Cyclical Corrections In Secular Trends
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, May 6th, 2008.
That is what is happening right now in stocks, commodities, and currencies, as the secular trends that were prevalent in all three asset groups up until mid-May will reassert themselves at the appropriate time, in the not too distant future. For stocks, this will involve a newer trend lower in both absolute and relative terms. For currencies and commodities the understanding is not so straightforward however, where all of the former are depreciating against the later being the important take-away. As per our title however, in the meantime cyclical (intermediate-term) corrections that can last for months are in play at present, meaning commodities could correct lower for some time (months) as the US Dollar Index ($) works off an oversold condition.
The most important thing to realize at present in my opinion is that relative weakness in the Euro, not strength in the ($), will continue to put pressure on the commodity complex, but that the latter will likely turn back higher prior to former's cyclical correction coming to an end. This is because of the 'race to zero' for fiat currencies against commodities discussed the other day. Of course precious metals will bottom well before commodities in discounting further strength down the road, meaning gold and silver could conceivably bottom this month, or in June at the outside, in discounting turns in commodities back into their secular trends soon enough.
What will cause precious metals to turn higher soon, which would catch many by surprise because of the brevity of the correction?
As you may know, stocks and precious metals (and commodities) have been working at odds (an inverse relationship) since last summer when the credit crisis took hold of macro conditions. And because what we will term 'pipeline inflation', which essentially refers to rising input costs that have not worked their way through to the consumer yet fully (it's starting now, but has a long way to go), one should expect the inverse relationship between stocks and precious metals to be maintained. This is because not only will the amount of disposable income available to the consumer fall as process unfolds, businesses who have been slow to pass along higher costs will soon be getting squeezed from on both sides (higher input costs and a slower consumer), with profits suffering substantially.
So, in spite of generous liquidity constantly being upped by central planners, even these measures will not prove to be enough, and more drastic currency debasement policies will result, which in turn will need to be discounted by precious metals. And you know things are already getting there because US monetary authorities couldn't have the $ running away to the upside Friday, so they announced a further acceleration in currency debasement prior to the release of the Employment Report to keep gains controlled. What's more, the gold count is suggestive the move lower is potentially close to completion. We will have more to say on this subject matter below in our own technical review, which is supportive of this notion.
And a runaway $ to the upside is last thing we will need to worry about if the good people over at Contrary Investor are right about future flow of funds trends, where as you can see in the attached study the US is in serious trouble, trouble that will not be monetized away in the future so easily as today. They will try however, potentially to the point of extreme excess, which is the 'big risk' moving forward in my opinion. As you know, Dave is following sharply rising food prices closely these days (along with energy of course), and how the overall process accelerates into not only bare shelves, but bare shelves at any price.
What's more, and as he goes on to point out, the same process will unfold with respect to precious metals, and their currently ignored related equities. They will be viewed as necessities in the future because of runaway inflation (not speculations), which is when people are willing to really pay-up for them. Right now, the masses are still 'tune out', or in denial about what is really happening out there, but this will change as prices keep rising. Naturally, you might be asking yourself, 'yes but why will this happen soon if commodity prices decline in coming months, which you yourself suggest is the likelihood with a cyclical correction?' I answered that question above already if you were paying attention. It's because of 'pipeline inflation' still working its way through the system, soon to be hitting the shelves as producers are forced to pass along price increases to the consumer or go bust.
Below is an email sent out over the weekend to a friend of a friend new to not only this discussion, but also investing in general. Here, it's important for you to realize just how many people are complete neophytes in this regard, completely unaware, and still trusting of the system. Here it is, as follows:
"The financial markets are a study of human behavior. For the most part, you will not learn much on TV, university, or wherever if you don't understand the big picture. Here, on a comparative, we are at the same point as the Roman's at the top some 2000 years ago. In terms of the basic dynamics, they are all the same. People, nor how they react to stimuli, no matter whether in the financial markets or not, are still the same today as they were back then. So, we look to history to understand what is happening today because it's all the same, only on a larger scale.
Right now, confidence men (bankers, lawyers, politicians) are in a bull market because our technological advances has made the populace rich, fat, dumb, and lazy. With peak oil however, and the implication basic survival will not be so easy for the masses as liquid oil gets more scarce (no other energy source can replace it), this will change. Shortly, getting back to the basics will be more important, and investing in basic investments (saving) will become popular again too. This is why precious metals are still cheap, because the population is still holding on to the belief we are wealthy, but in fact we are not. Times will go back to when our parents had to work night and day to survive.
Buy gold and silver, and make the future easier for yourself. Successful investing is all about getting on a trend before it becomes popular, before buying interest increases, driving the price up. The fact an easily controlled public has not jumped on the precious metals bandwagon is not a negative then, but a positive for those who grasp the opportunity. It won't be long before the public increasingly sees past the lies of confidence men and look at their pocket books that don't lie. The rate at which real purchasing power disappears moving forward will correspondingly finally bring about attitude change as a sleepy and complacent populace awakens in a foul mood.
Right now however, everybody still wants paper/digital investments because of past success, which is counter to the above understanding. In stead, one should look to the future, and what an easily pliable and bipolar / manic-depressive society will want in the future (what they don't have today), which is stability and security.
Again, buy gold, which has been 'safe money' for thousands of years, much to the chagrin of modern day confidence men who attempt to minimize it every chance they get.
The above is the Economics 101 you won't get in university."
Coming back to the inflation / deflation conundrum that appears to be confounding both readers and writers alike these days, that being some think we are on the cusp of hyperinflation set against those who see deflation just around the corner, you may be interested to know this question can be addressed in observing one ratio believe it or not. Of course you will not likely hear this out of other newsletter writers even if they know, as this removes the impetus for countless hours of debate and prognostication. Just look at Prechter, who is supposed to be an intelligent guy. How could he be wrong about deflation, gold, and stocks for so long and still be in business? Answer: Because it's what people (at least his subscribers) want to hear, and it sells subscriptions, so he remains wrong all the way to the bank.
Before we get to this chart discussed above however, and now that I have your attention, I want to go though a few other charts that were picked out as being important in my chart review over the weekend. You should know that our new ability to post full size charts from the Chart Room now will act to enhance my presentation abilities, and that you will benefit not only from better pictures, but also better analysis.
On with the show then. This first chart is the weekly S&P 500 (SPX), where you will notice a common theme in annotations, that being the broad stock market is now 'testing' the breakdown commenced last year, making a crescendo in March. Key within the annotated observations is that if current strength in stocks is truly of the corrective (cyclical) variety, then the SPX should flame out with spike highs somewhere between mid-channel resistance and the 50-weeks moving average (MA) at 1444. (See Figure 1)
In Figure 2, which is a monthly SPX plot, we get the same message as in Figure 1 with respect to mid-channel resistance and a test of a key MA, that being the 20-months MA. Here, it should be pointed out the 20 MA was the metric that also needed to be tested at the beginning of 2001 before the broad measures of stocks began to slide for real in the tech wreck. This time around, it's the financials that are the mania being corrected (or worse) in Supercycle Degree (or higher), so correspondingly the broads should also suffer considerably more this time around as well, especially considering financials high weightings within indexes. (See Figure 2)
Based on the above then, we know that if current strength in the stock market is of the cyclical variety, corrective tests of the secular trend (which is lower) should flame out in the vicinity of 50-percent retracements from all time highs, which happens to correspond to a range between 1438 and 1444 on the SPX. Further to this, and a message also found within annotations above, once the testing process is completed, where it should be noted the On Balance Volume Indicator (OBV) 20 MA is also being tested, a 'crash signature' is evident in trade, with over-zealous bulls divergently running the Accumulation / Distribution Indicator to new highs without corresponding volume to underpin the move.
Pressing on in terms of verifying the technically based suspicions presented above, we move onto the CBOE Volatility Index (VIX), which also appears to be testing the significant breakout displayed on the daily plot shown below. Here, it should be noted that although stochastic influences point to further significant weakness ahead with a series of diamond breaks, like with bullish breakouts, internals could shift quickly to produce false moves. This is what I suspect will happen once short sellers become exhausted, and the squeeze higher flames out. (See Figure 3)
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 newly 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.
On top of this, and in relation to identifying value based opportunities in the energy, base metals, and precious metals sectors, all of which should benefit handsomely as increasing numbers of investors recognize their present investments are not keeping pace with actual inflation, we are currently covering 69 stocks (and growing) within our portfolios. This is yet another good reason to drop by and check us out.
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 in 2008 all.