Gold at a Crossroads?

October 28, 2013

On moderate volume, the S&P500 inched up another 0.88% last week. Volatility was virtually unchanged…..still pinned down to ultra-low levels. Apparently, the momentum generated from the non-taper news from the Fed and the end to the partial government shutdown has carried the equity markets even higher.

But make no mistake, US equity markets are at extreme levels. Valuations are almost off the charts. At 25, the Shiller P/E for the S&P is now the highest its been in about 80 years, except for the dotcom period. Bullishness is also back to extremely high levels; the difference between bulls and bears among investment managers is back up to the highs reached earlier this year. And the S&P500 is certainly overbought, now that it’s hugging or exceeding its upper Bollinger band on the daily, weekly and monthly resolutions. And it’s from extreme levels just like these that equity markets always suffer their greatest losses, falling by 40% or more in subsequent months.

Does this mean that this type of fall is imminent? Of course not, but it’s important to understand that it’s more possible now than during most other periods when such extreme conditions are not present.

On the economic front, the US government is catching up with its delayed reports. Last week, Existing home sales were released and the results just missed expectations. The House Price Index, however, missed badly. Initial jobless claims came in much higher than expected….again. The PMI Manufacturing Index missed. Durable goods orders beat on the headline figure, but this was skewed by airplane orders received by Boeing. When transportation orders are stripped away, durable goods fell. ¬†They were supposed to rise. And finally, consumer sentiment fell to the lowest level of 2013.

All in all, there is no evidence that US economic growth is picking up. Instead, it’s stuck at stall speed and possibly even slowing down. Not good.

And all of this means that the Fed’s taper may be delayed, which perversely means that the stock markets may cheer.

But what about gold? For the last five years, gold’s appreciation had been closely correlated with the expansion of the Fed’s balance sheet, until recently, when it entered into a bear market correction. But over the last several months, gold has stopped declining, and has rebounded about 15% from its summer lows.

More importantly, gold is forming an important formation that is often quite bullish for future prices. Gold has followed an almost classic inverse head & shoulders pattern, and head and shoulders patterns signal a change in the major trend. Since gold has been falling for almost two years, the successful completion of this trend suggests that there could be significant upside to the price of gold over the next six months.

The test for this patter will come at the $1,450 price level. If gold can reach, maintain, and then go beyond this price, then it could be off to the races. Because beyond $1,450 not only will the inverse head and shoulders be complete, but the down trend line that began in late 2012 will be broken.

If this happens, technical traders around the world could pile into the yellow metal and drive its price much higher, first to the $1,525 level that used to be strong support, and then to the $1,800 level which is still an area of strong technical resistance.

The next several weeks will be very interesting for gold.

Debt Crisis Delayed. Now What?

October 21, 2013

The S&P500 jumped 2.4% last week in a knee-jerk reaction to the temporary lifting of the debt ceiling for the US federal government. Volatility promptly dropped back down close to the summer lows. And while one would think that investors would start rushing back into the stock market, driving the strong price increase, one would be wrong. Volume did not surge; it remained moderately low, continuing a long-term trend of gradually falling participation in the US stock markets by the average retail investor. In other words, Main Street isn’t buying this rally.

Technically, the S&P has re-entered into an uptrend, but because it started very close to the all-time highs, this uptrend looks especially risky. As of Friday, the S&P is already extremely over-bought on the daily charts, and very much stretched on the weekly charts.

Valuations, meanwhile, are hovering near historic highs. Whether one looks at the Shiller PE ratio, or price to sales, or price to GDP, the S&P is trading at levels that above 100 year highs, with the exception of the massive 2000 tech bubble, which as we all know, blew up in a spectacular fashion.

So stocks keep rising in the face of technical and massive valuation headwinds. And history shows—-very convincingly and very repetitively—that this is always a recipe for disaster. Even though the Fed’s easy money policy is embraced as a “can’t lose” boost to stock prices in the short-term, reality has always brought the stock market back down to earth in the past, and there’s no reason to believe that this time will be any different.

Meanwhile the US economic data flow will be resuming its normal release schedule soon, and all the missed reports will be release over the next couple of weeks. Even so the few reports that were released last week, despite the partial government shutdown, were mostly disappointing. The Empire State manufacturing survey missed badly. Mortgage applications continued to disappoint. The housing market index missed. Initial jobless claims were much worse than expected. The sole bright spot was the Philly Fed survey with beat expectations, even though it came in below the previous month’s level.

Finally, the big news of the week was the resolution of the debt ceiling crisis, enabling the US government to pay all of its bills by additional borrowing by the US Treasury (much of which will be funded by the Fed’s QE money printing program).

But the catch is that this is merely a short-term deferment. In only a few months, the same debate, and possibly crisis, will rear its ugly head once again. So in the short-term, equity prices may continue to firm, Treasuries could continue to strengthen, corporate bonds may also rise in price, and gold ought to continue to climb—-all at the expense of the US dollar which could be under pressure as the spending & printing spree continues.

So nothing has been fixed. Nothing has been solved. And very soon, the same pressures and stresses will likely return to the front page news.

X-Date Fast Approaches

October 14, 2013

Amazingly, on nothing more than the hope that US leaders would come together to extend the government debt limit, the S&P500 jumped 0.75% last week on low to moderate volume. As usual the investing public ignored this move; most of it was accomplished by high-frequency trading shops that drove the price higher on news of possible deals in Washington DC.

Was any deal actually reached by Friday evening? Or Saturday? Or Sunday? Nope, nothing was accomplished, and no deal even loomed on the horizon. But that still meant that what would normally have been another losing week in the stock markets, suddenly became a winning week.

What about fundamentals? Again, these seemed to matter less and less. While corporate earnings estimates continue to me slashed at horrific rates, US economic data continues to paint a picture of a stalling economy. Last week, most major news was not announced due to the ongoing “partial” (partial because only about 15% of the federal government is actually affected) federal government shutdown. But initial jobless claims absolutely soared; at 374 thousand, they rose at the greatest rate in several years. Consumer sentiment also missed expectations. And consumer credit—specifically credit card debt, the debt not fueled by US government programs (such as student loans and auto loans)—continued to decline, as it has been doing for the last several months.

While notable, last week’s rise in the S&P did not break the down trend on the weekly charts. For that to happen, the S&P would have to break out to new highs. And even the daily charts, which showed a massive reversal have not quite turned bullish. For that to happen, the S&P will have to follow through with positive days early next week. Also of note, several measures on market internals did not match the euphoria in the headline price increase. New highs minus new lows continued to deteriorate. The percent of stocks above their 150 day moving average also barely changed. And the NYSE summation index turned down rather dramatically. These internal breadth signals suggest that more selling could be around the corner.

Finally, the amazing part about the debt ceiling issue is the potential for massive fireworks if there’s no resolution. The absolute deadline, according to Treasury secretary Jacob Lew is October 17, which is only days away. This is the X-Date.

What happens after this if no deal is reached?

While nobody knows for sure, mainly because there’s no exact precedent in the US, the consensus is—-lots of bad stuff.

The most common view is that the Treasury will be forced to prioritize payments. This means that it will pay what it deems to be the most important payees first, with funds it actually has, and simply delay payments (creating a form of an IOU) to those payees that it deems to be less important.

The problem is that the global financial markets, never having to face such a problem which involves the global reserve currency and possibly the US Treasury market, may start to get scared.

And when financial markets get scared, the most natural thing to do is to sell. And if selling starts, especially when many assets in the US are near record highs (think stocks). then the selling can quickly turn into an ugly panic, pushing prices down much further than rational analysis would suggest they ought to fall.

The good news is that we don’t have to wait very long for this to play out. Tick tock.

US Government Debt Ceiling?

October 7, 2013

Apparently, the US government ‘shutdown’ had very little effect of US equity prices, not because there is little risk to US economic health, but mainly because traders and investors were betting that any ‘shutdown’ would not only be partial, but also because it would be very short-lived. As a result, the S&P500 closed the week virtually unchanged. Volume was light to moderate. Interestingly, one major red flag was the jump in the VIX index which suggested that market participants were hedging their bets—while they believed the shutdown issue would be resolved quickly, they were busy taking out insurance (buying options that would pay off if S&P500 volatility spiked) just in case they were wrong.

Technically, last’s results have not changed the bearish pattern established on the S&P’s daily and weekly charts. And several market internals indicators continued to weaken, implying that the US equity markets are weakening in the short-term.

The macro news in the US last week was mixed, and the most important data—the payrolls report—was not released due to the partial government shutdown. The Chicago PMI report beat expectations, as did the Dallas Fed manufacturing survey. The PMI manufacturing index missed. ISM Manufacturing beat expectations. However, the ISM services index missed badly. But the entire payrolls report, as well as construction spending and factory orders were missing. Regardless, the bottom line on US economic growth continues to be unchanged—the US economy is barely growing. Instead, it’s flying barely above stall speed, barely above the ground. It is perilously close to entering another official recession.

So if the US government shutdown did not derail US equity markets, what about the next imminent threat—the US debt ceiling obstacle?

Unfortunately, for investors, this could present a bigger threat to risk asset prices. Bank of America analysts for example, just published a report in which they consider this, if it happens, to be comparable to the Lehman Brothers bankruptcy. Almost all analysts agree that should the debt ceiling not be raised, then the US Treasury will simply begin to delay payments to various parties, possibly even the Treasury Bill holders. The fact that T-Bill holders may not receive preferential treatment is reflected in the yield in the closest to maturity T-Bill, the 30 day Bill, which is jumping in yield. The fact that the 6 month or the 12 month T-Bills are not spiking in yield means that the markets are betting that any debt ceiling breach would be short lived.

So while the partial government continues to fester, the upcoming debt ceiling deadline—on October 17—bears close watching. This could finally precipitate some sort of meaningful sell-off in risk assets, which would allow intelligent investors to buy at a reduced price.

The next week and a half will be very interesting.