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]