Death of the Fiat Currencies

As predicted, gold has held its key retest of the rectangle.  Tomorrow will be important.  We're watching for a key turn early next week.

Anecdotally, a year-and-a-half  ago a few of us had a nice dinner with some Swedish and French colleagues.  At that dinner, one of our French colleagues remarked that this crisis would destroy the dollar and that the era of US dollar hegemony was over.

While we're no fan of any fiat currency, a certain amount of hubris emanated from that conversation.  The retort was simple:  the US dollar will fail, but so will the euro before it is all said and done.

Given the panic buying into gold by Europeans that has escalated dramatically when, as recently as six month ago, these same Europeans believed that a socialist state supporting the easy life could be had by simply combining the currencies of several socialist states against the US dollar--well, you get the picture, dear reader.

No one is safe.  They are all fiat currencies--they simply fail at different rates.

The big implosion is not yet upon us yet, though it will be.  Those that want to protect what they have and chance prospering will be nimble...

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Don't Freak Out--Quite Yet, Anyway. How to Spot a Market Top.

Given today's fun filled market action, currency chaos, and roasting PIIGs, it's probably important to put some things into perspective.  Let's start by taking a look at major stock markets around the world.  You should see a trend here...

First, the S&P, which over the last few weeks has fared better than most of the other global equity indices.

As we discussed last time, the S&P has not had more than a 9% correction this decade, with the exception of the 2007-2008 crash.  Can it crash again?  Of course, but there will be signs again.  More on that top spotting a bit later on.

Let's zoom out a bit.

Note a few things on this chart.  First, from the bottom in March of 2009, the market has retraced 61.8% of it's crash from October of 2007.  That's a key Fibonacci retracement level.  At the same time, the market is overbought and overextended.  We can expect the technicians to sell the market here.  The real question is whether or not this is a correction, or the beginning of something much more damaging.

This brings us to the second point on this chart.  Note the red line.  A very important characteristic of markets is their behavior around this average.  Bull markets tend to correct to the line, with some possible overshoot, but do not stay below it for long (look at the July 2009 and February 2010 corrections as examples).  Here's the important premise: as long as the 150 day moving average is pointing upward, the bull market is intact.  Once the 150 day moving average slopes downward AND the closing price of the security falls below it, a full blown bear market begins. For the most part, market tops don't just happen immediately.  Topping is a process, not an event (some rarities, including the 1987 top, are exceptions).

So, at this stage the bull market is intact.  The burden of proof is on the bears to take control.  They have failed to do so in the last year.  It appears they will have their chance again now.  What transpires over the next week will be particularly important.  Why?  The US markets have been lagging, not leading, the global "recovery" for some time now.  When the US markets bottomed in March 2009, most global markets had bottomed in October, 2008.  The US had underperformed most global markets until the last few months.  Again, we do not believe this is a US leadership issue--US markets are just last on deck, so to say.  Let's look at several major global market indices as signs of what's to come.

Note the same behavior in the Shanghai Composite regarding the 150 day moving average.  Once it flattens and prices fall below it, you're in a bear market.  Since the bottom in October 2008, the SSEC topped out in August, 2009.  Below is a shorter term view from the August 2009 highs.

The SSEC is in an intermediate term corrective cycle, noted by the blue rectangle.  Prices have fallen below the 150 day moving average, but the 150 day moving average has not rolled over.  It will be critical for the SSEC to hold the 2639 level and then rise to break to the upside, above the 150 day moving average before it rolls over.  It probably has at least 3 months to do this.  If, in that period, it does not rise above the 150 dma and begin an upward trending pattern, ultimately breaking out of the consolidation zone to the upside, then this will probably forecast another round of market sell-offs, commodity price crashes, and the like.

Using this similar criteria and mode of thinking, take a look at these key markets and note the trend...

Australia has begun its consolidation as the pace of the rise of the AORD has failed to keep the 150 day moving average rising faster.  Australia is not going to help itself out by taxing miners more, but then again, when has government ever done much good for anything or anyone?

At first glance, you might think it's the AORD again, but it's not--it's Brazil's Bovespa.  It exhibits the same pattern as the AORD.

Canada is looking like the best of the resource-based economies out there.  If the rest of the global markets move into consolidation regions, along with oil and gold, the TSE will likely have a strong sell off.  Longer term, this market should remain in a bullish trend, but we may have a few months of weakness and a shocking sell-off ahead.

Interestingly, the DAX (Germany), CAC (France) and FTSE (UK) are generally showing the same patterns as the S&P.

Japan tends to move to the beat of its own drum, and we'll cover it separately another time.

In digesting all of this information, here's what's important.  We are likely entering a period, globally, where we trend sideways in global equity markets.  As the situation evolves, we'll be looking at changing our trading strategy to be less position-oriented and more frequent.  Expect choppy, sideways markets for some time to come.

Expect gold to do well here after this initial sell-off.  Again, note the consolidation pattern in gold, the breakout, and what we believe will be the subsequent pullback/retest of the consolidation rectangle:

We should see gold hold today's lows.  A closing price back within the rectangle signifies a false breakout.  Honestly, it's textbook at this point.  It may not move much in the next few days, but we anticipate it will challenge the highs soon.

A final note of possible interest.  One of the indicators we use takes the market date, mathematically derives a signal from it from which short term cyclical turns can be forecast.  It has an uncanny way of calling countertrend moves.  For example, if the markets are above the 150 day moving average (bullish), this indicator tends to call any sell-offs to within 1-2 days.  Each market moves somewhat to its own rhythm.  Interestingly enough, there are a series of upward turns forecast to begin (with Japan--actually it will turn down) on Friday through Tuesday of next week.  If we are still expected to maintain bull market territory in these averages, we should see markets flat to down most of this week with upward turns starting  with a downward turn on Friday in Japan and other markets reacting opposite it next week.

The TED spread is up, but not in any zone to be concerned with.  Markets are anticipating problems, but no REAL liquidity crisis yet exists.

One final comment.  Most of the extremely negative news currently revolves around how much each European country owes the next European country.  That is, as they say, a paper problem with a paper solution.  If for some reason debts are allowed to be defaulted upon, then you can expect another return to the 2008 global meltdown world of counterparty risk.  If the PIIGS are removed from the eurozone first, the euro will benefit.  If Germany steps away from the euro, the euro is toast.  We still expect a bailout of some form as soon as politicians realize that a default creates a chain reaction that will plunge the global economy into depression.  That's not good for their reelection chances.  Thus, if Europe comes up with a paper solution to a paper problem, you can expect the markets to go on an upward tear.  If they do not, they risk plunging their own countries, and the globe, into another crisis.  The markets are now telling them to print money to bail out the PIIGS or otherwise contain the contagion.  They will likely be pushed into doing something soon.

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Gold Preparing to Challenge the Highs?

The euro continued to take heat today with a downgrade in Portuguese and Greek debt to junk.  As the New York trading day began, gold was lower with a moderately lower stock market.  As time progressed, the euro went to new lows, gold (in US dollar terms) had a massive breakout, and the US stock markets took a serious beating.  As the day progressed, the large and mid cap gold miners recovered and went positive.

We have been waiting for a turn for a few days and expected a bit of weakness that should have ended today and prompted a buy signal.  However, today's move up in gold along with dollar strength implies that both significant short covering and Europeans fleeing to gold for safety is occurring.  In light of the US dollar's strength, gold should have been down to flat in dollar terms.

It's too early to say whether or not we've seen a new trend in decoupling whereby everyone is beginning to move to gold instead of paper currencies.  However, given today's action, we may be seeing the beginning of the real show in the gold market.

At this stage we're buying any weakness or a confirmed breakout above 1175 (which may occur tomorrow).  There are a substantial number of bullish, almost ready to break out patterns in many junior gold miners.  Since the HUI broke out today, we may see the juniors follow soon.

Get on the bus.  It's leaving.
Sta

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Chinese Market, Gold, and More About the Right Side of the Trade

Last week we posted some possible break out/break down scenarios in equity markets.  The US markets are holding up well, though we still anticipate them moving down in this correction.  Targets remain the same.  The Chinese Shanghai Composite did not fare so well, however.

As a recap, this was the picture last week:

A close up of the recent breakdown:

We're watching that red support line closely.  If the market breaks below that level, it could spell trouble for other equity and commodity markets.  However, we're not so sure it's going to happen.  To explain why will take a little time...

Earlier today, we discussed staying on the right side of the trade.  That is, is the intermediate term trend intact, or is there a large risk in the intermediate term?  We have a proprietary indicator called the WPA that we use for this.  For the record, it has called every significant top in the US equity markets having been backtested as far back as 1896 and in many global equity markets except one: it called the 1987 stock market crash too late.  That particular event was unique in that it was orchestrated by (then) new electronic trading run amok.

For most market tops, it sends a warning signal roughly six months in advance and a definitive sell signal just after the top, but before more than a few percentage points below the top.  That is, this is the indicator that protects you from the big crash with a warning and several follow-on signals up until its absolutely time to get out.

We noticed that in most emerging markets for which we have data, the signals come a bit later than we'd like.  Those markets are volatile.  However, it still does a good job.  Here's a glimpse using a 10 year view of the Shanghai Composite...

It can be difficult to follow if you're not sure what it is, but after some examination, reading it is quite simple.  In short, the purple wave shows critical levels.  If it breaks down below the zero line (right hand side scale), you absolutely *must* sell.  Once it bottoms and turns up, crossing zero to the upside, you should buy.  Note that fell and has quickly started turning up again--even with this large move down yesterday.  The implication, we believe, is that we will soon see a bottom.

Let's apply the same indicator to the last 10 years of the S&P and see how it did...

A simplified discussion of how the indicator works is on the chart.  In a nutshell, you're looking for a pattern of lower highs/lows when the indicator itself is in a high range.  Those are the warning signs that you have 4-7 months before a possible top.  With rare exception do you have periods where you do not get a lower high before the indicator falls below zero.  Note that this chart covers 20 years, and in that period of time you had 9 sell signals.  The worst performance for the indicator was during the 1987 crash.  Aside from that, the indicator would have at least spared investors from losses.   In two cases, it would have spared investors from the 2000 and 2007 crashes.  There was never a downside to selling when the indicator flashed a sell signal.  In 1987, it was realistically too late to have avoided the main crash. 

Also note that it produced 8 buy signals.  One was a false positive, but could have been avoided if buying only occurs once the price of the underlying security was above a long term moving average.  Filtering those results using that criterion, you have an excellent bottom caller with no losses.

Also note that we have recently seen a peak in the indicator and the beginning of a major decline.  We're still far from the zero line where we'll sell, but we have what may be the first sign of a market top within the next 4-7 months.  At this stage we're looking for a higher low in the indicator, along with a higher high in the equity markets.  That will be the negative divergence we're waiting for and the second sign we're nearing a top.

Perhaps one day we'll publish the complete study to those on our mailing list.  But for now, this should help put the idea of "the right side of the trade" into perspective.


Finally, gold and currencies are tracking almost exactly as predicted last week.  We should know if we're going to get a short term bottom to gold and the euro this week.  The euro is going to need to bottom here or face a bigger sell-off.  Of course, we'll post as the situation develops.

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The Intermediate Term - Staying on the Right Side of the Trade

Another bit of commentary regarding some trading and our general philosophy.

Any time you invest in anything (or for that matter, opt not to invest), you're taking a risk.  Our goal in trading is to move in alignment with the fundamentals, accumulating assets that are gaining in value and only moving out of those assets when there's a solid reason to do so.  Let's contrast this viewpoint with a few other strategies, and in our opinion, the pros and cons thereof.

Short term traders range from day traders to swing traders and try to capitalize on very small moves in the market.  Short term traders attempt to make profits by price arbitrage in a short timeframe and with leverage.  In this manner, making $0.02 on a large number of shares purchased with borrowed money can be a profit making bonanza, but the risks are high.  Every time someone enters a trade, there's a risk that it's the wrong move.  Short term traders must make frequent trades, and given the high leverage involved, need a very strong money management strategy to protect themselves from the leverage going against them.  Very few are consistently successful.  As one's timeframe becomes shorter, the risks become greater and the market becomes more unpredictable.

In contrast, long term investors that buy and hold often have to endure vicious corrections to the downside and significant periods of loss.  Over a long enough period of time (the fundamental timeframe), most trends are predictable.

We tend to trade in the middle--in what we refer to as the intermediate timeframe, which occurs in the 6-12 month period.  Over this timeframe, we use short term technical analysis to build or reduce our positions, the long term trend to make sure we're in alignment with the fundamentals, and the intermediate term trend to avoid substantial losses and manage risk.  It is the intermediate term timeframe that is key in our analysis, which is primarily a combination of daily and weekly data.

With rare exception, knowing the intermediate term trend ensures you're in the right side of the trade.  What that means is that if the intermediate term  for an asset is positive and upward moving, we would not bet against that asset even if it is correcting.  Instead, we add to positions when the short term is weak and the intermediate term is positive.  If the intermediate term appears to be weakening, then during a short term correction, we reduce our exposure.  If the intermediate term turns negative, we exit the position and go short when the short term goes negative.

This has protected our positions since this cyclical bull market began in 2009.  Longer term, we still expect to see the markets turn over.  But as so many bears have come to realize, if you go short on a market that has an intermediate term bullish strength, you can be taken out quickly and painfully.  At some point, when the markets show that over the intermediate period they are vulnerable, then we will switch sides of the trade.  Until then, the trend is your friend.

If you want to know a bit more about how to determine when the intermediate trend is changing, send us an email.  We're actively working on building a mailing list for those interested in more detailed information than we tend to post on the blog.  We will not sell, distribute, or otherwise divulge any email addresses or other information sent to us.

Stay on the right side of the trade.

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