The China Factor
Whilst the world currently appears to be focused in the goings on of the Middle East, Russia, and States side because of shock value media types endeavor to capitalize on, the real story as it pertains to lasting implications in the human condition would likely be better directed toward Asia right now in our opinion, as there is growing evidence a slowdown of measurable proportions is gaining momentum in this area. Certainly if one were to make the trip to Shanghai, easily the most thriving environment on the globe today, and where it would be difficult to perceive economic weakness is in the cards by viewing recent growth in their real estate, industrial, and financial infrastructures, you might think talk of a meaningful slowdown to be unfounded, with the worst one should expect being a mild regenerative drift. And while this may turn out to be the case, where concern past a potential 'blip on the screen' proves out in the end, we have our reservations about adopting the cavalier attitude official sources prescribe, because the global economy appears to be teetering on a precarious tight rope at present, with one false move enough to tip the balance.
We could take off in several different directions at this point based on the above opening, because there are numerous angles and complexities within which to view things in this regard. And with the world now a fully integrated financial / economic nexus, the scope of discussions concerning factors affecting the macro-condition of the global economy are becoming more complex every day, where advanced students for example, are now measuring growth rates in credit card participation rates amongst the citizenry of greater China to gauge future growth prospects, considering the fully mature character of advanced economies. With an approximate 22 percent penetration of China's population in this regard at present, one would think this leaves much room for growth, and is undoubtedly the primary reason foreign banks are fighting 'tooth and nail' to participate in what appears to be the next market to plunder, with India a close second in the measure.
Turning to a more practical view point as it pertains to both the immediate future, and how things may actually progress in a subsequent lasting fashion / larger degree now, where maintaining a balanced and broad knowledge of key measures within the mix is undoubtedly a superior approach over guessing about how above rationalizations should prove out in the end, a 'primary indicator' as it pertains to gauging the health of the global economy has recently 'hooked' down, giving us pause at this juncture in growth themes. The primary indicator of which we speak is shipping rates, where pricing trends in this most immediate measure of health in global trade will in fact lead other key metrics, such as currencies and interest rates, and where the Baltic Freight Index (BFI) comprises an averaged overall weighting of the various freight rates for all routes around the world reported to The Baltic Exchange daily, from which shippers will hedge their future needs via the Baltic International Freight Futures Exchange in London. Here is a picture of the Baltic Panamax Ocean Freight Index showing a top in April of this year, which is a derivative of the BFI, and is a key measure of demand as it pertains to Asian shipping routes. (See Figure 1)
As mentioned above, the BFI Dry Index has recently hooked down from what appears to be a reaction recovery in global trade this June, but was unable to sustain a move back to previous highs seen earlier in 2004, much like the price of gold and its related equities. In fact, if you compare the BFI plot to material charts representative of the precious metals (PM's) complex, one will notice a significant correlation between the measures, where stocks in the metals sector appear to telegraph what to expect in shipping rates, and where commodity pricing appears to run in tandem. Further, one should notice that significant weakness in the metal did not materialize until the BFI began to free fall in April, which when added to the remarkable similarity of pricing patterns between the two over the past several years, compels one to conclude that above all else, a buoyant and inflation driven global economic environment is necessary in order to expect the same conditions to be present within the PM's arena, both paper and commodity based markets inclusive. Here is a picture of gold that suggests a critical test in the $388 area may soon be upon us, where if the BFI continues down, much pressure will be applied at trend support. (See Figure 2)
With an overwhelming bullish consensus amongst participants and advisors alike
in the PM's group at present, we must school a degree of caution associated
in running with the pack given the above knowledge, which I can assure you
most are either unaware or are not taking the risk seriously. Indeed, it would
be fair to say that most are expecting a money supply driven fiat nirvana to
develop as we head into 2005, where newly created fiat representations are
expected to thwart the deflationary impact of a faltering economic landscape
in the world.
Others see supply-side constraints, such as a reduction in official gold sales http://www.lemetropolecafe.com/img2004/gold020904.pdf as being the primary factor that will drive prices higher as time passes, where they admit to a probable softening in physical demand for the commodity, but do not see this advent as being pivotal in terms of concern.
While we remain optimistic about the prospect of a bullish outcome for gold ultimately, as you can see above, key relationships and data points are suggesting caution is warranted at this time, despite growing fundamental underpinnings on the supply-side. Therein, one should realize that in spite of physical supply-side considerations that will undoubtedly win out in the end as growing numbers of investors around the world endeavor to flee the ravages of a fiat based system, if demand is temporarily subdued sufficiently to tip the balance the other way, the prospect of materially higher prices may be delayed. And as mentioned, the BFI, as well as other inter-related measures are suggesting demand may become a problem as we move forward, where confirmation of the turn lower in global shipping rates should be provided soon.
One such factor set, as mentioned, is the interest rate profile in the States, where if global trade is about to contract, absolute levels of trade derived Dollars will undoubtedly shrink as well (i.e. perhaps even the US Trade Deficit), significantly constricting foreigners US Dollar (USD) funds available to support the bond market. And given the domestic fiscal situation in the US, where just a relatively slight rise in rates will likely trigger a disproportionate contraction in consumer spending, and then government budgets, significantly hampering official attempts to monetize debt, one cannot reasonably expect such efforts to be successful for long short of a 'Weimar' scale printing press agenda, which of course will also fail in the end. Perhaps this is why the 'yield curve' has yet to see a bounce since the onset of a steep decline that was triggered at the turn of the year, and why the States may finally be forced to 'bite the bullet'. (See Figure 3)
Such an outcome will undoubtedly send hedges and speculators scrambling out of their re-inflationary bets in an abrupt fashion, which will likely be reflected on the currency front in growing proportions prior to an equity collapse, and is in this authors opinion why the US Dollar Index has simply been testing the breakout on the weekly chart over the summer months, in preparation for a meaningful move higher. The math in this respect is quite simple in actuality, where if rates were rise as a product of slowing foreign demand for domestic debt at the margin, an accelerating condition set conducive to both rising rates and the currency unit could exist simultaneously for a period, especially if foreign participants developed a desire to de-leverage US debt. (i.e. think margin calls on foreign hedge funds heavily leveraged into US financial assets, derivative based bets being unwound, etc.) With a break of the 50 weeks moving average (WMA) now behind us, the 200 WMA becomes the next significant target with a penetration of the previous high at 92.29 closing basis. Make no mistake about the possibilities here; the USD is set to triggered a 'buy signal' on both the weekly and daily charts (i.e. think 'cup with handle' measuring to 94), where significant moving averages appear ready to turn higher any day now. Look for the target area to be met sometime in early November with a three-day close greater than three percent above the 155 EMA on the daily providing 'trend confirmation'. (See Figure 4)
This advent would be deflationary and feed on itself, where as mentioned just above, equity markets would likely feel the pinch as fall months bring a turn in the leaves. You will know there are potential troubles in both US and interconnected Asian stock markets if the Nikki breaks back below the 21-day exponential moving average (EMA), and the large round number at 11,000, given the central role Japan plays in the big picture. (See Figure 5)
And we would be amiss not mentioning the technical picture in Chinese equity markets given the theme in this paper, where it appears prices as measured by the Hang Seng are attempting to put in a bullish impulse leg, but where the advance in this regard has been muted thus far considering the amount of energy that has been expended, suggestive the move throughout summer was corrective, despite the break back above the 200-day moving average (DMA). Look for a bearish kiss of the 50 DMA off the 200 DMA in the near future if the BFI continues to fall. (See Figure 6)
Moving into the commodity front now, one could logically conclude a technical examination of oil may be timely given its central role in the global economy. We however, are of the opinion it may only languish range bound if global macro-conditions turn deflationary, where we prefer thinking price changes in 'black gold' may posses less predictive value than other measures, especially right now, because of potential relative price inelasticity to economic circumstances brought about by geopolitical events, not to mention life-cycle supply-side constraints. For this reason, and in search of an alternative to oil then, I would like to take a look at copper, an industrial metal, and a commodity that like oil, cuts through the very fabric of global trade (i.e. think China, technology, housing, etc.), and has supply-side issues, but will likely not be as price inelastic because of extraordinary events and / or speculation on the part of hedge funds. (i.e. the last time I checked, terrorists are not blowing up copper mines.) Here is a longer-term chart of copper that clearly demonstrates it has seen a tremendous run over the past two years, but that we may be witnessing a rare 'fifth wave failure' at this juncture, which is suggestive a significant correction in the works. (See Figure 7)
If copper cannot top previous highs before the 200 DMA is penetrated on a decisive basis (i.e. think a close greater than three percent below the mark), which will turn the 50 DMA down, likely triggering a 'dead cross' sell signal through time, a 'fifth wave failure' will have indeed occurred, normally calling for a full retrace of the entire structure. In this case however, we may see the 'inverse head and shoulders pattern' hold, again, if the descent is triggered as described above, stopping it at the 'golden retrace' in the 90 area. There is no guarantee the two-thirds retrace will hold however, as this degree of retracement would be expected after a 'fifth wave extension' in fact, but one must remain commodity bullish long-term given various powerful signals elicited over the several years, and until proven otherwise.
As an investor, and if you are long inflation / cyclically sensitive investments at this time, like PM's for example, one would be well advised to keep an eye on copper, especially if leading economic indicators continue to decay. (i.e. think BFI.) Therein, copper should prove to be hypersensitive to macro demand / supply conditions in the world's economy as we press into next year, and failure to signal a buoyant condition in this regard should give those pinning their hopes on the traditional positive effects associated with a turn in both the 'ten-year cycle' and '40 week cycle' now, in this increasingly integrated global economic climate, cause for concern something grander in scale is operating in a dominant fashion at this time.
Without delving into further complexities associated with the whole debt, demographics, deflation conundrum, as it has certainly been well covered by a group of very capable aficionados of late, we would like to begin wrapping up this discussion with one simple observation regarding gold, which will also serve as an example of the swing trading methodologies we employ at Treasure Chests, yielding our subscribers in excess of a 50 percent return on long positions only thus far in 2004, and where we successfully called the top in the PM sector earlier this year, along with every meaningful turn thereafter. With this knowledge, and serving both of the purposes outlined above, we will assume that at present, gold is the ultimate barometer regarding whether the global economy is about to inflate, or deflate, because within the constraints in which our modern 'fiat based' system operates during predominantly weak economic conditions, a buoyant and expanding money supply (i.e. liquidity) environment is key to maintaining demand-side pricing power, which as you know from reading the very capable work provided by David Chuhran above, the health of which is questionable moving forward barring extraordinary measures.
Setting aside the need for a discussion about the vulgarities of paper gold pricing mechanisms that have served to strongly influence both short and intermediate term pricing trends in a negative fashion since the bottom in 2001 (i.e. sideways presently), one should note that at this point in the game, it is a growing fundamental demand for the physical yellow metal which will ultimately determine long-term price trends, and in this regard, gold must exceed the 50 percent retracement off 1980 highs at $556 USD before a bull market is triggered by definition. The question then arises, "with gold currently at $400, which is a full 28 percent below the point a bull market defining signal will be elicited, how does one know they have a better than even chance of participating in the ride to this level, if higher prices are indeed in the cards within a reasonable time horizon, and without having to wait until the signal is provided?"
While no guarantees can ever be provided in this regard, and without entering into a discussion concerning other proven market timing methodologies involving market internals, sacred relationships, and a myriad of other technically based doctrines that must be employed as cross verifiers, for simplicities sake, which is a prerequisite to becoming a successful investor, we have developed a proprietary trend confirmation system dubbed the 'progressive interval system', which has proven to provide swing trading based buy and sell signals within an intermediate-term time horizon, allowing participants the luxury of knowing whichever direction prices are heading, you are in possession of the knowledge a confirmed status is present in the move. In applying our system to gold's picture now on a basic level, as the degree of intricacy facilitated once a firm understanding of the parameters employed is only limited by your objectives (i.e. short, intermediate, or long term), the first observation to be made is that currently the yellow metal is vexing both above and below the large round number (i.e. interval) at $400, where market participants are endeavoring to discern which way the next meaningful break will take prices.
Here is a simple chart showing that even if gold were to pullback all the way to the 62 percent retracement in the $320 area, the presence of a pronounced 'inverse head and shoulders pattern' suggests a move to $556 to test the bull. And if gold were to break higher directly from current levels, the measures become more lucrative for investors of course. (See Figure 8)
Further to this knowledge, and pivotal in attaining a basic understanding of our system, recent trade has worked well in terms of exactly matching our definitional framework, because with gold in the process of deciding which way it will break away from the $400 mark, the last intermediate-term closing basis high put in was at $412.90 spot on August 20th, which exceeded the large round number by more than three percent (i.e. > 3% above $400), but did not do so for three consecutive trading days (i.e. closing basis); and, nor did it do so by a convincing margin, which did not allow for the possibility of a back-test whilst maintaining the three-day -rule requirement. If the hurdle had held for the specified three-day time interval, a 'confirmed' intermediate-term 'buy signal' would have been triggered, and we would not be having this particular discussion right now.
Exactly what degree of a buy signal would have been triggered if this occurs? As the naming of the system implies, and although lesser degree intervals would be approached in the same manner along the way, (i.e. think 25-point intervals), a move to $500 would have been signaled (i.e. the next large round number interval), where a three day close three percent above the higher degree large round number, would of course signal a move to $1,000 within the progression. (Note: The sinusoidal progression channel drawn in Figure 2, along with Fibonacci based resonance characteristics within the move thus far allow for a progression to $500 at this time.)
Of course we are a long way from such an advent, and in fact heading in the wrong direction at the moment. Therein, if you take considerations associated with the metrics in our system the other way, one would realize we are now likely heading for a test of the $388 mark (i.e. = 3% below $400), where a close below the measure for more than three consecutive trading days would signal a move to as low as $300 is underway. Of course where we are open to a reversal higher well before this mark should be seen based on an integrated approach within the full spectrum of various technical disciplines we employ, which are regularly discussed for the benefit of our subscribers at Treasure Chests. And to finish up in this regard then, the central point we would like to highlight at this time is that by employing proven methodologies, such as the 'progressive interval system', one can remove much of the gambling / speculative element from investing, whether it be in PM's (i.e. think precious metals stocks as well), or other markets such modus operandi do well to define.
Clearly, we are at a pivotal juncture for gold, and of course the precious metals sector at large, which in a round about way we have zeroed in on because it is our belief that although factors such as the BFI will undoubtedly influence / signal health considerations within the macro-global environment (i.e. think liquidity, Asia, and growth), one can never be sure a new paradigm, or perhaps more appropriately termed 'old paradigm', will reassert itself on the investing public sufficient to thwart both new and old obstacles which are placed in the path of a natural progression. Certainly, if gold can hold its ground against a potential onslaught of approaching negatives that exist presently, we will have this answer very soon, and where we at Treasure Chests would be happy to welcome you aboard in our ongoing monitoring of the process. Therein, we firmly believe no matter how long it takes, patient, prudent, and well-informed investors will be there to reap the benefits of a potentially explosive PM bull market, whenever it decides to legitimately signal its intensions. That's right, you haven't seen anything yet, with the big question of the day being, "when will this party really get rolling?"
Good investing all.