Intermediate-term set-up for a gold rally?

Traders have been bearish on gold and gold stocks since late October, the longest stretch in recent years. All such previous instances were followed by significant multi-week rallies. Here’s a daily chart, showing some divergence in RSI.

Here is GDX, the gold miner ETF, which looks good technically, as well as being cheap vs. the metal itself:

 

A caveat here is exemplified by the coffee futures market (see recent posts), which has steadily declined since a manic high 18 months ago. Gold and silver experienced a mania around the same time, which perhaps capped their 11+ year bull run. If that is the case, a situation like the present could actually resolve not in a rally, but in a crash, as crashes may develop from oversold and bearish conditions that would otherwise be bullish. For this reason, as well as the value discussion below, I would be careful about any longs and use a stop-loss.

I still maintain that gold is overvalued relative to a meaningful basket of other assets and metrics. Today, a kilo of gold buys (or rents) you more real estate, commodities, labor, automobile, etc. than at any time in modern history, save bottoms in those respective markets and tops in the metal.

This doesn’t mean that gold can’t rally for a few weeks or months or even make a new high – it just means that doing so would make it even more historically overvalued. The time of gold being a great value has long passed. It has done a very nice job at protecting holders against the Federal Reserve’s war on savings, just like it did a good job at protecting against inflation in the late 1970s, but gold peaked prior to inflation, and today gold may peak prior to the end of Bernanke’s tenure.

I often make the point that gold is not the only hard asset. In an inflationary episode, there are many ways to play. The dollar lost 2/3 of its value from 1980 to 2000, but over that period gold lost 90% of its value when adjusted for inflation (70% nominally). As in equity investing, the price you pay determines your return. I would look for hard assets that are closer to historical lows, or at least mean values, rather than something near a high.  Distressed real estate comes to mind, or even Japanese equities.

Heck, if we get another cyclical equity bear market within the post-2000 secular bear, there will be plenty of hard, productive assets available for reasonable prices in the stock market. BTW, every episode of double-digit inflation in the US since 1900 has ocurred during the latter years of a secular bear market in equities (1919-1920, early 1940s, 1979-1982). Thanks in large part to Mish‘s explanations of the credit market, I have been a deflationist since late 2007, despite the shrill warnings of the hyperinflation crowd. There is no telling how long our own Japanese situation lasts, but we likely have at least a couple more years to go.

Coffee update: new lows, traders still very bearish.

Positive divergence on RSI though. At this point, I would say the market can continue to make marginal new lows for a while, but that a significant rally may be imminent. This market has continued demonstrate how relentless a downtrend can be after a mania (mid-2010 to mid-2011). As often as not, such a market returns to the base from which the ramp started (around $1.30/lb in this case). 

Image

 

Japanese yen getting oversold on low sentiment.

Traders are again very bearish on the Japanese Yen, just as they were back in March 2012, prior to its 8% rally against the USD. JPY/USD is also getting very oversold, as shown by RSI on a weekly chart.

Image

The daily chart is showing a positive divergence in RSI, a bullish sign:

Image

However, a glance at the monthly chart shows a major break of the uptrend since 2007, as well as a deterioration in RSI (diverting downward over the last 18 months).

Image

Traders are more bearish now than in March, but this condition has not yet been sustained for long enough to give the buy signal we had then. Also, I believe the yen may putting in a long-term top, due to the trendline break as well as developing trend of lower lows and lower highs in sentiment readings. Any multi-week rally that may be setting up should be viewed in that context, perhaps as an opportunity for entering a short position.

That said, a yen rally would fit into the global context of a nascent US recession and top in equities, as the yen and dollar have been safe-haven trades along with government bonds from the US, Japan, Germany and UK, among others. Sentiment on US equities has rebounded sharply since mid-November, when it reached oversold territory by some measures. Equity sentiment is not elevated, but if we are entering a bear market it need not become elevated before deteriorating again (a trend of lower lows and lower highs in sentiment was observed in 2007-2008).

One other interesting piece of data here is that Nikkei sentiment has been on the low side since mid-2011. Sometimes the yen and Nikkei have a strong negative relationship, other times positive, so I don’t know how this fits into things, unless Japan is finally going to reflate after 20 years of a bear market in stocks and strong currency and bond markets. We may indeed be at such an inflection point. I would certainly rather buy and hold Japanese equities than bonds here.

Who wants coffee?

Not many traders, apparently. Sentiment has been low for most of 2012, never even once reaching 50% bulls according to DSI. The latest slump has made futures traders extremely bearish on the beans for three weeks now, but in the first half of 2012 we saw this condition sustained for longer than I’ve ever witnessed on a contract. Despite a preponderance of bears, the price continued to slide, even at an accelerated pace, before a small rally this summer. Prices and sentiment have since returned to their lows.

Daily close, cents per pound:
coffee 2010-2012

Despite all of this bearishness and a 50% decline, coffee is still not particularly cheap by historical standards. It has been working off a mania that resulted in a parabolic doubling in 10 months from summer 2010 to spring 2011. I can’t publish the data, but picture bullishness alternating from medium-high to very high for the duration of that rally. This probably goes a long ways towards explaining the steady decline and bearishness. Prices have now returned to the base of that ramp, but if we look at a long-term chart, we can see that the spike was the final blowoff of a bull market coinciding with the general commodity boom, and that today’s price is still triple the 2001 lows. Commodities are cyclical and tend to swing from extreme to extreme, adjusted for inflation, so coffee wouldn’t be historically cheap today unless it were under $1.00/lb.

Monthly close (through Oct):
coffee 1982-2012
Indexmundi.com

I don’t see any great opportunity in coffee either way at present. It just makes an interesting study in herding behavior.

BTW, has anyone else noticed that retail bean prices at fancy grocery stores increased from the $7-10 range to the $10-13 range a couple of years ago? This coincided with the futures spike, but the correction hasn’t been passed on to consumers. Some players in the supply chain are likely enjoying fatter than usual margins.

Vast majority of traders now bearish, equities short-term oversold

The easy money for the shorts has been made. This doesn’t mean that the market is likely to rally, just that we have now enjoyed the portion of the decline that our intermediate-term sell signal in late September and early October all but guaranteed. This in no way rules out further declines immediately ahead, possibly severe. It is just that traders could easily find safer entry points for short-to-intermediate-term short sales, or worse exits.

Stocks remain at historically high valuations, economic headwinds are mounting, and bullish sentiment has been dominant for years, so we are likely at the start of a significant turn.

yahoo SPX 1 year

Budget talks are meaningless

‎- The US federal budget deficit for 2012 was $1.3 trillion.

- Military expenses (on and off budget) are going on $1.5 trillion/year.

- Entitlement expenses are $2 trillion/year and growing by $200B/year.

- Democrats’ proposed tax raise on $250k+ would net $40-50B/year.

The tax raise is only a symbolic bargaining chip. It is meaningless to the budget, which is sacrosanct to both sides. Nothing but the interest rate cycle will stop this train.

 
Image

Quick update: topping pattern still in place

Stagnant prices? Check.
High sentiment? Check.
Declining RSI? Check.

Sell that market!

SPX 1 year

vix 1 year

naaim

New highs can’t be ruled out, but starting from conditions like this, they will be small in relation to the likely decline.

Throw in a developing recession and high Shiller PE ratio, and you’ve got the strong possibility of a major top.

-
PS – If you’re in the US, and you are the voting type (I am not), please consider the Libertarian Party and Gary Johnson.