Knocking on Deflation's Door

By: Erik Swarts | Mon, Oct 15, 2012
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Since I began publishing my work last year, I have referenced various versions of the following chart - as rationale to why I follow silver and the silver:gold ratio so acutely.

SPX Silver:Gold Ratio
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Broadly speaking, the ratio and the SPX have trended together since the initial banking crisis in 1990. However, since the US dollar index peaked on July 5th, 2001, both the ratio and the SPX have performed very closely. In essence, when a currency sensitive and "emotional" asset proxy such as silver outperforms gold - traders risk appetites are heightened within the system - which is then expressed broadly across risk classes.

Taking a broader macro perspective, and by removing the extremes of the ratio and expressing itself in a long-term moving average, one could argue that it has represented the great asset inflation (Irrational Exuberance) and reflations of the past two decades. I find this thesis strengthened by the rigid and conforming pattern of rising resistance and support.

Silver:Gold Ratio
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Not surprisingly - and as displayed in the strong performance correlations of the first chart, the secular decline of the US dollar since 2001 has played a pivotal role in providing the motivational propellant in the precious metals complex. This intern has driven risk appetites higher, against the correlating backdrop of reoccurring monetary interventions over the past decade. It is also apparent - based on the strongly trending negative correlation today of the asset relationship, that should the dollar continue to strengthen, the deflationary threshold I delineated by the ratio's long-term moving average - will be breached.

This is why - in my opinion - Chairman Bernanke decided to embark on another round of monetary stimulus last month - despite the equity markets siting at recovery highs. The problem though appears to be that the dollar has made a secular low in 2011, inverting the variable in our monetary handlers reflationary equation.

US Dollar Index vs Silver:Gold Ratio 50 Month SMA
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Should the dollar continue to strengthen, as recently expressed in the "spring" low comparative chart - assets such as silver and gold will continue to weaken.

Structure of a Spring Low
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My work over the past five months in the commodity currency of the Australian dollar - also points to a shifting macro environment where the dollar reasserts dominance in the face of a declining commodity cycle.

Equity vs a Commodity Currency
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Bernanke knows the specter of deflation is out there - in fact it appears to be knocking on the door.



Erik Swarts

Author: Erik Swarts

Erik Swarts
Market Anthropology

Although I am an active trader, I have always taken a broad perspective when approaching the markets. I respect the Big Picture and attempt to place each piece of information within its appropriate context and timeframe. I have found that without this approach, there is very little understanding of ones expectations in the market and an endless potential for risk.

I am not a stock picker - but trade the broader market itself in varying timeframes. I want to know which way the prevailing wind is blowing, where the doldrums can be expected and where the shoals will likely rise. I will not claim to know which vessel is the fastest or most comfortable for passage - but I can read the charts and know the risks.

I am not a salesperson for the market and its many wares. I observe it, contextualize its moving parts - both visible and discrete - and interpret.

I practice Market Anthropology - Welcome to my notes.

Erik Swarts is not a registered investment advisor. Under no circumstances should any content be used or interpreted as a recommendation for any investment, trade or approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational and informational purposes only. All opinions expressed by Mr. Swarts are subject to change without notice, and the reader should always obtain current information and perform their own due diligence before making any investment or trading decision.

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