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. ┬áLast 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).

A look at the real value of gold on an historical basis.

I like making random gold ratio charts in stockcharts.com since it lets you chart the ratio of anything: gold:oil, gold:copper, gold:SPX, etc:

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If you do this kind of analysis on a longer-term basis, you see that gold is getting a bit expensive relative to other commodities, capital goods or labor (or you could say that each of those things is getting cheap when priced in gold). What is clear is that gold is no longer cheap by any measure. I don’t think this type of analysis has anything to do with where gold price goes in the near-term (technicals and sentiment drive that), but it’s helpful to think about where gold is on an historical basis.

  • The Gold:Oil and Gold:Copper ratios are moderately high, and would be off the charts if oil and copper were to crash.
  • Rent on a nicer 1BR apartment in Manhattan has fallen from 8 ounces in 2001 to 2 ounces today. This is about what it cost in the 1920s-60s.
  • 10 ounces in 2001 bought a 12-year-old Honda Civic, and now it gets you a brand new one with extras. A Model T Ford cost 15 ounces by the 1920s. The VW Beetle cost 30-50 ounces in the ’50s.
  • Median family income in was about 50 ounces in 1920, 90 ounces in 1955, over 100 in 1965, 70 in 1975, 75 in 1985, 95 in 1995 and way over 100 in 2000. Today, it’s about 30.

On a purchasing power basis, gold is adequately priced – it is certainly no longer cheap. Of course, markets don’t care about this on anything but the longest term – gold was overvalued at $500 in 1979, but it still spiked over $800 and then fell to a ridiculously low level in 2000. In the scenario where the dollar goes to zero, everything will soar in dollars, not just gold, so you’d still have to evaluate gold in terms of goods and services.

I’m still in the dollar bull camp for the foreseable future. Treasuries are pointing the way (record low 10-year yields, 3.5% on the 30-year, almost like Japan), and it looks like another bout of deflation is underway, if you define deflation as a contraction in money and credit (if credit is marked to market). Europe’s soveriegn debt implosion is deflationary. The same goes for the Australian real estate collapse and the pending RE collapses in China and Canada, and the US muni and junk market troubles.

I don’t see the dollar as any worse fundamentally than the euro or yen, and much better technically. Japan’s history since ’89 is proof that printing and spending and running up huge public debt doesn’t necessarily kill your currency. When there is too much private debt going bad but not being written off, it overwhelms the mismanagement of the currency and props it up. It doesn’t matter what you think of the fundamental value of the dollar if you’re in debt and can’t find enough dollars to make your payments. And until asset and labor prices and demand for goods and services can justify borrowing costs, there’s no credit expansion so no inflation.

Sentiment-wise, we’ve still got a great long-term case on the long-dollar trade. Fear of the dollar has been widespread since early 2008, but the DXY has just bounced around sideways – no crash. The crash happend from 2000-08, while nobody but old-school Austrians noticed.

Kyle Bass and Hugh Hendry on shorting Japan

Two good interviews here with these fund managers.

EDIT: The Bloomberg interview of Kyle Bass is no longer playing, and I can’t find it on youtube, so I’ll just post a couple of other links:
All I could find was this on his new fund:
http://dealbreaker.com/2011/04/want-to-invest-in-japan-kyle-bass-has-a-fund-for-that/
Here he is talking inflation last October:
http://www.youtube.com/watch?v=bCYIBf4_GMw

Hugh Hendry on the rationale for shorting Japanese corporate credit (extremely low yields, overexpansion, China crash & contagion)

FYI, I think talk of inflation is still premature, since there is still too much credit to be liquidated before currency creation overwealms credit destruction. Significant inflation is more likely to appear towards 2020 than 2012, and we could easily see another episode of deflation in the next year or two.

Toppy action in dollar index, another rally in stocks coming?

The dollar index is showing waning strength on advances, and its rally is very long in the tooth. There could be worse times to take a short position on DX. At least there is a clear and close stop price at the highs.

Here’s the 2-hour bar, then the 5-min:

TD Ameritrade

Here’s what ES looks like to me this evening (5-min chart). There’s an upward divergence in RSI, indicating waning oomph on the sell-offs:

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I took a long position in CHF and ES (SPX futures) after the close of regular trading today, and I’ve shorted some Treasuries and yen, but I’m still short oil, palladium (added to my position today), copper, silver, gold also added more today) and copper. I’m agnostic about the intermediate-term direction of the risk/inflation trade and just trading what I see: commodities look broken, but stocks still have rebound potential, as do the euro, franc and pound.

This chop and weak rally action in stocks precludes neither a big new rally nor a fall into the abyss. Big rallies like August-October 2007 or Feb-April 2010 have started slowly with chop like this and kept the bears confident. The timeframe for such a rally is limited, however, and if we don’t take off in another week or so momentum will peter out and we can start to roll over. This is what happened in late spring 1930 after the first hard leg down from the top of that post-crash rally.

Do we finally have an intermediate bottom in the euro and franc?

Last night’s sell-off in risk brought new lows for the euro and Swiss franc, though no other currencies made lows vs. the USD. Now with today’s rally, EUR and CHF have spiked very hard. This jumpiness and the presence of an upslope in RSI bottoms on the hourly chart (and the fact that June would be month 5 of extreme bearishness), suggest that a relief rally could be forming. I would not be surprised by $1.28 for the euro and $.91 for the franc. As usual, I’m not counting on it (the daily chart would look better with a deeper low), but we do have the formula for a short-covering rally.

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Here’s the 4-hour chart of the franc. There is a strong buy signal here, as the new low was made with very weak selling according to RSI, which stayed in its uptrend.

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You can see on this daily chart that there is no strong RSI buy signal like there was 15 months ago:

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A sharp rally here would likely coincide with rallies in stocks and commodities, but I can see the a scenario in which gold and silver do not participate or even fall as everything else rises.

Also, I’m still long-term bearsh on Japanese yen, and this price does not seem like a bad entry for a short (I put one on at $0.01104 this AM, and also shorted Treasury notes for a short-term trade to balance the odds of a rally in stocks & commodities).

Do we have a bottom?

It would be nice and tidy if this morning’s 1036 print on ES turned out to be the low for a couple of weeks or even a month or two. Stock indexes made a price extreme unaccompanied by new highs in the VIX or yen or new lows in the euro, pound, copper, silver, gold and many bellweather stocks. The later rally was fast, furious and broad.

Here’s how this week in ES looks to me in the scheme of things. A right shoulder would be beautiful here:

TD Ameritrade

To re-iterate, I’m a huge bear for the 6-18 month horizon (my SPX target is an indecent number well under last year’s lows). I’m bullish for the 1-6 week horizon — I anticipate scaling back into a heavy short position in stocks, copper and oil on any rally here.

Bonds

I’m back home from overseas, though a bit tired after running the gauntlet of cattle pens and inquisitors that has ruined the air travel experience. It’ll never be like this again:

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Here’s a quick look at the pattern in the long bond, noting a possible 12-13 day high/low cycle:

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I see the Yen is still moving in tandem with bonds:

Yen and bonds, two of a kind

I don’t know exactly what to make of this pattern, but it is not unusual to see these two move together. As forms of cash, they each tend to do well when the deflation trade is on. In fact, other than short positions, they are the only things that beat the dollar when everything else falls.

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I don’t know what it means that the Yen has been doing so well even as stocks have risen over the last year. Perhaps it’s a vote of no-confidence.

Even if stocks and commodities roll over hard, I actually wouldn’t count on the Yen rallying as powerfully as of 2008, or even at all. Its long-term trend has been weakening.

Yen to test the highs?

Don’t sell short the Yen just yet. It is wedging up to the highs and still seems to find a bid when stocks fall. I noticed this large wedge on the USD.JPY 5-year:

Interactive Brokers

A breakout of that wedge will be bearish for Yen, and a nice spot to think about shorting. For now, I’m letting it run, since the Yen is still the only thing stronger than the dollar in deflation. Note, however, that each subsequent move down in dollar/yen is shallower and choppier than the last, hinting at a pending reversal.

Here’s another way to look at it. There’s still an unbroken longstanding support line in Yen/Dollar, but the rise in 2009 was choppier and at a shallower angle than previous rallies. You can also see in weekly RSI that the trend is tiring:

Sunday night futures update

In the first hour of Globex futures trading (starts for the week at 6:00 New York time), I closed up the gold and stock longs that I put on late Friday. I’m letting the Yen run, since it was so deeply oversold and has some support at this level.

Friday’s dollar rally was awesome, and may bode the start of an enormous rally, but it remains highly overbought on a 15-minute scale, so now is a good time to take a wait-and-see approach. Same goes for gold — it’s oversold near-term (from 1228 late Thursday to 1145 Sunday night) but still highly overbought long-term. Because of the extreme overbought condition after a giant parabolic rise, it has the potential to keep dropping straight off a cliff with just brief pauses to keep us guessing. Knife-catchers beware.

Here’s a 1-month view of February gold futures:

Source: Interactive Brokers, LLC

I’m going to watch for good entries on the long side of the dollar and short side of gold and stocks. Things may be aligning for a major downdraft in stocks, now that the dollar is looking up. With the Yen oversold and Nikkei overbought, Japan is also setting up for another try at the deflation trade.

Yen (priced in dollars), 1-month:

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Nikkei stock index futures, 1-month: