Hey Gold, Don’t Get Cocky!

Gold Fever - Article Header

Seen this movie?  If not, it appears to be starting another theatrical run.

With the recent action in gold, the precious metals bugs are all stirred up.  Price action has been constructive.  Big time asset management names are mentioning it and the metal is definitely conveying a message.  New songbirds are putting their price calls out there for short-term and long-term destinations.  The old songbirds are putting their same old calls out there as they suffer permanently from the fever.

There’s no fever like gold fever, and I’m an expert in the symptoms.

We’re already seeing the $10,000 and up per oz. calls for gold.  What’s funny is you see the same old reasons for why precious metals are going to boom.  Everybody was selling the same handful of points in the last gold bull run and those same points are being tossed out there again as if they have meaning or truth.

– Negative real interest rates

– Excessive debt loads

– Accommodating monetary policy by central banks

– US Dollar losing value via debasement

– Inflation expectations

– Supply shortcomings

This is folly.  These are not reasons for anything; merely convenient sales pitches that still work on the zealous subset of speculators that are looking for either a reason to stay devoted to the precious metals or believe an amazing amount of money will be made by a small speculation.

From a technical analysis standpoint, it’s time for a rally and the price action hasn’t disappointed thus far.  However, technical analysis has virtually no merit any more due to the advent of the internet.  This has been statistically proven.  Tape-reading still has merit in conjunction with technical analysis and fundamental analysis, but it takes real talent and luck to fight the machines.  Here’s a Captain Obvious chart of gold proving higher prices in the making.

Snarky Gold Chart (7-13-2019)

But there’s only one thing that could potentially drive the price of gold and the precious metals to those high price levels so blithely forecasted.  Here it is in plain, bold English:

A HIGH PERCENTAGE LOSS OF RESERVE STATUS IN THE USD

That’s it.  I believe that to be the only driver that will get gold up over $5,000/oz. or higher.  Something in the order of the USD losing perhaps 35% or more of it’s reserve status which will coincide with decreased use of dollar-settlement in international trade.  Or said another way, chaos.  Because if the rest of the world decides to shift part of the USD’s reserve status to another currency whether it’s gold, Bitcoin, SDR, yuan, etc.; you can bet those in power in the US will be wreaking havoc as a result.  This will be adjoined to the financial/economic chaos that will already be in place.

There still exists old-world faith in the precious metals, and blockchain currencies do not have enough cumulative faith by investors to reel in allocation decisions.  This is the path for significantly higher prices in gold, silver, and the PGM complex; potentially even for the commodity complex.

Regime changes in currency reserves are not fast.  They don’t just happen like a stock market correction.  Many powerful and wealthy nations have a vested interest in the USD maintaining it’s ultimate reserve status.  Just bear that in mind as we watch the dynamics between all asset classes, markets, economies, and countries play out in real time going forward.

It’s tough to visualize if you can’t foresee a world where the USD loses place and face.  But hell, don’t take my word for it.  Google and consider the opinions about the subject of some of the most powerful financial insiders in the world:  Larry Fink – Head of Blackrock, Ray Dalio – Largest principal in the largest hedge fund in the world, and Mark Carney – Head of the Bank of England.

Ain’t no fever like gold fever.  Keep your wits goldbugs.

Bitcoined to Death

September 2nd, 2017 Update:  Depending on when you read this for the first time, how ignorant do I sound as of today with Bitcoin having doubled from the original publishing date of this article?  Not to mention, all the other ICOs since then that are minting millionaires.  My knowledge and experience say this is one of the ultimate bubbles in history.  My brain and heart tell me to make hay while the sun shines.  My ego just calls me an asshole for continuing to miss out.

Have you had enough of Bitcoin and the awe-inspiring wonder of all things blockchain yet?  The blockchain not only cures cancer and AIDS but can make you fly…like Superman.  That’s the hyperbole surrounding cryptos.

“If only I’d just bought 10 bitcoins in 2009!”  Boo hoo.  So you didn’t get rich on Bitcoin.  You probably didn’t get rich on real estate in 2005 or tech stocks in 1999.  The investment world keeps turning.

Never invested in Bitcoin or Ethereum for that matter.  Maybe that makes my opinion irrelevant.

I have read a lot about cryptocurrencies though, specifically Bitcoin.  I missed that train along with the majority of people in the world.  I just can’t wrap my mind around something that isn’t universally accepted that has to be traded on potentially questionable exchanges where competing investments keep cropping up to defeat and dilute the entire concept of the limited-money.  Maybe I just don’t get it.

I do know that blockchain technology will stand the test of time.  The current crypto brands?  I’m not so sure.

My prediction, some sort of scandal or several will avail themselves quite soon causing a sell-off in Bitcoin.  It doesn’t matter whether it’s serious account-hacking somehow or exchange scams, because this sort of pricing will bring out the most intelligent criminals in the world.  And this latest maniacal move up will be entirely erased.  Hope I’m wrong.  Honestly.

Bitcoin YChart (5-28-2017)

Ever ridden the The Dragster at Cedar Point?  Bitcoin owners may be about to experience their own thrill-ride.

                      The Dragster - Cedar Point

If you haven’t hopped on the crypto-train yet and you feel the need to invest in one of the “currencies” in the current price environment, then by all means, indulge.  But consider having a read of these two articles.  One shares the opinion of an experienced player, the other about just one illicit way in which to have your profits harvested from you.

1. http://themacrotourist.com//macro/my-great-bitcoin-bungle

2. https://www.forbes.com/sites/laurashin/2016/12/20/hackers-have-stolen-millions-of-dollars-in-bitcoin-using-only-phone-numbers/#38bad65438ba

To current owners, I wish you well.

The Last Gasp

As you know by now, I think we are in the final stages of the topping process in major markets.  This is going to be a multi-month affair.  I suspect the top and crash begins later next year, but so do many other pundits, pros, and bloggers which makes me leery.  There’s nothing worse than contrarian consensus by large groups in the game of speculation.

Like its predecessors, the crash won’t look like one at first.  Sure, players will get scared and react but then we’ll see a bounce off the first initial move to the downside.  This will be an opportune time to liquidate positions to make a final cash raise to either capitalize during the crash or wait for the inevitable value opportunities that will arise.

There is a set of indicators that go along with this move downward and bounce that has proven efficacy as a guide.  It’s the 5 month and 10 month Exponential Moving Average (“EMA”).  Observe.

SPX - 5 & 10 Crossover (10-10-2016)

These aren’t magic indicators.  I’m not saying they are guaranteed to work.  I’m only saying they’ve proven themselves as guides when a real bear move has begun.  There are a multitude of economic and financial indicators that I also like to use along with anecdotal evidence, too.  Keeping an eye on this particular set of EMAs however can potentially keep your losses to between 10% and 15%, assuming you act.

In a bear market where there’s the potential for a halving of portfolios, I’d say 15% in losses is solid.

Volatility in the biggest asset classes will be unimaginable.  The algorithmic, high frequency trading operations in combination with central banks have broken all markets.  There will be no liquidity for the big timers when the bear begins.

HFTs are the true market makers and all algorithms are written to pull away and sell when bottoms fall out of markets.  Look at the S&P 500 in May of 2010.  That was really the first indication that markets would never liquidate in a typical fashion ever again, until HFTs are properly regulated, taxed, or removed from existence in markets.

There are plenty of examples between May of 2010 and now, but the move in the pound sterling at the start of October provides such a fine illustration.  What’s more liquid than the currency markets of the most developed and powerful Western nations?

Nothing.  And yet still we see the destructive power of HFT on any market.  Does this look normal in a power currency?

Sterling Madness (10-16-2016)

In earlier Asian trading, the intraday damage was even worse.  Observe this bit of madness.

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These moves are a product of liquidity being immediately vacuumed from the asset classes where all the largest players play.  This will happen again and again when the markets make their final turn.

You can liken it to a hull breach for an astronaut in space without a suit on.  One second astronaut HYG is floating around the lab in a jump suit, happily conducting experiments with OPM.  But OPM in high-yield instruments in a low-yield environment can be a volatile material if not handled appropriately in a proper setting and an explosion occurs breaching the hull, sucking HYG out into the liquidity-free vacuum immediately to death.

Did I say liquidity?  I meant oxygen.

You get the point.

Coming back to what a last gasp means; it means there will be a final run in risk assets to squeeze out the final profits of this bull.  Many, including myself, have called it a melt-up, but I grow weary of the term.

Please don’t be fooled by some of the ignorance being freely proffered out there that we are in the early years of a cyclical bull, similar to 1982.  We are not.  The evidence is broad, clear, deep, and obvious.  One needn’t a fancy finance degree or years managing wealth in order to see this.

The end game is here, but not before that last gasp for profits that I keep describing.  I suspect that many of the sectors that powered this bull market prior to 2016 may reassert themselves to take us home.  Why is that?

Interest rates.  Plain and simple.

Those with access to leverage at these historically low rates will borrow capital to fund buyouts and takeovers which will drive asset prices upward.  The upward move will then draw in speculators looking to hop on the trend or front-run it.  This quest for yield whether in debt, equity, or private equity i.e. IRR, will be the fuel for the last gasp up in asset prices.

Despite what I think may happen in semiconductors or social or biotech or emerging markets as risk-on gains speed, keep your eyes on the one asset class that has taken out all comers in 2016.  The Rocky Balboa asset class for the year.  You know what I’m referring to and this is even with the recent sell-off.

2016 Performance Chart (10-16-2016)

Precious metals.  You don’t have to love them or hate them.  Opinions don’t have to be binary.  Be agnostic when speculating.  Follow the trends.  Follow the money.  More importantly, follow central banking and political lunacy.

Let’s look at one more chart that potentially validates that this bull market is long in the tooth.  It depicts the times over the last 50 years when payouts to equity investors have exceeded  profits.

Total Payouts via ZH (10-11-2016)

You can ignore what is glaringly obvious or you can prepare.

Speaking of obvious, let’s begin to wrap this post up with another pithy little ditty of a quote, this time from one of the world’s great speculators.  It’s been reprinted time and again, but it’s simple yet brilliant message is timeless.

I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up.  I do nothing in the meantime.

– Jim Rogers

I haven’t touched on trading since the summer and I just wanted to share some set-ups that appear to potentially be building little piles of money in a corner waiting to be picked up.

Keep an eye on these sectors, either short or long:

Short:  sugar, energy(big 3), US dollar, and technology

Long:  grains, bouncing precious metals, and the pound sterling

Despite your opinions, never forget about counter-trend rallies, even in the face of what appears to be an unstoppable trend.

Financial System Liquidity–“When the Fun Stops”

At the end of my last post I stated I wanted to cover the,

…banking system and how it will exacerbate the shock to the financial system when whatever sovereign does what it’s going to do.  Specifically, I’ll expound on liquidity.  How it works and why every pro in the world already knows the danger it presents when it dries up.

For an outstanding and general explanation of liquidity within a market system, have a read of the excellent March 2015 piece, Liquidity, by Howard Marks.  He shares simple but keen insights on liquidity’s functionality across the entire financial market eco-system.  The masters always make the difficult seem simple.

The liquidity I’ll be referring to is really more akin to leverage and it’s how a significant percentage of the party is funded in the investment world between banks, asset managers, pension funds, insurance companies, corporations, hedge funds, and various other entities.

Let’s start with what I suspect to be the average opinion of how a financial layperson thinks the system works.

The financial layperson thinks the investment world takes in cash and assets from clients or customers and then redirects those resources into investments for the benefit of everyone involved.  On the surface, it is that simple.  Bank takes in customer deposit, then lends out cash at a premium.  Asset manager takes in customer investment capital, redeploys into assets with an expected ROI.

But for those in the know, there’s a much more sophisticated game played behind that simple perception.  The game of lending and insurance but under a different name called derivatives, specifically swaps and repos.  Observe how the financial world actually works, courtesy of the Office of Financial Research.

imageEven if you don’t understand all the components or every aspect of the diagram, the complexity and interconnectivity should jump right out at you.  “Securities Dealers” and “Broker-Dealers” are essentially just banks.  Major banks.  Systemically important banks.

What this diagram maps out is how the financial system constantly redeploys other people’s money (“OPM”) to eke out additional yield or lever up on a “winning” thesis.  This system diagramed above is the direct result of rocket scientists, PhDs, and all other people too smart by half taking their game to Wall St. instead of sharing their talents with the world of science.

That too is a direct result of too much money and glory heaped upon the successful investment managers in the the last four decades.  But all the low-hanging fruit has been picked and what we’re currently left with is an investment ecosystem fraught with risk, overloaded with high IQs, and very little excess returns on investment.

A very significant percentage of the asset classes flowing through the diagram up above are interest rate swaps and credit derivatives.  Major institutions think they can outsmart the sovereign entities of the world by hedging against the interest rate risk created by the central banks of the world.  So trillions of dollars are traded in interest rate swaps, which in turn can be funded via a repo transaction.  Do you see how the complexity of the financial system’s plumbing increases total system risk?

What’s a swap?  What’s a repo?  Well they don’t involve spouses or cars, sluggo.

Remember, they’re typically utilized as a hedge and very often just an outright speculation.  One of the terms I love that banking pros use in place of hedge is “immunization overlay.”  Really?  I need an immunization overlay to protect my bet on the 3 ponies in the 5th race for the trifecta.  Only bankers.  Anyways…

A swap is a “simple” transaction between two parties.  There is a multitude of various types of swap transactions but significant percentage of swaps are used for interest rate derivatives.  As an unrealistic but clean example, let’s say Entity A owns $50 million in Deutsche Bahn 5-year bonds yielding whatever and Entity B owns $50 million in floating-rate notes from the US Treasury yielding who cares.

Let’s say Entity A is worried that the Fed Funds rate will somehow affect the value of its fixed rate bond from the German Railway company, and they know Entity B has some floaters that will create a potentially more profitable use of their money in light of their thesis.  Entity B has the opposite stance and thinks volatility in Fed Funds rate will negatively affect the value of their floaters and they think a steady-eddy holding in Deustche Bahn debt in euros may be a better allocation of capital.  The two entities can simply swap the cash flows of each of the debt instruments and voila!  Asset quality is altered and risk is hedged.

Did you see how simple that was?  Reality is never that simple.

Now here’s where the game get’s even more interesting.  Entity A believes so strongly in its thesis that it thinks it can use its German Railway debt to speculate a little more.  Entity A calls up Bank X and says it has $50M in Deutsche Bahn 5-year bonds and wants some cash to speculate against US entities sensitive to movements in the Fed Funds rate.  Bank X says ok and it’ll give Entity A $45M for the DBahn bonds which Bank X will hold as collateral for 90 days.  At the end of the 90 days, Entity A has to repurchase (“repo”) the Railway bonds from Bank X at the full $50M.  That $5M difference between the cash amount and the repo amount is called the “haircut” and it’s a gigantic source of cash flows for the banking system.  Everybody wins!  Right?

Technically, this repo example is just a collateralized loan, and repo is often utilized in government securities as opposed to private sector assets.  None the less, a repurchase agreement is a repurchase agreement.

Entity A can now go short the companies sensitive to US interest rates.  Bank X gets a cool $5M for lending out other peoples’ money.  Observe a simple diagram of a repo transaction below.

imageThere’s another kicker for Bank X, as now it has those Deustche Bahn bonds on it’s balance sheet but maybe it doesn’t want them.  So Bank X finds another entity willing to take those bonds in another repo transaction but only for 60-days, so that it may use the cash generated to go speculate in some other asset class.

Let’s say instead that Bank X does nothing but holds onto the DBahn bonds as collateral.  In the event that Entity A runs into financial troubles and depending on how the contracts of the transaction were worded, then Bank X can liquidate those bonds when and where they see fit in order to be made whole if it looks like Entity A is in trouble.

These kinds of transactions are the lifeblood of the financial system.  This is how the banks, hedge funds, asset management shops, etc., find liquidity to speculate in whatever endeavor in need of cash flow.  You might know this system under another guise, shadow banking.

This is precisely how the 2008 crisis was exacerbated.  There were trillions of dollars of these sorts of transactions in the mortgage backed security (“MBS”) arena.  Unfortunately, the whole system is based on confidence.  Each of the players believe in and have confidence in the stability of the system and the valuations of the assets classes in which they are playing as well as the valuation and credit worthiness of the other players.  We all know what happens when confidence leaves the station.

The central banks of the world think they have risk managed within the financial system via their controls, regulations, and ability to manipulate the money supply as well as interest rates.  Here’s their perception of a ring-fenced system.image

But literally every pro and every central banker knows this pic to the right is a joke.  And a cruel one at that.

Everyone knows that there is literally no stability once confidence decides to jump out of a window.  When players in the financial system lose confidence in the financial system due to the sheer amount of debt in existence at the sovereign level in combination with the incompetent monetary policies already in existence, it’s going to be a fire sale.  Everything will go in the most indiscriminate manner which will only fuel the fire.  Every single banker, professional investor, PhD economist, and educated corporate executive knows this.  But you aren’t going to see reports about this on MSNBC or the front page of the Times.

Here’s the reality of the interconnectivity of risks within the financial system.  The risks are shared throughout the system.

It’s one giant, incestuous orgy to share cash flows and risks and it can’t be stopped.  The only way this game stops is via a crash and a reset of the financial system.  New laws.  New regulations.  New players.

The rules change but the game is the same.  Why do you think all these quotes stand the test of time?

Securitization was dreamed up as an innovation to hedge risk tied to debt.  Unfortunately, all the incredible amount of debt and innovation have achieved is to gum up the financial system and turn liquidity(smooth oil) into a viscous sludge when it disappears along with confidence.

Care for a better diagram than the previous.  Take Deustche Bank.  It has the highest derivative exposure of any major bank in the world.  It’s easily in the worst financial position amongst all the largest banks in the western world. image

It’s financial connectivity just might be enough to spark a chain reaction if Deustche Bank fails.  As I stated in my previous post, I think it’s a sovereign nation that ends the music for the next crash.  But that doesn’t mean that bank failures aren’t on the program.

A majority of these swaps, repos, and other derivative transaction are done bilaterally; meaning just between the two parties.  Central banks would love for all these kinds of transactions to go through a third party to clear these transactions and the third party be obligated to report the transactions.  Makes sense, right?

But there are no laws forcing the use of a central-clearing, third-party.  And in the financial system, entities are always going to act for their benefit.  A majority of these transactions provide a superior benefit via bilateral facilitation.

Don’t think for one second that the risks associated with current worldwide debt levels and the transactions I just described up above aren’t entirely real.  Why do you think the Fed makes the major banks conduct a stress test under an “adverse” scenario?  Have a look, courtesy of JPM, at the very plausible scenario below that the Fed ensures each major Wall St. bank will be able to “survive” at current capital levels.

image

Unemployment jumps to 10%.  House prices fall by 25%.  Equity markets tank by half.  I’d say this is a very real scenario.  What’s totally fiction is the safety of the banks based on their capital levels in the event that a crash creates the stated conditions.

These stress tests are called the Dodd-Frank Stress Tests (“DFAST”).  There’s nothing stressful about these stress tests for the banks, as DFAST is a farcical play put on for the masses to make it seem as if the banking system is properly capitalized.

It’s not.  That’ll be proven again.  In spades.

The DFAST is a well-intentioned undertaking that even makes the banks detail the key risks in the event of an adverse scenario.  Observe.

image

All the obvious and most important risks to the financial system are conveniently laid out for anyone to see via these DFAST summaries.  I’ve highlighted what I think are the 5 most critical risks to the system.  “Country” and “Credit” are what I spent a lot of time on in the last and current post, but the “Model” risk is interesting to see.

All these derivatives, the swaps, the repos, etc.; they’re all evaluated with a risk-assessment model called Value-at-Risk or “VaR” for short.  VaR is simply a statistical methodology for determining the risk level of an asset or portfolio.  And VaR is how all the financial system institutions essentially measure the risk in their portfolios, not just the banks.  The problem is that VaR works under stability until it doesn’t under instability.

VaR was utilized to assess the mortgage backed securities in the lead-up to 2008.  The problem with a model is that it’s garbage in, garbage out; whether it’s a human or machine performing the assessment.  The MBS valuations and thus risk assessments were off in another galaxy because the ratings agencies were saying the debt securities were AAA-rated and the models statistically showed virtually no chance of default.  A biblical flood, major meteor collision, and lightning striking 20% of the world’s population would have to occur first before the AAA MBS began defaulting.  Once again, we all know how that one played out.

Well we’re back at the same place as 2007 – 2008.  This time, instead of housing, the name of the game is sovereign debts via the central banks and the financial institutions and corporations keeping the system propped up via debt issuance and bilateral/trilateral funding.  And what models are being used to assess risk?  You got it.  VaR!  Yarrrrr!

You may be thinking, “No way.  There’s no way all these players still use the same or similar models to assess the risks of all these derivatives within their portfolios.”

Ok.  Have a look at what S&P peddles.  Oh wow, it’s a shiny automated VaR model to assess credit risk.  And you get a nice little whitepaper to go with it to explain why you need their particular tool.

So where is all this information on derivatives?  In the same places as always.  The quarterly and annual reports of the publicly held players and the US Office of the Comptroller of the Currency puts out a quarterly update on bank trading and derivative activities.  It’s how I obtained some of the information for this post.  Have a look.

image

What we haven’t seen a significant amount put into operation yet is credit default swaps (“CDS”).  Not only do they have the negative connotation from 2008 but players are fearful to be a counterparty in one of those transactions.  As the central banks continue to flood the world with liquidity, players will begin to get greedy and believe they can structure CDS to take advantage of the next crash.

I suspect this next crash will alter the financial system and environment permanently, in light of that, entities are not going to be made whole for their CDS exposure like in 2008.  That would be politically untenable and I’m not so sure that even the politicians would sign off on another bold ass-fucking of the tax-paying public.

The reason you should care so much about this component of the financial system is because of the risk it introduces to the world economy and markets.  Not only are the models flawed in assessing the risk in all these financial instruments, but the counterparty risk in all these derivatives are the true danger.  Because of the inter-connectivity of the world’s financial institutions.  It’s only going to take one.  One major bank or one major insurance company.  Just one to begin the domino process.

So what does that process look like?  Let’s look at a feasible but extreme scenario.  Italian debt as a percentage of it’s GDP is out of control.  Even worse, nonperforming loans (“NPL”) i.e. bad debt within Italian debt instruments are at Depression-like percentages.  Observe the following chart of Italian banking NPL through 2015 from the World Bank.

italian-npl-percentage-world-bank-july-2016

It’s clearly a problem.  Now let’s say Deutsche Bank is woefully exposed to this nonperfoming debt in Italy.  All it would take is a trigger like a major accounting fraud is discovered at Citigroup while derivative instruments begin crashing at Deustche and the counterparty massacre begins.

While this happens and to help allay fear, let’s say Japan and the ECB simultaneously co-announce deep cuts in their central bank interest rates of an additional -1.5% each.  At the same time, the ECB announces it is going to buy 10% of all European companies with market caps over $10B.  Additionally, the Netherlands announces their exit from the EU.  You think fear might start rising?

Let’s add another fear factor to the scenario, Japan announces it’s going to spend $1 trillion USD on infrastructure and technology development to create jobs but simultaneously announce a $27,000 USD annual living wage.  Economists call this “helicopter money” and it’s the last blank bullet Western central banks possess to stimulate animal spirits.

The scenario is extreme, but the world’s markets are dancing on a razor’s edge.  Do you see why gold sounds so sound?  Do you see why some exposure to precious metals could possibly help carry portfolios through the next crash?  Millennia of monetary utility.  Zero counterparty risk.  Accepted value around the world by all people.  Doesn’t sound so crazy to have exposure to the asset class, does it?

It’s just about quitting time so let’s address the two most important aspects of even knowing or sharing this information.  How is it actionable and in what kind of timeframe?

Well if you’ve read any of my material over the years, you should have a pretty good idea of how I think it’s actionable.  Increase cash levels.  Increase precious metals exposure via the physical metal and intelligent allocations into precious metals stocks.  For the latter, see the J-perp portfolio.  It’s a basket of junior players that in 2016 is outperforming virtually every index and hedge fund known to man.

Begin to pare back winning positions that are leveling off.  Going to cash means liquidating where appropriate in order to raise the cash.  Many of the world’s best value investors have started that process some time ago.

As for timeframe, I’m more convinced than ever that sometime in 2017 is when it all begins.  By begins, I mean the wobbling.  Like a top slowing its spin and starting to topple.  We may not see an outright initiation of a crash, but I’m confident that serious wobbling will begin.  I already believe that the action at the end of 2015 and beginning of 2016 was the start of everything.  That period of volatility was the waking up of the bear and the starting point for the last-gasp melt-up in markets around the world; the final blow off for profit grabbers.

Bear in mind that central banks control everything now.  Sentiment and liquidity via free market operations are a thing of the past…for now.  Which means that through their actions, many players believe that the universal bull market can continue for years.

I believe this to be flawed thinking.  When confidence takes its leave, there’s no amount of money that can be thrown at the issue.  There’s no amount of negative rates that can spur true economic development, because animal spirits will be neutralized by fear.  Banks and sovereign wealth funds will be monetizing even more ludicrous amounts of varying asset classes.  You thought it was crazy for central banks to start buying stocks and corporate debt?  Just wait.  Desperation will breed decisions that will go down in history.

It’s a fine line between pessimism and realism.  I’ve shared enough of both in this post and the last.  You’ve gotten useful charts.  I’ve provided what I think are some important points about how the financial system truly works.  Now it’s up to you to make key decisions for your own portfolios, because when the fun does stop, the amount of leveraged liquidity wending its way through the system will hasten a cataclysmic financial event.

All that being said, let’s ride the final melt-up for all that it’s worth and try to get paid.

I’ll leave readers with one final quote to sum up my thoughts on the complexity of the financial system.  It’s a pithy little ditty by a recognized genius and one of history’s greatest brains, Leonardo da Vinci.

“Simplicity is the ultimate sophistication.”  Here, Here.

Evaluating Markets Not Called Stocks

In my last financial post, I stated that I thought the market would move sideways for approximately 7 weeks before a catalyst would present itself to drive the market higher going into the beginning of the summer. So far, so good. Yes, the market is up about 1.5% but it appears to be the start of a sideways consolidation as the market exhales some energy.

I suspect we see a little downside move over the next week or two, as part of the sideways action, followed by a move back up to current levels about 3 maybe 4 weeks from now. By then, that catalyst should present itself for the resumption of the trend back up to new highs. Will my hot streak continue? If past is prologue…

clip_image001

Right now, I want to talk about the US dollar and its potential effects on various commodities. Specifically, we want to watch oil, precious metals, and the grains.

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It’s easy to observe the stiff support at $94 and I think this time is no different. I suspect we get a slight bounce of about $4 up to about $98. This is in line with previous bounces off of $94 during this 15-month consolidation. There are plenty of analysts out there who think the USD bull will renew to move a lot higher. The thesis of the trade being a fear-based allocation in light of a pessimistic international outlook to various economies and the worthless, respective monetary policies currently employed by central banks.

I disagree. When the big one hits, the real correction across all markets, the USD will at first be a bastion of relative strength but that sentiment will be temporary. The problem with the thesis that we are in the early phases of a USD bull is that it runs counter to the other widely held thesis that the next financial crisis will be co-focused around an international collapse in confidence in the USD. That’s a discussion for a future post.

I believe the momentum has shifted for commodities. I suspect the worm has turned in the precious metals complex. Corn, wheat, and soybeans are potentially at the beginning of a spike. Oil has been unstoppable, but that DOHA meeting of the controlling powers will have a heavy influence on trading behaviors. It’s not inconceivable that the USD and commodities could run in the same direction but that belies decade’s worth of a consistently negatively correlated relationship.

Specifically, I’m referring to short-term action. Months not years. But let’s look at multi-year charts for gold and the grains, of which I’ll use my typical go-to trading medium of JJG.

Gold:

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What goes up generally comes down. Gold has held strong with a sideways move off the hard spike higher to start the year, but with the pending move in the USD, I think we’ll finally see the correction that many have been calling for. You can see that around $1,140 represents a stiff area of support. I suspect that could be gold’s next destination over the next several weeks or months, however that still represents a higher-low leaving a new uptrend intact. If one were inclined to trade, that’s $100 of movement to design a short-term, multi-month play as it moves lower and then begins a recovery. One pattern to watch, if you believe in such hokum, is the little head & shoulders that has formed since February. Will the break of the right shoulder-base be a catalyst?

Grains:

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I have had a lot of luck trading this grains ETF. Some of my biggest returns in the shortest amount of time have come from scalping the market for a nice rip on these multi-month grain rallies. Sentiment, professional hedging, and seasonality point towards the potential of another run. More importantly though, price action agrees. It looks like a based-low was established to start the year and last week represented a possible higher low. The price action was especially promising to end the week. Position accordingly.

But if the USD is about to bounce, won’t that hurt commodities? Even agriculturals? Not necessarily. Oil will very likely be affected but again the speculator positioning by huge players could potentially cause another squeeze as much as the DOHA meeting could negatively affect prices. Gold sentiment was stretched anyways. But the grains don’t always run counter to the dollar. In fact correlations between the USD and grains do not share an easily deciphered message. Grains can and do run in lockstep with the dollar at times. Have a look below.

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In two of the last 3 rallies, the grains (blue-dotted) ran concurrent with the USD. Even though the USD is potentially beginning a bounce, so could be the grains.

As stocks continue their consolidation, the USD should be the dominant theme in the markets as it moves upward over the next several weeks. Watch associated commodities. If you’re feeling really brave, try trading the other currencies with a rising USD as your foundation for analyses. Good luck out there.