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January 06, 2009

Bond Bubble Bursting?
by Captain Hook

The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, December 18th, 2008.

They've done it now. The Fed has revealed the level of panic they are in behind the scenes by cutting rates to zero and promising unbounded quantitative easing. Here, it should be noted that based on remarks from the Fed Policy Statement Tuesday, quantitative easing is now set to go beyond the bailout style monetiziations of financials that have primarily characterized re-inflation efforts under the gaze of Bernanke and Paulson so far to include just about anybody who needs 'social assistance', which apparently includes all degrees of bad investors / speculators these days. Make a bad investment. No worries if you're an American apparently as 'the check is in the mail'.

Of course it's foreign debt holders the Fed was most vehemently attempting to appease / persuade with it's comments yesterday basically assuring them monetization efforts will be extended to all levels of obligations, not the least of which being Treasuries considering their importance to mortgage rates. This of course means the Fed was talking to the Chinese considering recent comments of concern, which were apparently well founded set against yesterday's developments. One does need wonder if foreigners will remain sanguine this time around if Americans devalue the dollar ($) by a half once again however. (See below.)

Be that as it may, it's clear the Fed is very worried about the threat of deflation, or should I say economic exhaustion, and they should be. In remembering our comments from the other day on the subject it's important to remember that true deflation has not gripped macro-conditions yet. What's more, and to allay fears the Fed has shot all it's bullets with these last policy measures, gold is counting higher in fives once again, as can bee seen here on the daily, implying an inflation is alive and well. That is to say it should be recognized the Fed intends to devalue the $ in the race to zero by any means, which implies the printing presses will remain on overdrive indefinitely.

And if this fails, and the system appears ready to crumble, well, then it will be time to play the gold revaluation card at some point. Of course we may not need to worry about seeing this, which must be viewed as unlikely at the moment considering other policy measures, if the backwardation / COMEX delivery issue comes to full bloom later this month, with force majeure possible. Gold might need to back off now because the $ is short-term oversold, but this is constructive because it will be 'ready to rumble' again by month's end this way, ready to punch through the 200-day moving average (MA). In this respect the set-up is looking constructive in my opinion.

Unfortunately however, I cannot say that about the rest of the equity complex. To start with, you should know precious metals shares could face a good-sized correction post options expiry this Friday, so be prepared. They reached channel related resistance on the Amex Gold Bugs Index (HUI) outlined earlier in the week, and pulled back yesterday. Here, the logic is what has benefited from options related buying prior to expiry will suffer temporarily afterwards (for at least a week), and visa versa. And buy this logic then, and abased on a topping Gold / Crude Oil Ratio, don't be surprised if energies do relatively well next week, sucking up the liquidity fleeing other sectors that have risen since November. (See Figure 1)

Figure 1

Of course based on the count presented above, one does need to wonder just how well the energies will be doing if everything else in commodity land is falling. As you can see, if we get a little pop in the TSE over the next couple of days, both count wise and structurally it will be in a position to fall again, which can't be good for the energies. And you've got the same corrective appearance in the Canadian Energy Index, so I'm afraid past some strength associated with early January Effect buying, from a technical perspective things are not looking so rosy next week, and perhaps longer. A perceived failure of the S&P 500 (SPX) at the 50-day MA next week post expiry will likely take the entire equity complex with it temporarily.

In this respect it should be noted strength in the broad markets going into options expiry this week can be attributed to mild outpeformance by tech (Nasdaq 100), which is a result of a rising open interest put / call ratio in the NDX (big) contract, as can be seen here in Figure 6 set against broadly oversold conditions. This is why one should be cautious post expiry then, because the influence of this high put / call ratio will disappear next week. Of course the opposite will be true of the low put / call ratios on all the other indexes, so don't be surprised if the light volumes over Christmas allow for even more strength. Such an outcome would not be consistent with either the 1929 or 1938 post crash patterns, still possible by and large.

The $ is expected to fall more given recent Fed Policy however, so the correction higher in equities should extend into a more complex pattern if history is a good guide. Here, it would be very unusual 'wave wise' to see an impulsive five-wave sequence lower the likes of what was just witnessed not followed up with more of the same after a well deserved correction, to be expected next week. (i.e. post options expiry.) Of course this may not necessarily mean good things for the broads if a falling $ is accompanied by crashing bonds, which is normally the result after a 'blow-off', Fed induced or not. The question still remains, 'will foreigners continue to support the bond market while knowing the chances of getting any of this money back is now dependent on monetization practices?' (See Figure 2)

Figure 2

As you can see above, the charts say the answer to this question is 'no', and that the blow-off is almost completed. With Paulson leaving in January, the man attributed with fostering such a generous relationship with China, the message the bond market might give us soon is they don't like Fed intimidation tactics, testing Bernanke's resolve to 'monetize or die'. Of course a snowballing $ slide would bring the entire world down on the US, potentially ending the reserve currency status for the Greenback in de facto fashion. A long-term chart of the 30-Year Bond, having reached the long-term channel top, suggests such an outcome is very possible indeed, whatever reasoning one wishes to ascribe to likely weakness. (i.e. asset allocation selling is also possible.) (See Figure 3)

Figure 3

It should be note a significant sentiment change associated with the broad stock market occurred post options expiry on December 19th that has confirmed Treasury bond selling is asset allocation derived, aided by the bubble dynamics that took prices to the channel top denoted above.

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our continually improved web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing all.

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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