Stock jitters, Gold and JPY still compressed

Gold and the yen each worked still lower this week on highly depressed sentiment readings. Each of these has had a negative relationship with the “risk trade” lately, falling as stocks have rebounded from their oversold and overbearish condition of mid-November. Now, stock sentiment has recovered to neutral territory, and traders are afraid of these sometime “safety trades.”

Trader opinion gold has been very low since late October, a full eight weeks ago. Every similar instance in the past several years has been followed by a substantial multi-week rally. That said, if the bull markets in precious metals and the yen are indeed over, we should expect downtrends to become more protracted, with sentiment remaining low for longer.

Here’s a 1-year daily chart of gold:

1-year daily JPYUSD:

I’m holding to a thesis that the risk trade is topping out here as the US slides into a recession that remains largely unrecognised. Tops are rarely sharp peaks, but consist of several months of choppy sideways action during which sentiment deteriorates from giddy to nervous and the VIX picks up even before prices have fallen substantially. I view the rebound since mid-November with that context, akin to the action of April-July 2011 or pretty much all of 2007.  Last nights mini flash crash in stock futures fits into that context of a increasingly jittery market.

We’re three months from the 4-year birthday of the (presumably) cyclical bull market. It is now older than most cyclical bulls within secular bears, though the last bull phase lasted from March 2003 to October 2007, 4.5 years.

Another cyclical bear and a recession and drop in corporate earnings may finally compress multiples to the investable levels required to build a solid base for another bear market. I don’t expect this to happen quickly, though, since prices have a long way to go before we see anything that can be called historically cheap. I wouldn’t be surprised to see stocks hold at or beneath current levels for the rest of this decade as inflation creeps in towards the end and boosts earnings, as happened during the latter stages of the last three secular bear markets (roughly the 1910s, ’30s, ’70s).

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.

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

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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).

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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.