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Signal Failure

By: Captain Hook | Monday, February 10, 2014

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Sunday, January 26th, 2014.


 

My own personal circumstances aside, it appears we are also entering a trying time for stock market bulls, precious metals bears, and the powers that be, this being signaled in the apparent fifth-wave failure of the Dow / Gold Ratio (DGR) last week. The failure occurred on Thursday with a five-wave sequence tracing out to the downside, which was both confirmed and extended sufficiently on Friday to remove any doubt as to the move's impulsive nature. And although there's still the possibility of the larger sequence to the upside still completing with another surge after a more complex correction unfolds, one must remember the onus is on the bulls / price managers to maintain price stability over the next few months with not only the stochastic / overbought conditions Dave was discussing last week, but also one must realize the 1929 analog is now in play, where the Dow continues to trace out an eerily close pattern match.

So again, and the single most important understanding you should take away from the price action over the past few days is that with the apparent failure in the DGR last week, the cyclical corrections in stocks and precious metals have ended, bring this markets back into their secular trends, which is down in real terms for stocks, and up for gold. What's more, you should also realize that between now and the beginning of April the Dow (stocks) could fall precipitously to match the 1929 analog, up to 50% on an exact pattern match, where if open interest put / call ratios remain in a 'crash signature', as they are now (updated ratios here), at least some degree of a meltdown should be witnessed no matter how much intervention the new Fed head promises. (i.e. because she is new, and the first woman in this position, expect a considerable reaction, although the market may not care past normal volatility.) The thing is, with growing and now considerable numbers depending on the financialized economy, people will be forced to actually sell stock (not just hedge using options) just to pay the bills (protect capital) if stocks continue to cascade lower. This is where margin debt related selling could really accelerate things considering we are at record levels.

So, don't listen to people blindly that would like you to believe the worst can't happen because the Fed is on the job. In fact, because of such a belief, the manifestation of which can be tracked by following open interest put / call ratios and short interest here and here respectively, which are both bearishly aligned at present, the chances of a surprise are quite high if you understand these things. In terms of placing a bearish bet on such an outcome, if you so inclined, with the Fed meeting this week (expect strong intervention) one would likely do well to wait for the Dow to rally back above 16,000 in tracing out in what looks to be a developing head and shoulder's pattern, where it could possibly rally all the way back up to the 16,200 area before failing again. Again, be wary of reinvigorated bears / hedgers by watching put / call ratios and short interest (which should be updated soon) however, this is how you can get burned by the bureaucracy's price manager's. Of course if China is pulling a Lehman here, thinking they can let a few credit unions go under and it won't matter, we could have a genuine rodeo on our hands here.

Technical Note: Use the Dow pattern, and possible rebound back above 16,000 this week to guide you in shorting decisions associated with other markets as well. (NDX, copper, etc.)

Moving onto precious metals now, which are the flip side of the DGR equation, it appears more buoyant put / call ratios (see attached above), along with the apparent turn(s) back into secular trends for the sector (which were caused by the change in these ratios), should continue to yield further gains for not just the metals, but the stocks as well. The only question in this regard is whether the broads crash in coming months, and what degree of negative price action this causes before precious metals (stocks) really get some traction once liquidity conditions improve. Because it must be remembered precious metals stocks are not proxies for precious metals, they are leveraged bets in precious metals mining, and for this reason will suffer when liquidity conditions contract for real.

And there's another problem in the more immediate future, that being the Fed still can't count to five, raising the prospect of DGR pattern completion discussed on these pages for some time now. You will know this is a distinct probability if the Dow closes next week back above 16,200. If they can pull this off, which will be difficult and is not likely given the factors discussed above, then one should cover any short positions established in this area because the signal they intend to push stocks higher, and precious metals lower, via pure manipulation (and inflation), taking the DGR up to the 233-month exponential moving average (EMA) at 14.5 would be triggered. Of course if they fail in this regard we would have 'signal failure', evidenced in the fifth-wave failure in the Dow, and again, some degree of crash over the next two months.

Under this scenario, gold would continue to grind higher, with silver following reluctantly because of liquidity concerns, and the volatility this could create, along with the fact the put / call ratio for AGQ is still depressed, so the machines are not supporting prices like they are for gold and the shares. Going a little further down this road, you should know that the machines are still firmly in control of these markets, leaving the open interest put / call ratios and shorts (sentiment) as the single most important factor in determining short to intermediate term price action. And you can see this in the trade. This is why GDXJ is outperforming GDX, because its put / call ratio has skyrocketed in relation to GDX. So again, watch these ratios every day because if the GDXJ ratio collapses, so will the juniors.

So we need to see these ratios not only remain elevated, we need to see all the ratios in the precious metals arena go above 1 in order to have confidence the corner has truly been turned. If not, if these ratios and short interest were to turn lower again and remain depressed, then the machines will be back to punish precious metals investors (because of stupid speculators who buy the aggressive paper instead of the physical metals and shares) yet again.

Sure, one day all these paper games will end and the Fed's influence on precious metals prices will be gone, but that day is not here yet based on the evidence before us. These bankers like their plush lives and fat paychecks and will do anything to preserve the status quo, right down to selling all the gold in their possession, which admittedly, is getting closer, and despite word is now 'getting around' in official circles. (i.e. it's coming, but the change must be reflected in the trade, starting with silver breaking higher, showing the banking cartel's boot has been lifted from its neck, along with outperforming gold on a consistent basis.)

So, be careful, approach purchases gingerly, and watch the ratios regularly in order to monitor sentiment.

See you next week.

 

Author: Captain Hook

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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