Value of Perfect Information

After writing an article about the Platinum-to-Gold ratio, I decided to do more with the excel sheet,
like calculating correlations and plotting the price charts for example.
In this article, I will just focus on the Gold price.

Here we go, the Monthly average Gold Price since January 1968:

It looks a bit bubbly, right?
If you think this looks like a bubble, then please have a look at this Log-scaled chart, which looks far from bubbly:

The thing I observed was that the price action in Gold from early 2000 until today was similar to the price action from 1968 until April 1979. Let me show you:

One might argue that the price action from 1972 until 1975 is not similar. I agree. However, the correlation between the gold price from 1968 until 1979 and the gold price from early 2000 until today is an amazing 89,65%.

Now what else did I notice? That the price action from November 1975 until April 1979 is almost exactly the same as the price action from January 2008 until today. To show you, here is a chart:

If this monthly chart was not convincing enough, here is a weekly chart (click the chart to ENLARGE):

Chart created with Prorealtime.com

How high do you think the correlation between both periods is (measured on a monthly basis)?
That’s right, an astonishing 97,83%!

Don’t believe me? Here is the excel sheet I used, with data from Kitco.com

So what would be a price target for gold, based on the 1981 intraday high of $873 per ounce if the correlation would hold?

That’s right, $5,000 per ounce:

Now you have another way to look at mr. Armstrongs prediction of $5,000 gold.

For more analyses and updates, please visit www.profitimes.com

As the crisis in Libya continues and oil exports are disrupted it’s important to understand the impact this has on various economies.  As the 18th largest exporter of oil, the impact on the global economy as a whole is somewhat muted, although their grade of oil is higher than others.  Regionally though the impact represent a significant risk to individual economies. Portugal, Ireland, Italy, Greece and Spain already faced with struggling economies and financing concerns are at greatest risk. The chart below shows how much oil each country imports from Libya as a percent of total imports.

Anti Gaddafi forces control the eastern Libyan region which is a significant portion of oil facilities. Tripoli and the west are held by pro Gaddafi forces. Imagine if Gaddafi destroys the facilities before losing power?  This explains why the US and other countries are moving military assets into the region and the discussion of a no fly zone is accelerating.  The most recent COT report showed commercial net positioned for a sustained rise in oil prices.

Some mixed messages come out of this week’s CFTC Commitment of Traders Report. Below are six charts with my best estimate of what the data is telling us. The three key takeaways are

• Commercial traders appear positioned for further bond weakness

• Commercial traders are reducing net short positions implying copper weakness

• Retail traders are positioned for further USD weakness, implying USD strength

Bonds

Looking purely at the relationship to 30 year yield and the SPX, this chart implies that further bond weakness (lower price higher yield) would be a positive for the SPX. This cannot be taken purely at face value though. There are many implications to a weakening bond market beyond this chart. Still, the data below would imply continued equity strength.

Bonds – Commercial Net

Commercial positions continue to move towards a more net long in the face of 30 year weakness.  At face value this chart would imply further bond weakness to come.  It’s important to note though that commercial positions are approaching a 52 week high.

USD – Commercial Net

This is a tough one to read.  The commercial trader position is net long and matches that of the prior 52 week high.  It is very possible their net long position grows but considering this position relative to the prior 52 weeks, it is quite possible they begin getting more short which would imply USD strength.  The USD has bounced off key support which would further argue for a reversal to a more short commercial net position.

USD – Commercial VS Retail Net

This next chart is that of the non reporting positions versus commercial positions.  Non reporting (retail) are relatively short versus prior times in the year so there is fuel for a short squeeze in the USD.  Hard to make any definitive call though.

Copper – Commercial Net

This is a rather interesting chart.  Copper caught a nice bid the past week yet the commercial traders are not buying it (literally).  They appear to be getting more net long (this  chart is inverted for comparison sake) which would imply pending copper weakness.

Copper – SPX VS Commercial

Nothing too definitive can be drawn here other than a word of caution for the SPX as commercial positions appear to becoming more net long (chart is inverted for comparison sake).

The US equity market may be experiencing low volatility but beyond that HFT driven “market” volatility is rising fast. There are a lot of moving parts right now, each of which on their own could cause a severe shock to an extremely fragile global economy. It is important to stay focused on what is out there and the risks they present. Maintaining a false sense of security regarding the future of QE is ignoring the real investment risks that are present today. One does not know when nor which event will be the tipping point so patience is needed. It’s important though to stay focused and educated so when events surface as investors we are ready to react.

I want to focus on global food prices, primarily the recent price action in rice. Below is an excerpt from a 2009 USAID Study

“Approximately 1 billion people—or one sixth of the world’s population—subsist on less than $1 per day. Of this population, 162 million survive on less than $0.50 per day. At the household level, increasing food prices have the greatest effect on poor and food-insecure populations, who spend 50 to 60 percent or more of their income on food, according to the International Food Policy Research Institute (IFPRI). Overall, increased food prices particularly affect developing countries, and the poorest people within those countries, where populations spend a larger proportional share of income on basic food commodities.”

Even within the US, food prices affect one in seven Americans. That is because 15% of the US population does not have the income to pay for the most basic necessity of life and that is food. Rice is one of the largest staples of the global diet and its recent price action is signaling yet another threat.

This heat map of rice consumption per capita shows Asia as the most at risk to rising rice prices

Rice prices in 2010 relative to the 2007-08 highs are relatively low but as the chart shows, price can accelerate very quickly.

The chart below shows just how fast prices have begun to move since 2009. In fact the prior resistance level has already been taken out and a massive melt up is not only possible but also probable. We are in a yield chasing environment right now. Those who missed the move up in sugar and cotton, etc will pile in to the rice trade and accelerate this move.

“It’s really very simple Governor, when people are hungry they die…” Bob Geldoff

Some interesting divergences with the SPX and the commercial positions on oil and copper in the most recent Commitment Of Traders report.  Leaving my bias out, looking purely at the charts, the SPX appears ready to finally correct.  So without any further commentary, here’s what we have.  For those new to the COT report there are three categories of traders (1) Commercial – don’t fade these people, (2) Non Commercial (3) Non Reporting – fade these people.

SPX versus Copper Commercial Net

SPX versus Crude Commercial Net – the only “color” I will add here is notice how about six weeks ago the SPX popped above the position line when the prior sixty weeks it was below, all while the rate of change of the CL position has slowed.

SPX versus Nymex Light Sweet Crude – This chart is as of 1/25 (Tuesday) before oil prices spiked with the protests in Egypt.  So if I were to draw the chart as of Friday 1/28 the divergence would be far less but “this time it’s different.”  This time the spike in oil is purely on fear and we know how fear is supposed to affect risk assets.

I have a proprietary trade signal which has correlated nicely with the SPX and also showing divergence.

On the surface, sure, all looks well. To even talk about a double dip right now will get you banned from CNBC (which isn’t a bad thing for your credibility). Before people go ahead and call mortgage gate a non issue, bank health a non issue, macro economics as rebounding, check out the headline from October 5, 2007 (yes 2007).

Nonfarm payrolls rose by 110,000 last month — including 73,000 in the private sector — very close to expectations of a 113,000 gain in total payrolls.

The S&P 500 highs were on October 8, 2007. What happened after that? Subprime was NOT contained. Financials having declined for 5 months were a leading indicator of the indices. The economy was not doing a goldilocks dance as Kudlow so proudly declared each night. This is all in the back drop of a weakening dollar and rising commodity prices.  Seems quite familiar to our current environment.

Bulls are celebrating ISM Manufacturing and Services reports showing expanded growth (above 50 is expansion, below contraction). Looking inside the report shows some troubling signs though, primarily prices paid. As the USD has continued to get slammed the past few months, input costs have continued to rise. In this current economy, producers do not have pricing power on non essentials to pass along those higher prices. The result is their margins have been and will continue to get squeezed. To combat tighter margins, employers will begin laying off “non-essential” employees. New Orders in both reports have shown increased strength which is certainly a good sign for future ISM reads but is this solely due to the weak USD helping exports? Just like the EUR/USD was going to parity back in the summer, everyone is talking the end of the USD right now as the reserve currency. At some point that may very well be true but a reversal in the USD will put pressure on future ISM reads. Sovereign debt concerns have not passed, just kicked a little further down the road. Dec. 7 is national run on the bank day in France, which has now spread to a handful of other countries all as a result of austerity and another form of protest (important to remember EU banks are leveraged 10 times US banks). Don’t be so quick to favor the EUR over the USD. Both currencies are bad but it’s a lesser of two evils scenario right now.

So the ISM manufacturing and services both were positive signs for future growth of the US economy but need to be taken in context of what is driving them.

The broad markets along with metals have been on fire but in the last two weeks we have seen the sentiment become stronger. The extreme bullishness we are seeing has made it difficult for low risk swing traders to get in on the action simply because there have not been many sizable pullbacks. Instead the prices have been inching their way higher with very minor pullbacks before surging again.

The only way to take advantage of this type of price action in order to keep risk low is to take small positions when the market drops to the 5, 10 or 14 moving averages with a mental stop to exit the position if the market closes below the 14ma. Any position take up here should be small because the market is in runaway mode, meaning everyone is buying on the smallest of dips. The largest moves tend to be near the end of a trend which is why I feel this market could keep running for a few more weeks before taking a sharp plunge.

Natural Gas

If you have been reading my work over the past year you should know I don’t like natural gas. More people have lost money trying to play natural gas than any other investment vehicle out there which is why I don’t cover it very often. Many of you have been asking about Natural Gas (UNG) so here are my thoughts on it.

UNG has been in a down trend for several years and the only trades should be short positions at this time. The argument from some is that it’s undervalued and with winter just around the corner prices should go up. It’s a valid argument but price action is what makes traders money, not fundamentals.

The daily chart of Nat Gas below shows what I feel is about to happen. Remember, UNG is a terrible fund to be buying. Unless natural gas is moving strongly in your favor, this fund continually loses value simply because of the way its created.

Looking at the actual natural gas commodity chart is a different story… The trend is still down, but it does look as though it’s trying to form a base when looking at a 3 year weekly chart. That being said, there is still a very good chance we see gas test near the $3 level before starting a new trend so trying to pick a bottom here is not something I would be doing.

Trading Conclusion:

In short, the equities market is still in a strong uptrend. I’m not comfortable taking any large positions at this stage of the game but if we get a setup I will not hesitate to enter with a little money.

As for natural gas… trying to pick a bottom is deadly in a down trend as bounces tend to be short lived or flat.

I will cover the dollar, gold, oil and the market internals in the member’s pre-market morning video…

Happy Trading

In… September’s Federal Open Market Committee minutes, the Fed officially announced that … “Unless … underlying inflation moved back toward a level consistent with the Committee’s mandate, they would consider it appropriate to take action soon” and take “… possible steps to affect inflation expectations.” That’s Fed-speak for a MANDATE TO CREATE INFLATION — with lots more money printing, and many more purchases of Treasury bonds, mortgage bonds, corporate bonds, commercial paper, even possibly equities or real estate! No wonder the dollar is crashing toward new, all-time lows against ALL major currencies!…  No wonder gold is soaring — again!

So says Larry Edelson (www.moneyandmarkets.com) in an article* which Lorimer Wilson, editor of  http://www.MunKnee.com, has reformatted into edited excerpts below for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) Edelson goes on to say:

For a long time I’ve been warning that Fed Chief Ben Bernanke would:
• Print money, virtually nonstop.
• Do everything in his power to keep interest rates near zero “for as far as the eye can see.”
• Worst of all, literally CREATE inflation, even if it meant going into the open markets to buy up all kinds of assets.
Now, this is precisely what the Fed says it wants to do!

Overseas investors are clearly running scared of the endless supply of dollars the Fed will be printing …so they are buying gold, hand over fist. Meanwhile, savvy domestic investors are also gobbling up gold, driving gold trading volume to record highs … piling into every conceivable gold investment under the sun — from gold coins and bars … to mutual funds … to gold ETFs … and gold futures contracts.

Editor’s Note: Don’t forget to sign up for our http://www.munknee.com/newsletter/”>FREE</a> weekly “Top 100 Stock Market, Asset Ratio & Economic Indicators in Review”]

The above is hardly surprising when you consider the dollar’s downside fate is now virtually sealed … that the Fed has officially admitted that it will take any measures it deems necessary to devalue the dollar and boost inflation — no matter how unorthodox those measures may be. Adding fuel to this fire …a massive tug of war is about to begin in Washington!

In my 32 years in the markets I have never seen a set of forces merge together at one time and place like we have today!
Not only is the U.S. still mired in the worst economic disaster since the Great Depression …[and] the Fed embarking on unprecedented misadventures to boost inflation … but we ALSO face one of the most historic Congressional elections, ever!

What will happen? There is no question in my mind that, in this teetering economy, we will see:
1. a monumental tug of war between a more conservative Congress and a more aggressive Fed backed by the Obama administration …
2. a sea change in the financial markets, and …
3. every stock and ETF you own directly impacted.

My Recommendations
1. You absolutely must hold a long-term core position in gold regardless of any short-term fluctuations. The most handy vehicles are gold ETFs like GLD.
2. If gold suffers a temporary correction — which would be completely normal — [you should] use it as a buying opportunity to ADD to your core gold holdings.
3. [You should] seriously consider foreign currencies. On any short-term weakness, one good choice is the Australian dollar, which you can also buy via an ETF — symbol FXA.

*http://www.moneyandmarkets.com/news-flash-fed-declares-it-must-create-inflation-dollar-collapsing-gold-soaring-40373?FIELD9=2 Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. To view archives or subscribe, visit www.moneyandmarkets.com

In my September 1st piece, I argued the importance of valuing Gold relative to Silver via the Gold/Silver ratio, concluding that gold will UNDERperfom silver despite its status in the limelight. Indeed, the G/S ratio has fallen 7% since the article, hitting a new 13-month low of 59.0. My case for “faster” gains in silver remain in place.

So how about Gold/Oil ratio? Readers of my book and previous articles on the topic recall that the G/O index bears a highly negative correlation with risk appetite/stocks/market sentiment. The rationale being that when G/O ratio ceases to rise and begins to pull lower, it is a case of re-emerging energy prices relative to metals, usually reflecting improved appetite/higher growth/weak-US-based gains in energy prices. The converse case applies.

The G/O ratio is especially valuable during the early stages of a rebound as it predicts deteriorating risk appetite and falling equities (2008 example) while a peak followed by an early stage decline, usually suggests rising stocks, led by higher energy prices (April example) and May example.

With the above evidence continuing to prove effective since 2007 (time of writing my book), let us integrate it into the G/O relationship of today. The chart below shows the G/O ratio in the upper panel and the S&P500 in the lower panel. The latest correlation between S&P500 and G/O ratio on a 2-month rolling basis stands at -0.63. The red lines indicate the inverse correlation of the overall trend. Note how G/O ratio began drifting lower (due to faster oil appreciation relative to gold last week), which has been accompanied with a clear increase in the S&P500 (and other stocks). The break out of the S&P500 above 1,150, could mean further decline in G/O ratio — potentially towards the 6-month trend line support of 15.20.

And if the above dynamics continue i.e. further declines in G/O ratio and higher S&P500, this could well take the form of rising oil prices revisiting the $86-87 level.

Diamond in the Energy Rough

The weekly US crude oil chart below shows a rare “diamond formation”, which in technical analysis is a rare pattern. Diamonds could be either continuation patterns (bullish) or reversal patterns (bearish). In this case, the weekly chart broke above the $80.50 trend line resistance last week (falling trendline line), showing a continuation out of the multi-month pattern, whose 1st half held up during Oct 2009-May 2010. The importance of last week’s break out and this week’s follow-through is highlighted by the break of the all-important 200-week MA. The next test emerges through a required break above $83, which is the high from Aug 2010 (small red circle). Tuesday’s closing price was at $82.82 was not enough. A Friday close above $83 would be necessary, while a close above $75-76 is required to maintain the uptrend.

In the event that $83 is broken with a weekly close (preferably), this stands the chance of extending S&P500 towards its next resistance of 1,190 (200-week MA, which was broken in June 2008) and 11,200 on the Dow Jones Industrials Index. Is this plausible? An “upbeat” US earnings season and rising confidence that US markets will be “liquefied” by Fed asset purchases could well do the trick — for now. The implications for the USD index suggest a possible decline below the 76 trendline and into a prelim target of 74.

Bank of Japan Follows Fed into Zero, ECB Stands out as “Hero”?

Today’s BoJ decision to jump back into zero interest rates along with the Fed means the ECB is left alone with 1.0% policy interest rate, a notion that is hard to resist by FX traders favouring further gains in EUR. This is especially the case as the ECB shortens the duration of available funding. Meanwhile, FRBNY pres Bill Dudley reminded us last week that additional QE is a defacto easing of fed funds rate.

Don’t Confound Inadequate Liquidity with Unnecessary Liquidity

Many have wrongly stated that rising EURIBOR rates (Eurozone interbank rate) as a sign of inadequate liquidity, which is a sign of lack of confidence. But they confuse rising EUR interbank rates — resulting from inadequate liquidity due to lack of lending & trust among banks, with rising EURIBOR — usually associated with lack of need of funds (the case today after Eurozone banks demanded less loans from ECB). Last week, Eurozone banks demanded EUR 104 bln from the ECB’s 3-month liquidity operation, well below the expected EUR 150 bln. JC Trichet has expressed this as sign of less need for funding. But the unexpectedly low demand could further drive up EONIA as excess liquidity declines by an estimated EUR 80 bln. EUR 3-month LIBOR is now at hit a 15-month high of 0.89%, extending the spread over its US counterpart to 0.58 bps, the highest since Feb 2009. As long as the ECB and Eurozne banks are content with shorter marturity loan facilities and any event-risk is averted with regards to the P-I-I-G-S, euro shall remain supported at $1.33. But with my $1.3850 target been hit (see prev IMTs and tweets on twitter.com/alaidi), I need a new fundamental catalyst for a break above $1.3940.

BoJ Easing Will Not be Enough

The decision by the Bank of Japan to purchase everything in sight except for stocks reflects the desperate situation of the central bank. The BoJ slashed its policy rate from 0.1% to between 0% and 0.1%, while creating a temporary fund of about 35 trillion yen to buy various financial assets (government bonds, corporate bonds, and commercial paper). Will the BoJ buy stocks as it did 2 trillion yen worth of bank shares in 2002-3? For those who were around in 2002, remember, the BoJ included stocks in its shopping list well into mid 2003, until.. you guessed it.. it resorted to pure yen-selling intervention into March 2004. The BoJ’s measures may be sufficient to prevent yen strength vs. commodity and European currencies but are unlikely to reverse the USDJPY beyond the 85 yen level.

My QE is Bigger than your QE

And if you think the 35 trillion yen announced from the BoJ is large, it is only the equivalent of about $420 billion, which is less than half the anticipated +$1.0 trillion in treasury purchases expected from the Fed. As the Fed’s QE2 is set to overwhelm the easing measures of the BoJ, any rebound in USDJPY will be short-lived — just as short-lived as today’s bounce in USDJPY to 84.00 before falling back to 82.97. Can the BoJ ultimately resort to fresh wave of yen-selling intervention? Perhaps, but its case is increasingly untenable considering i) yen is in fact weakening vs most of other currencies; ii) interventions are politically incorrect as they were frowned upon by EU and US officials. I expect gradual selling momentum to re-emerge, triggering 81, with 79.70 an increasing likelihood before year end.

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