Race To Zero Acceleration A Certainty
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, June 23rd, 2009.
Just when you think you have it figured out - bang - something changes. And present circumstances are no exception to this rule. Last week it appeared conditions were forming to sponsor a significant sell-off in stocks / equities this summer / fall, where a combination of sentiment and internals were moving into alignment in this regard. Not out of character in a mature market environment however, speculators stepped up put buying at expiry late last week, which has materially altered the sentiment backdrop, and correspondingly the prognosis for stocks moving forward. Now, what is anticipated because of this is while stocks could still soften further in coming days and weeks, instead of more substantial losses a tighter consolidation pattern should emerge, where assuming the sentiment picture continues to push in this direction, eventually a secondary reaction higher in equities should be triggered, extending the present countertrend rally within the larger secular bear market.
So be careful about taking excessively bearish prognostications too seriously moving forward, at least as far as stocks are concerned. Here, using the S&P 500 (SPX) as proxy, it would be surprising to see a lasting decline through 810 knowing this (think head & shoulders pattern), where we suggest short sellers increasingly scale out of positions this week while the influence of the July options cycle is at its least being furthest away from expiry. You will remember this is the timing dynamic as it pertains to the influence of options on the trade, where it becomes more profound as expiries approach. This means that this week could see further weakness in stocks / equities, but that as month / quarter end approaches, the risk of a 'jam job' will increase considerably. Thus, the risk adverse should cover any short positions you may have on this week, looking to get progressively long as month end / the next expiry approaches.
This sentiment certainly does not extend to the bond market however, which will trade diametrically opposed to stocks moving forward given the huge funding US authorities intend to float to pay for their deficits, along with the fact it will take increasing monetization to pull this off. Here, if we see general price levels take off, such an outcome would also reinforce an inflation related sell-off in bonds, where both domestics and foreigners alike will be looking for better places to put the money. Precious metals should be the alternative of choice in this regard, which would of course negate any lasting perspective concerning cautious comments pertaining to the sector made last week, along with reinforcing a positive gold price picture. As far as precious metals shares are concerned then, and although more corrective price action could continue in the short-term, it's anticipated the 'tests' discussed last week should hold by and large, which means slowly scaling into positions in coming days / weeks is most likely a good idea.
The Gold / US Bond Ratio plot pictured below sets the stage for just how important a break higher in gold against the long bond would be here. Such an outcome would certainly stifle any reckless talk of deflation for a while, that's for sure. (See Figure 1)
It would be more reassuring a rally in precious metals will have more staying power however if the Gold / Dow Ratio was able to correct further, characterized by RSI vexing lower channel support. Of course this could be accomplished by stocks pushing to new highs set against gold taking it on the chin one more time at some point in coming weeks, which you will remember fits with the view a seasonal inversion in stocks is underway. (i.e. stocks could push higher between May and November, a typically weak period within the annual cycle.) So, don't be surprised if stocks get a lift as month / quarter end approaches next week. (See Figure 2)
Such a view is presupposing quite a lot however considering a confluence of other negative technical / sentiment related considerations however, with the NASDAQ / Dow Ratio at the forefront in this regard. A look at the daily shows profound negative divergences have developed within the indicators (along with an outside down / reversal day lower yesterday), suggestive investor appetite for risk should see an intermediate-term duration turn to the downside, which would of course negate more bullish aspirations for stocks. And below we see a monthly plot that is threatening to bust a move to the upside with any further strength. Here, it's important understand that the only way this could happen is if US authorities further accelerate the rate at which they are debasing the dollar ($). (See Figure 3)
So, the question is will the drug addicts in Washington up the dosage this summer, which could turn the $ lower in profound fashion. To sympathetic druggies, the answer would be obvious, which is why one cannot rule out another burst of strength in equities as the excitable types ponder possibilities of hyperinflation. Of course this is impossible within a conventional definition given the bond market will blow up first, but don't tell them that. They will run equities back up the patriotic flagpole on even worse internals / technicals than what has been witnessed these past months in the name of duty, or whatever else is going through their little minds. Of course it's not that such a strategy will not work for a while, even with primary US creditors accelerating an exit strategy from $ hegemony dominance.
All US officials need to do is announce an implied open-ended monetization of the T - bond market and that would trump anything trading partners would be able to counter within the race to zero. This is because the amount of US $ denominated debt towers over all of its counterparts with 50-plus years of reserve currency status, which necessarily means nobody else would need to print more new currency than Americans. Naturally after this last easy money party is over the prognosis is terminal in terms of globalization ($ hegemony dominance) however, where increasingly economies / trade will regionalize, and the complexion of world commerce will encounter profound changes that will last lifetimes. This is of course why one needs to own physical gold and silver, where the latter should rejoin the former at some point as recognized money once again.
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Good investing all.