Tuesday was quite a day in the markets. Late notice of a commodity sell-off on Monday may have put some readers in a tight position. This is probably going to be part of the trend for 2010, which will be a year where the markets will need to be watched closely and regularly.We are considering offering a service for faster recommendations via Twitter or mobile text, to those that are interested in up-to-the-minute protections and recommendations--obviously, managing money internally is more of a pressing concern than being altruistic in timely public announcements. That may change moving forward. Stay tuned.
We would like to take a larger view of the markets to start the year, making some intermediate and longer term predictions and commenting on the general health of several sectors, including gold, energy, food commodities, base metals, currencies, stocks, and bonds. In addition, we need to take a look backwards and see what we got right, what we got wrong, and update our past predictions with new information. This will take several days, if not a couple of weeks, to release on the blog. Again, given the priority of managing money vs. posting public information, we must focus on the former first, which may drag this process out a bit.
It appears that our call on the gold market bottom on December 22 was a spot-on hit. The gold market has been consolidating, and we expect a larger breakout to occur soon. But let's not jump ahead too much quite yet...
Correlation Update - USDX and Asset Price Correlation
We start the year looking at correlation between the US dollar and various asset classes.
In November, we began commenting on how gold's inverse correlation to the dollar was breaking down, and how gold was "getting ahead of itself," ultimately culminating in an intermediate sized correction. In fact, correlation of most assets with the US dollar has been weaker over the last few months. If you examine the above chart closely, you'll see that the correlation has been breaking down more frequently over the last couple of months. We've commented on this possibly happening several times in the past, and now it appears that this trend may fully develop in short order. This is a major change for 2010 investing. The US dollar still has influence over asset prices, but asset prices are increasingly moving up or down in US dollar terms regardless of the USDX. We believe that we are in fact seeing more institutional money taking positions in hard assets regardless of the currency market issues. While we still need to see this play out longer to confirm a new trend, we may be seeing a period where individual asset classes begin trading according to their own supply/demand fundamentals with influences based on a global increase in money supply (inflation) instead of simply being priced as bets against the US dollar. We wrote
a bit about this in October, and that essay may be valuable for distinguishing between inflation vs. currency flows. In a nutshell, this will be the single most important change of events we will see in 2010 as a means of predicting asset price direction.
We believe the most important point to this is that we may possibly see a general stock market that begins to roll over near the end of Q1/2010 or into Q2, regardless of the USDX direction. Select stocks focused in the right sectors may continue to rise as general commodity prices rise. More on this in a later part of this series where we examine individual commodity groups and stock markets.
US Dollar
The dollar appears to have topped at 78.45, and as we thoroughly covered in
our essay on the dollar, this rally seems to be no more than an intermediate term technical rally without any
real credit crunch fears. As a result, the only thing really affected was the price of gold (note that silver continued to do well despite gold's actions) and gold stocks.
Let's start with the big picture, and refine our view.
In our essay on the long term technical view of the dollar, we pointed to a concern in that the dollar decline is likely to accelerate to the downside if the key technical level of 68 is broken before 2014. This year we may, indeed, test that level.
In the longer term (or longish term) monthly chart, we can see how and when this may occur.
The lower blue trendline indicates the key support level for the dollar moving forward. It is the trendline that we believe would have occurred without the credit crisis. At this stage, the US dollar is still above that trendline. The upper blue trendline (note how the two of them together form a falling wedge) is the new, post-credit crisis trendline, which at this stage assumes we've seen a dollar top for the time being (more on that below). Those trendlines point to a period between July and December (second half of 2010) in which the dollar will be challenging the 68 level. At that stage, we expect a major dollar rally (a breakout of the falling wedge to the upside) which will cause a strong sell-off in assets prices (presuming a reasonable degree of correlation between the dollar and asset prices holds as the year progresses). Until then, we anticipate on minor rallies in the dollar or minor pullbacks in asset prices (when a particular sector or asset becomes overheated).
The intermediate dollar trend is definitely negative as it has bounced off of the 50 level on the RSI and is negative on the slow stochastic, as well as a negative divergence on the MACD. This was a 5.7% rally--well within the intermediate term rally expectations we outlined in our
most recent thesis.
In the short term, the dollar has broken below the 77.40 level support line and will likely be challenging our old friend 75.83 soon.
We need to take a look at the euro as a confirmation on USDX level activity.
The intermediate term chart has the euro coming off of the 1.425 level that
we discussed as support in November. There is resistance around 1.48 where this most recent decline began, and then the euro will challenge its old highs. Note that the slow stochastic and RSI have both turned up. Momentum has not yet come into the market, but as it does, we believe the euro has a good chance of regaining ground quickly, despite all of the problems in the PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain).
The short term euro chart shows a resistance at the 1.45 level just above where the euro has been consolidating off of its lows.
This is a key resistance level in that breaching it implies that the euro is still in a bull market relative to the US dollar. We believe we will see consolidation for a few days to a couple more weeks just below this level before a breakout occurs.
While we believe that the dollar rally is behind us, a break in the euro below the 1.42 level would be a cause of concern. A break above the 1.45 level implies the risk trade is back on.
Gold Market
Most technicians cover the gold market as part of the commodity complex. From our perspective, nothing could be less true. Gold is only a commodity when times are good and fiscal policy from governments is sound. When the opposite condition is true, like today, gold is the money of last resort.
As we've stated before, the best long term technical indicator for the end of the gold market will be a 1:1 DJIA:gold ratio (or possibly lower--see the essay for more details).
In the longer term, monthly chart below, you can see the trendlines that have defined various phases of the gold market in the last 10 years. Note that the trendlines are becoming steeper, which we would expect as the gold market moves more and more into the mainstream. Note that we're near the overbought levels still on the RSI. At some point, which we believe will occur when the dollar has a major rally, the gold market will likely have a major correction of 20+%, probably in H2/2010.
In the intermediate term, we can see the key support and resistance lines corresponding to price movements alone (red), longer term trendlines (blue), and the neckline of the inverse head and shoulders pattern (purple). Our intermediate term forecast is for at least 1300, and the correction we've had thus far is simply a price correction/consolidation on the way to that forecasted target.
The short term gold picture is overbought, and in the last couple of days we've seen a correction. Along with the euro, we believe that gold will generally basebuild here before turning back up to challenge the 1175 level, and then the 1225 level. This correction will likely be over this week.
Silver
In 2010, we're going to cover silver more explicitly on the blog as we expect silver to continue to outperform. As long as the general trend on the chart below is down, silver will be outperforming gold in the longer term trend. Within that longer term trend, leadership will change, but the general rate of appreciation is on the side of silver,
as we've noted previously. We are in the period where silver is outperforming on a longer term, short term, and intermediate term basis. Invest accordingly until we get to the bottom of the trend channel.
The big risk in silver shows up on the intermediate term chart where a rising wedge is forming. Wedges are notoriously fickle patterns and should not be taken as major trend changers. We would not expect this rising wedge to break to the downside until silver is at the bottom of the trend channel (above) where it will consolidate and allow gold to catch up, or this wedge will simply fail. Keep an eye on the lower trend channel just to be safe.
The short term silver picture is positive as silver is coming off of the bottom of its channel and trending upward. Like gold, it is overbought short term and is correcting, but that is likely to complete this week.
If you missed the buying after the precious metals hit the bottoms a couple of weeks ago, this correction will create another decent entry point. We tend to be more bullish on the precious metals stocks than on the metals themselves at this point.
That's all for now. We'll have follow ups on energy, commodities, and stocks soon, as well as a complete short/intermediate/long term forecast for all of these markets in the next week or so.
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