Mixed data + low holiday volume

After news of Bhutto's assassination sparked a rally in gold, crude, and bonds, we saw lower than expected durable goods orders and higher than expected consumer confidence numbers, providing a mixed view of the U.S. economy. Considering the seasonally low volume across all markets (happy holidays!), I must assume that any market movement right now is just noise. I don't know why I'm looking at markets when I should be getting wasted instead!

Gold breakout not confirmed by volume

For those following the gold market, the ultimate question has been whether the current triangular formation will result in a breakout to the upside or the downside. Indeed, the two-month consolidation in gold is very near its end, and we will probably see a breakout by the end of the year (or early January). Considering the recent dollar rally, along with seasonal factors supporting the dollar during the months of December and January, I have been anticipating a breakout to the downside for gold: a drop to $760-$775 would be a great buying opportunity for gold's ultimate ride to $1,000 and beyond. During the past week, however, gold has seen a strong rally from $790 to $830.



Although the triangular formation for Feb. Gold futures (shown above) seems to be intact despite the current rally, other gold charts such as GLD and Gold EOD (shown below) are showing signs of a breakout to the upside. Such breakout to the upside, however, should be dealt with caution. This is mainly because the current rally has not been supported by volume. I would expect a breakout from a two-month consolidation to be confirmed by well-above-normal volume, but this is not the case.





So...with the consolidation near its end, is gold going up or down? I think gold will cool off from its current rally (perhaps we will see positive durable goods and consumer confidence numbers today), and eventually break to the downside during the first week of January when we get an onslaught of economic numbers: manufacturing, FOMC minutes, employment, ECB rate decision. If not, we should see gold shoot above $850...hopefully with some strong volume!

Chart of the month: euro sell-off

The chart below (March EUR) really sums it up. Once again, the Economist cover contrarian trade prevails. With models and rappers talking up the euro, a dollar counter-rally makes sense. Euro has sold off to my initial estimate around $1.43 (post below), and it may continue to sell off, pending future data. But I'm expecting not much action until year-end, at least not until we get US payroll data and ECB rate decision during the first half of Jan. 2008.

Dollar is bid...euro, gold, silver under pressure

Yesterday we got big retail numbers and the dollar rallied hard, causing euro, gold, and silver to sell off. Today's inflation numbers diminished rate cut expectations, and intensified the dollar rally. Although the Fed has dropped its previous language of balance between growth risk and inflation risk, the Fed has not given the market a clear signal that it will give priority to growth risk. Instead, the Fed has unveiled a new plan to soothe global liquidity problems. The response from the stock market was temporarily bullish, but short lived as doubts were raised as to the plans novelty and its ability help resolve the real underlying issues of inter-bank liquidity: housing and credit crisis. What we really need is for the Fed to break out of its "gradualism" and be more aggressive. Of course, the Fed will eventually have to resort to aggressive measures...it's just a matter of time before we see more pain in the US economy.

In the meantime, looking at the euro, the big question is how far will it drop. My guess is around $1.43, and then I think it will range until early next year, or at least until we see more pain in the US.

Euro/$ puts pressure on gold and silver

Weakness in the European economy, especially the money market, seems to be intensifying. Yesterday's global central bank coordination announcement revealed more serious liquidity problems (or as some say, insolvency) among banks in Europe. So I think this announcement may have created more fear, at least in Europe, rather than soothe the markets. Consequently, the euro is currently under a lot of pressure (shown below), which is also having an impact on gold and silver. Despite yesterday's rally, sparked by the Fed's new plans for capital injection, it is important to remember that the Fed still disappointed market expectations concerning the fed funds rate. A euro sell-off may very well bring gold and silver down to $760 and $13.5. Retail sales are expected to come out strong, while inflation numbers are expected to come out high. So watch out for a sell-off in euro, gold, and silver!

Has crude bottomed?

With inventory numbers coming out today, I need not explain how important they will be for crude: just look at the chart below. I think crude has bottomed, and a clear break above 90.625 would be very bullish. We may very well see $100 traded by the end of the month.

Gold and Silver: Post-FOMC (what were they thinking?)

First, a comment on yesterday's Fed decision: what were they thinking? Ohhh...so this is what they had in mind: a new money pumping machine! Indeed, markets have reversed sharply overnight.

An important debate in recent weeks has been whether gold would correct to $780 or break below $780 to pre-October levels of $740-$760. Similarly, traders debated whether silver would correct to $14 or break below $14 to pre-October levels of $13.25-$13.50. Indeed, the recent volatility in the gold market (silver has been less volatile, surprise) has made it impossible to find a clear direction. Two weeks ago, gold went from $780 to $845, and then back down to $780 in just matter of ten trading days!



Despite all the noise during the past month, gold and silver seem to have slowly consolidated above $780 and $14. I think we will see a rally to re-test November highs.

One caveat would be the the impact of the euro on precious metals, as investors see gold as a hedge against weakening dollar. Both the dollar and the euro are depreciating due to excessive money supply, and the euro/dollar exchange rate has become a function of which central banks inflates the most. So precious metals should eventually decouple from its relationship with euro/dollar, because gold has been, and will continue to, appreciate against all major currencies. For now though, it seems like the recent dollar rally has come to an end (shown below).

Gear Shift in Gold: acceleration mode

Stocks sold off yesterday on diminished rate cut hopes, and precious metals also experienced selling pressures. While silver futures sold off all the way to 14, gold futures held steady at 790. I have been silver-biased for a while (perhaps because I was long silver during its parabolic rise in early 2006), but after experiencing a blow to my pnl yesterday, I acknowledge that gold is better. Silver may tend to outperform gold during strong rallies, but silver is more volatile and vulnerable during times of risk aversion in the markets (like right now: look at bonds). Gold has shifted gears to acceleration mode (chart below), and interestingly, the start of the new uptrend line coincides with the 10/19 stock market sell off. Don't forget that the Fed has cut 75 bp in the past six weeks, and there is still a lot more reflation to go. Everybody is talking about $100 crude, but it won't be long before we hear $1000 gold in the media.

Thoughts before Fed announcement

Good morning. Today is Fed day, and the markets have taken some risk off the table during the past two days. Crude, gold and silver saw a sharp sell off as traders took profit ahead of Fed day. My positions were also stopped out, but I did notice that euro/yen and nzd/yen were not budging. Let's also not forget that reflation is still in tact. A positive market reaction to the Fed today will probably send bond prices to 111-112, while gold will break above 800. There is a lot of talk about how the Fed must meet market expectations (futures predict 95% of 25bp cut), and we will most likely see a 25bp cut. If the Fed doesn't meet market expectations, things could get really nasty.

Bullish on tech stocks?

The key issue right now is whether the housing virus is spilling into the broader economy. Weak earnings in manufacturing (domestic) and financials are indicating a possible spillover. Although the employment situation seemed pretty positive last month, it may be only a matter of time before employment numbers break lower. Despite this ongoing debate about a possible recession, tech stocks have outperformed the dow/s&p since the subprime crisis came to light. Also, look at the bottom graph to see how the nasdaq is still very undervalued relative to the dow. Compared to the late 90's, technology in many sectors (consumer, internet, alternative energy, healthcare etc.) has advanced dramatically (also increasing global market share), and it will be interesting to see how tech stocks weather through increasing U.S. recession pressures. Last week's Google earnings and today's Apple earnings are bullish for tech stocks.

[NDX/INDU: 2-year chart]


[NDX/INDU: 10-year chart]

Fukui meets Bernanke: who will inflate more?

On the 20th anniversary of Black Monday (10/19/87), stocks sold off sharply, fueled by renewed recession fears. Consequently, the yen traded to pre-fed rate cut (9/18) resistance of 113 as carry trades were unwound. Although a more dovish BOJ may help sustain the carry trade against the dollar, possible spillover of the housing correction into the broader economy will force the Fed to keep cutting borrowing costs and put more pressure on the dollar. Fukui was hawkish at the G7 meeting this week, but his comments seem to conflict with the IMF's view (slowing growth and deflation) of the Japanese economy. Fukui was probably bluffing as usual.

[Dollar/Yen spot: 5-month chart]

Bonds: rally or range? The Fed would love to see a rally...

Market expectation for another fed rate cut has risen sharply this week, shooting euro, yen, crude, gold, and silver through major resistance levels (silver still needs to break $14.1). Bond prices also had a strong rally to long term resistance, and a break will send bonds to 114-115. The Fed certainly does not want to see dropping bond prices and a steepening yield curve. This signals rising inflation expectations, which make it harder for the Fed to cut rates. With adjustable-rate mortgage resets in the horizon, a rate cut at the end of October is necessary; the only question is whether another rate cut will be sufficient (probably not).

[Bonds futures: one-month chart]

Gold is ready to launch...again

While remaining flat during the day (perhaps as everyone's attention was on crude), gold began picking up late in the afternoon and has continued to rally into the Asian markets. Gold broke $770 and the next target (top of next box) is $790, at which point speculation will push gold past $800. But with euro/yen and stocks selling off (mentioned in previous post), gold and silver will have to withstand some potential stress.

[Gold futures: one-month chart]

Tomorrow (10/19!) might be a bad day for stocks...

Euro/yen is selling off, and the nikkei has buckled below 17000 just two hours into the open, dropping more than 250 pts. Hopefully precious metals will hold up against the pressure, as the dollar will certainly slide if stocks sell off tomorrow (10/19/2007).

Yen breaks from downward trend

The yen has broken a downward trend (shown below), signaling a potential unwinding of carry trades. Despite overall dollar weakness, I found it interesting that the euro and the yen have moved in almost opposite directions during the past two months. Perhaps this is because carry trades were predominantly in euro/yen. Whatever the case may be, it is nice to see both currencies starting to move in unison - up against the dollar. The housing market is obviously still a major concern, and weekly data continues to remind us of that fact (plus, more rate cuts!). I have been wary of a massive sell off in euro/yen as it may have an adverse impact on precious metals, but if both the euro and the yen rally against the dollar, euro/yen is most likely going to consolidate and trade sideways for a while. As a matter of fact, I would really like to see euro, yen, gold, and silver all rally together at the same time!

[Yen futures: one-month chart]

Copper: housing slump v. Chinese demand

Copper is at long term resistance, and a pretty significant one at that (shown below). Because copper is a core resource in home building (electrical wires, pipes etc.), it is considered the best indicator (also, timely response) for the health of the housing market. Indeed, the price of copper peaked at the same time the housing market peaked during the second quarter of 2006. Consequently, the price of copper lost most of its 2004-2005 gains by early this year. Copper inventories rose rapidly, resulting from a slowing demand in the U.S. housing market which is second after China in copper consumption. Despite the rise in inventories, copper supply is nowhere near 2003 levels, while Chinese demand for copper continues to grow. The big question is whether China continues to buy copper (on top of increased efforts in mining and recycling) as the price of copper tests the current resistance level for the fourth time in the past two years.

[Copper spot: three-year chart]


[Copper inventories: three-year chart]

A Must for Silver

Silver must break $14.1 by the end of this week (or early next week at the latest), otherwise it may drop to $13 (shown below). Setting aside jobless claims and leading indicators, there are no more major data releases this week which may impact fed rate cut expectations. My only concern is the performance of risky assets such as euro/yen and stocks, which are currently facing major resistance levels. Hopefully the large players are looking at the same technicals below, and realize that silver prices must break resistance to keep rallying. Only a small nudge beyond $14.1 is sufficient to send silver to $15, as haters cover their shorts and speculators rush in.

[Silver futures: One-Year Chart]

Glitch or Omen?

Asian markets just opened and the silver chart below scared the hell out of me!

Possible Risk Aversion

Risk appetite may be due for a correction. Looking at the euro/yen cross rate (shown below), one can see how fast global risk appetite (yen carry) has bounced back since the recent fed rate cut. Things could get nasty if euro/yen does not hold 165. Despite a stabilization in credit liquidity, the housing market is getting worse day by day, while banks are laying off employees and reporting lower earnings. So what's there to be optimistic about? Just in case, I have hedged my long gold and silver futures with puts on banks.

Thoughts on ABX Index, market sentiment...

The ABX Index is in the news again, with the current series falling to August levels as Moody's announced further downgrading of subprime ratings. From Wall St's point of view, liquidity in the credit market has stabilized, but are market players just delaying the inevitable write downs? Corporate earnings have been disappointing investors so far, and it will be interesting to see how the market interprets the continued onslaught of negative housing data (like tomorrow's NAHB housing market index). Expectations of another fed rate cut have decreased since the last FOMC meeting, but with two weeks left until the next meeting, market sentiment may quickly lose its current optimism.

Silver v. Gold

Today, crude and gold prices broke into unchartered territory; they are rallying into the Asian markets as I write. For those who have missed this massive rally since August, there may not be a pullback for a while. Trade volume for crude and gold have surged during the past couple months as smart money (inflation up, buy gold) began piling in. Last week's positive employment and retail data put pressure on gold, but every time there was a pullback buyers came into lift the offer, holding support at $730/oz.

Despite gold's rally today, Silver was down, failing to break resistance at $14.100/oz. Of course, gold is the go-to inflation hedge, and gold probably has better fundamentals than silver. But silver's relative under-performance is disappointing because the last time serious money poured into precious metals (early 2006), silver led the charge (shown below). The silver-to-gold ratio has waned during the past year as both metals consolidated, but the ratio may be ready for a flip as increasing capital flows into the much smaller silver market may have a greater positive effect on silver prices than on gold prices.

The other side of the argument (gold is better than silver) presents pretty convincing empirical evidence, showing that silver outperforms gold when there is confidence in financial assets. This seems relevant right now, as risk appetite in financial assets is still sensitive to ongoing housing market deterioration and future fed rate decisions. If silver is going to prove itself more worthy, now is the time to do it.

[Silver:Gold]

Yen, Gold, and Silver Technical Alert

The Dollar has rallied back against the yen amidst today's positive ISM non-manufacturing data, which beat expectations (discussed in previous post). But stocks retreated as more banks came out with bad news. It probably makes sense for banks to finally disclose some problems and admit mistakes now that the stock market has rallied back to pre-August subprime panic levels. At least the liquidity situation seems to have recovered, and risk appetite might be growing again. This is evident in the reemergence of the yen carry trade on the backdrop of the yen's big long-term technical breakdown following a bearish triangular formation (shown below). With Japan pumping as much money into the economy as the US, a yen sell off to 118 in the short term may be possible. More positive employment data this Friday will trigger another yen sell off.

[Yen futures: One-Year Chart]


Gold and Silver have rallied hard since 9/18 (rate cut), but they are now back to 9/18 support levels amidst a crude sell off and a dollar rally (fueled by stock rally and positive economic data). A break below these support levels will be bearish, and gold may drop to $715/oz while silver may drop to $12.8/oz. Negative employment data this week will help gold and silver hold its support, as it will reinforce a rate cut at the end of this month.

[Gold futures: One-Month Chart]


[Silver futures: One-Month Chart]

Bonds: battle at resistance

Note the well defined RSI divergence since last week (shown below). I mentioned in the previous post that bonds were at resistance, but after a sharp sell-off, bonds rallied through one more box to reach a more long-term resistance level (also the center of the huge doji formed on 9/18 when Bernanke cut rates). Today's negative housing data helped the bond rally, reminding people that the worst in the housing market is far from over (DUH!). Although today's housing data was worse than the market's forecast, I don't think we will see spillover effects in the broader economy until end of this year or next year; it takes time to cut back on spending and layoff employees. Looking back to last week's economic data releases, jobless claims dropped, GDP remained unchanged, and ISM also remained unchanged. Therefore, this week's ISM non-manufacturing, jobless claims, and employment data are most likely to remain unchanged or even beat expectations. Short bonds.

[Bond futures: one-month chart]

Long Bonds at Resistance

30-yr Bond futures have climbed back amidst negative economic data indicating that the Fed will cut rates again this year. Moreover, the Fed announced this morning that its inflation measure matches forecasts, pushing bonds higher. But with silver, gold, and crude oil beating historical highs with never before seen prices, inflation seems far from under control, and I think the rally in long bonds is overdone. Inflation expectations and potential record highs in the stock market should send the 30-yr below 110 in the coming weeks.

[Bond futures: one-month chart]

Steepening YCRV

Bond prices have climbed back since last week, and this morning's negative economic data (existing home sales, consumer confidence) releases provided a bullish case as a safe haven. But sellers stepped in during the afternoon, erasing the day's gains. It seems that today's negative economic data gave support to Bernanke's rate cute decision, and made further rate cuts this year seem more likely. This only means that there will be more inflation created to sustain the housing problem, which is far from over. The market seems to be more concerned about inflation, downplaying bond's role as a safe haven. It will be interesting to see how long bonds react to this week's economic data releases (durable goods, GDP, new home sales etc.) which will most likely turn out to be negative.

No hurricane, but technically bullish

Here is a chart of NOV07 natural gas which became the front month K today. There seems to be a potential inverse head and shoulders formation, indicating a bottoming. Moreover, relative strength has been increasing steadily while natural gas made multi-year lows. A rough hurricane season and colder than expected winter can also facilitate a move through $8 to test the $9 level.

Hurricane coin toss

Since falling from $8.5, natural gas has been trying to find a bottom (low: $5.25). Natural gas has recently formed what seems to be an inverse head and shoulders pattern (not shown here), with a very pronounced support/resistance at $6, as shown below (also the right shoulder of the pattern). I have missed a couple opportunities to play the natty roulette at $6, and it looks like I finally have a chance.













Making things more interesting is a potential hurricane development in the Gulf of Mexico, and whether this system develops into a serious threat depends on which course it takes, as shown below. The strength of the potential hurricane is directly correlated to how long the system hovers over the currently warm sea waters. I'm betting that the system will float west and develop into a hurricane significant enough to nudge natural gas prices higher. Although natural gas is heavily weather/inventory driven, it has not really participated in the broad inflationary rally in commodities, and it will be interesting to see how it performs in the coming weeks.

Fear of inflation

Today was an exciting day. Silver made a a very strong run to finish at roughly $13.6/oz, but the most exciting move came from bonds; just compare the chart below to yesterday's chart.

The day after B-52 Bernanke...

Well Bernanke showered upon us a chunky 50 BP cut, and the markets responded swiftly. After a brief volatile gyration, gold, silver and FX began making strong gains. Gold is at record high's (you'd have to look back many years to match today's high), but because silver is still shy of May 2006 high's, it is easier to estimate resistance levels. Since last year, I incorporated a concept called "Box Theory", and looking at the silver chart below, once could detect a roughly $0.400/oz box range. Today silver is at the top of a box (yesterday's high), and it is a matter of time before we see a trend of boxes on top of another.

Considering that Bernanke has just unleashed significant inflation upon the markets, as shown in record commodities and FX prices, we are bearish long term bonds. Bonds have rallied significantly since August, and a bearish triangular formation has formed over the past couple of weeks; most likely just in time for a sell-off in fear of unexpectedly higher inflation.

Much needed crack, I mean cash

I am back from a very long break (working as a summer associate at Linklaters, structuring CDO's that people won't see again for a long time, moving out of dirty Brooklyn and moving into pretentious Soho, traveling to a paradise island in Thailand etc.) By the way, what better day to recommence trading than today's Bernanke festival? The market has been addicted to easy credit for the past 5 years, and today Bernanke must give the market its much needed fix.

Today is the big day everyone has been waiting for: B-52 Bernanke (a la Puplava) is about to unleash piles of cash over the markets. When the subprime/credit crisis really began to reveal itself in August, most people had no doubt that the Fed would slash the fed funds rate by at least 50 basis points. Since then, the Fed has undergone a massive reinflation campaign by lowering its discount rate and exchanging almost any piece of crap for cash, thus providing much needed liquidity into the financial system. By doing so, the Fed has technically already lowered the fed funds rate by 25 basis points and injected inflation into the markets. In recent weeks, we saw gold make new highs, silver make a strong comeback, and crude reach a record high. This trend became more pronounced when precious metals began moving independent of stock performance in the past few weeks.

With inflation indicators at record highs, many people recently became wary of whether the “academic and inflation fighting?” Bernanke would indeed cut 50 basis points. But we’re talking about B-52 Bernanke here, and he is certainly not an inflation fighter. The central bank is constantly on a PR campaign to establish itself as an inflation fighter, but in reality, the central bank is the sole creator of inflation and the market depends on it more than ever. Recent fear of an "excessive" rate cut will actually provide the Fed today with room to make a 50 BP cut and beat market expectations.

So what should one buy and sell? Obviously, we are very bullish on gold and silver. Unfortunately, silver has been lagging behind gold (silver is still $2 shy of its 2006 high), and some are doubting the performance of silver, citing reasons like decreasing industrial demand. But watch out for silver, as I will begin following silver very closely.

Feels great to be writing again!!!

Fresh Start

I am planning a new start/structure to the market commentary. The past couple months have been very busy, and I did not even make a single trade (doesn't mean my mind's been away from the markets). Since the last commentary, stocks have made new highs, but commodities have gone nowhere (except for crude) - hopefully we'll see more volatility soon. Please stay put for the new Prudent Observer!

Perfect time to SHORT LEND

Stocks: short LEND, HRB, MCO, WFC, GOOG, EEM, FXI
While the markets continued to gyrate this week, the question remained: will stocks decline further? The U.S. stock market found some stability this week, but most probably due to short covering and option expirations. LEND has made a 100%+ come back this week, providing a perfect opportunity to load up on put options. Right now (3pm), the market is declining into the close, and this may be signaling that next week will be pretty bad for stocks. All eyes will be on Bernanke next Wednesday.

FX: long euro, long yen
With a deteriorating economy and stock market, I am bearish on the dollar. As the fed attempts to prop up the markets by injecting capital, the dollar will take a further hit. Euro futures made a big move yesterday (shooting above 1.3250), and the yen is poised to break out of its triangular formation.

Bonds: short 30-day, long 30-yr
I see a steepening yield curve in a desparate situation where the fed jacks up the money supply while investors seek protection. Next week's FOMC statement will be crucial.

Crude Oil: short crude (target - between 55 and 54)
The calendar spread for crude futures has widened since the last post (below), evidenced by crude's declince by almost $4 this week. But crude will probably not dip below 55 due to buyers with long-term demand.

Precious Metals: long gold
While I remain long-term bullish on PM, a potential across-the-board asset correction cannot be ruled out. But gold is currently a good hedge because it is considered a safe haven, and many foreign governments are diversifying out of the weakening dollar.

Long-term Crude Calendar Spread

Crude futures market is shifting from backwardation to contango; the market is tightening. We are bullish crude. The strength in crude and abundant global liquidity have helped push gold and silver above long-term resistance levels. We are also bullish gold and silver.

BHP: next big private equity target?

BHP has strong assets (commodities!), and Jim Rogers is predicting a buy out.