI shows more possible downside.  We have a descending wedge, which while a generally poorly performing pattern, may indicate a rally is coming.

A closer view shows the behavior around 78, where there was a 1.1% decline below the 78.33 level where the dollar recovered for a few weeks (aka, a false breakdown).  We need a daily close below 75 to ensure that this does not happen again.  As of this writing, the dollar appears to be having a minor recovery from its lows and the chance of a return back above 76 is a possibility.  We can see that 75 marks the point where a false breakdown (1.1% from the 75.83 level) may cause a rally, and the point where the descending wedge would break to the downside.  75 is the key daily level to watch.

Note that most all other assets, notably gold, are overbought and have been for some time.  It is risky to enter new positions there, though over time gold is probably our favor asset (for the next few years, anyway).

Summary

We stand at an important crossroads here.  72 on the USDX is certainly in the cards as a result of the double top formation.  Some downside targets put a low for the double top of the dollar at the 67 level.  If we look at our present situation with a wider lens, we can see that the 67 level would be a strong indication that the dollar is in very serious long term trouble (68 by .  Our rate of decline in the USDX is also very troubling.

A close below 75 on the daily chart, or as we stated last week, a close below 75.50 on the weekly chart indicates a rapid acceleration toward 72, with a possible pitstop at 74 (especially if we decline here without a minor rally).  The ceiling on the minor rally should not exceed the 50 day moving average, which is 77.45 at this time.  A major rally, again which we would expect to see beginning at the 72 level, would not exceed the 38-year trendline.

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It's Getting Serious

Generally speaking, we try to offer information for people seeking to understand what's happening in the world and how to protect what they have in these perilous times.  Our position is simple: the US, and parts of Europe, are in the early stages of an inflationary depression.  Asia, assuming they focus on being less reliant on the US and Europe as customers, are in a recession.  The dollar, as reserve currency of the world, is in trouble due to profligate spending and overextension.  We are in a period where we will revert back to more equilibrium in the world, and the transition will be very painful.  It is likely that many will lose everything in this transition, which will take a decade or so to play out.  The transition time may include wars, starvation, and most certainly increased government oppression around the world.

We use the technicals to help navigate the financial storm, but the reality is that over time, holders of most fiat currencies are in trouble, notably Americans.  As we enter a time of incredible strife and conflict, it will be imperative that intelligent people spend time preparing for what's to come.  Food, water, energy, clothing, shelter and protection should be the key focus for people just starting out.  Have several months worth of living expenses in cash.  After that, just note that cash in all of its fiat forms is being destroyed through the actions of banks and the government.


Gold is, in our opinion, the single best protection in this environment--physical gold in your possession.  After that, the goal should be either to diversify assets into things that are guaranteed to hold value (tangible assets) or to take appropriate risks for capitalizing on the chaos that will ensue.  Yes, it sounds terrible to capitalize on destruction, but the destruction is going to occur whether you capitalize on it or not.  You can either benefit from it or suffer from it.  That is a personal choice.

Yesterday, we wrote a piece on currencies and inflation.  Last night, we reported on the breakdown that in the dollar and its imminent test of support at 76.  We've reported many times that there's not much support for the dollar between 78 and 72, with the exception of minor support at 76.  We have touched and bounced off of 76, consolidated, and last night we reported that we would test 76 this week again, and that gold would break through its resistance at 1020.  We didn't know it would happen quite that fast, but it occurred today.

We're at an important stage.  A drop from 76 to 72 in the USDX is a major drop.  Asset prices will rise quickly in response.  The 72 range is a critical range.  If the dollar breaks down below 72, the risks are substantial. 

If you own no physical gold at all, you should consider purchasing some on any pullback.  Email us if you'd like the names of some possible suppliers--we have no affiliation with them other than being customers ourselves. 

We will be watching the 76 closely and reporting on it.  Gold will react opposite the dollar.  It may lead the move, but gold will not truly take off until the 76 level is broken through.  That may happen at any time.  You can see the inverse correlation between dollar-based asset prices (including gold) and the dollar itself.  Stocks today have shot up on lousy fundamentals as the dollar has taken a dive in overnight trading.  This is a serious time.

More on gold, the dollar, and gold stocks later today.

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Inflation,. Floating Exchange Rates, and Competitive Devaluation

Often, there appears to be confusion regarding the USDX going up or down and deflation or inflation, respectively.  The USDX and inflation/deflation are two different, though related, things.

What is the value of a dollar, or any currency?  By itself--nothing.  Since Nixon removed the dollar from the gold standard in 1971, the world has moved on to floating exchange rates, which began in 1973.  In fact, currencies now only have value against one another or tangible things--in and of themselves, their value is relegated to the belief that the supporting government will tax its people to provide more paper currency.  Currencies are usually quoted against one another as pairs; for example the euro versus the US dollar (aka, EURUSD) or the US dollar versus the Canadian dollar (USDCAD).

Sometimes, it makes more sense to look at the value of a currency relative to many other currencies.  The US dollar index (USDX) is a measure of the US dollar (USD) against the currencies of its key trading partners, including the euro (EUR), the Japanese yen (JPY), the Canadian dollar (CAD), the Swiss franc (CHF), British pound sterling (GBP), and the Swedish krona (SEK).

There are some countries, notably Saudi Arabia and China, which peg their currency to the US dollar.  If the US inflates its money supply, these countries must also inflate their money supply so that the value of their currency is some multiple of the US dollar.

The value of a currency is analogous to the value of a stock in a company.  Ultimately, it's a voting record.  The value of IBM stock, for example, is very much related to the earnings, dividend payments, and future prospects of the company.  The stock has no real inherent value in and of itself--it is worth what people think it is worth at that time.  Currencies are very similar.  They are the stocks of the nations from which they are issued.  The value of the currency is largely arbitrary, but is based on economic prospects of the country, interest rates on the government bonds (like US Treasuries or UK gilts) that it pays, etc.

When the dollar (or any currency) goes down relative to another currency, the only real effect is that it benefits the US' export competitiveness and makes imports from the other country more expensive.  For example, if the US dollar goes down relative to the euro, then goods from the US are cheaper for European consumers, which is good for US exporters.  The reverse is also true, though--imports from Europe are more expensive to US customers.  Given how many goods are imported into the US (and most of Western Europe), this means a general rise in prices for consumers of those goods from countries whose currencies are rising relative to the US dollar.  Note that China has a peg with the US dollar (at least right now), so Chinese imports will stay cheap in dollar terms as long as Chinese labor stays cheap and the currency peg is maintained.

This condition of floating exchanges rates and artificial pegs to some currencies has had the effect of inducing business to outsource its labor throughout all of the higher cost, "first world" countries.  If one can make a widget in China cheaper than in the US, even after taking into account the cost of foreign production, management, and shipping it across the ocean, then business will naturally gravitate toward lower production costs (which is great for consumers of the product).  If the Chinese renminbi were allowed to float against the dollar, free market currency flows would strengthen the renminbi relative to the dollar, making the cost of Chinese-produced widgets more expensive, and the outsourcing from US business would slow until there was a market-based equilibrium.  Of course, if all countries were trading based on gold and not on floating currencies, this would be a non-issue anyway.

Contrast this concept with inflation.  Inflation is an increase in the supply of money.  Much like a company that issues more and more stock, the remaining pool of stocks is diluted and worth less.  It is simply a supply/demand issue.  In this way, inflation can influence the value of the currency from a floating exchange perspective because as the supply of money increases, currency traders are more reluctant to hold that currency.  This is how inflation and the value of a currency in floating exchange terms are related.  However, they are not the same thing.

This is all very important in our current environment, and when we look at a measure like the US dollar index (USDX).  The USDX is a measure of the value of the dollar against some major trading partners for the US, heavily weighted toward Europe and then Japan.  Most of the industrialized world is deeply in debt.  Inflation erodes debt because once a debt is undertaken, it is typically paid back at a fixed rate of interest.  If you can simply print more currency, then the value of each unit of currency becomes less, and by implication, the total amount of outstanding debt is less, relative to the amount of money.  The debt, in essence, becomes cheaper to pay for.  Of course, the creditor is paid back in devalued money, which is not a good for the creditor.  The result is that any country that is known to be inflating its currency rapidly will also lose currency value relative to other currencies with lower rates of inflation.

What we see today is a state of competitive devaluation where all countries are inflating their currencies to some degree.  As one country outpaces another in the inflation department, the value of that currency falls.  Fact is, though, that all of the currencies together are becoming less valuable.  However, relative to one another, they may be holding ground.

This is an area in which gold is particularly valuable since it is the most inflation-free money in the market.  Currently, the USDX is generally declining.  Occasionally, it rises relative to other currencies for various reasons (for example, a liquidity crunch).  All the time, the general number of dollars is rising along with the number of other currency units (euros, yen, francs, etc).  Thus, the USDX is a reasonable measure of dollar performance versus other currencies, and by proxy a measure of the health of the economy versus other countries, but it is not a measure of inflation, per se.  Gold, on the other hand, is relatively fixed in quantity (new supply is limited to a few percent a year), so what we see today is gold holding its value relative to many currencies, even if the value of those currencies relative to one another holds steady.  One of the interesting properties of gold is that it really isn't used for much of anything other than a currency of last resort--a store of value when other currencies are being inflated away.  An excellent illustration of this property was gold holding its value during the credit crisis.  This is the primary reason that so many pure commodity traders misunderstand gold.  Gold is not a commodity.  It is a currency.  It is the only trustworthy currency when economic times are stressed.

Let's take a look at the dollar now against several other currencies over time.

The first is the USDX in various forms of measurement against various baskets of currencies.  Note that this chart is from inception of the dollar as a floating currency, unbacked by gold, in 1971.

Note the dotted line labeled "Interpolated USDX" which is our own measure of the USDX that is designed to smooth the curve fit between different periods of measuring the USDX different ways.  It generally tracks with the "G-10" and "Major Currencies" measure of the USDX.  By that measure, the USDX peaked in early 1985 and has been on a rampant decline versus most all major currencies since then.

The second chart here is the same USDX measurement from above since the year 2000.

You can easily see the credit crisis that started to set up in March/April of 2008 as the dollar was bottoming, and then rose until March of 2009, when it resumed its decline.

It is easier to see it on the technical chart below, which is just a blow-up of that period of time until now.

The next few charts show the US dollar paired against select currencies from 1999 to present.

Against the euro.  The euro, except for during its inception period and during the credit crisis, has generally been rising against the dollar.  Note that this chart shows the euro in dollar terms, so it is rising (meaning a falling dollar.)

Against the yen.  The trend has been a weaker dollar relative to the yen since 2002.  This chart is the dollar in yen terms, so the dollar is falling relative to the yen.

Against the Swiss franc.  Part of the Swiss currency is backed by gold.  The dollar has fallen against the Swiss franc since the gold market started to take off in 2001.

The British pound may be the only currency in worse shape than the US dollar.  The pound generally rose against the dollar until the crown's profligate spending and borrowing exceeded that of the US, on a relative basis.  There was some recent strength again, but it appears to be short lived.

Against the Canadian dollar (the loonie).  Canada is a natural resource-based economy, so the dollar has done poorly against the loonie except during the credit crisis.

 

 While not part of the USDX, the Australian dollar, like the Canadian dollar, is resource based.  The Aussie dollar has done very well against the US dollar except during the credit crisis.

Outside of gold, the Aussie dollar and the Norwegian krone (value relative to oil) are the only currencies we would own.

All of these currencies can be seen on the chart below.

 Now, let's look at things in terms of the currency of last resort--gold.

As the reserve currency, gold is priced in US dollar first and foremost.  Here is the Gold/USD chart as a basis.

Gold priced in euros.  Gold is up against euros, but up against the dollar even more, meaning that the euro (as can be validated from the chart above) is up against the dollar.

Gold priced in Japanese yen.  Again, the yen has fared better than the dollar, and gold has fared better against both.

 

 Gold in Swiss francs.  Even though the franc is partially backed by gold, the Swiss government has continually worked to devalue it relative to the euro and dollar, for trade purposes.  No fiat currency is a safe haven.  Gold has risen against both.

Gold in British pounds.  The pound is trying hard to devalue more than the dollar, and gold is up against both.

Gold in Canadian dollars.  We don't like the loonie as many as some because the US is Canada's largest trading partner.  There is an incentive for the Canadian government to keep the loonie devalued.  Again, gold beats both.

Gold in Australian dollars.  The Aussie dollar has done well, but we can see the general trend is that gold will outperform.

A summary chart of gold in various currencies.

Here's the takeaway.  The dollar is falling against all major currencies.  This makes things in dollar terms more expensive.  Gold is rising against all currencies.  This is a long term trend, not a short term trend.

Gold is the currency of last resort as the other currencies are inflated away.

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