Sunday, March 25, 2012

Macro Analysis 3/23/2012

Stocks had their worst week of the year thus far but lest you think I'm intimating ugliness or disaster the S&P500 was down only .50% and the NASDAQ Composite was actually up .41%.  Stocks are manifesting extreme resilience in the midst of dire forecasts of economic gloom surrounding China and the Euro zone by market prognosticators.

We're going to be looking at some charts today to see if we might glean a glimpse of where these markets might be going in the weeks ahead.

Those of you who follow me regularly know I'm monitoring the Russell 2000 closely for clues on where equities in general are going.  The Russell led this market higher from December to February when it flattened out into a very tight trading range.  Here's an updated Weekly candlestick chart of the Russell with resistance and support levels:

(click on chart for larger image)

The downward sloping resistance line (purple dashed) obscures the latest weekly price action (red arrow) so here's a magnified version of the past six months:

What I'd like my readers to take away from this chart is the tight trading range on the weekly chart that started as the market entered the first week of February.  Last week's price action formed a candlestick known as a "doji" (blue arrow).  A "doji" signifies indecision.  The Russell is at a crossroads. 
In all objectivity (as much as I can be objective since I'm an intermediate to long term bull) the downward sloping resistance line on the first chart is a negative but the Russell continues to trade above its 50 and 200 day simple moving averages and the price action still confirms that the rally remains intact.

Market internals remain strong in spite of this week's retrenchment.  Here's a daily chart of the NYSE (New York Stock Exchange) up volume as a percentage of the NYSE total volume:

The blue dashed uptrend line has not been violated and this is a positive for the market.

As I stated in my introductory comments, it seems China has taken over as the market's primary worry.  Flash PMI numbers I spoke about in Thursday's blog post are pointing to a contracting economy and the Shanghai Composite finished the week down 2.3%. 

One of the ways we can really understand what's going on "under the hood" of the Chinese economy is to look at commodities.  Regular readers know I addressed lagging commodities often in February, later attributing this weakness to the slowdown in  China's voracious appetite for commodities (highlighted in my blog post of 3/12/2012).

Rather than just post another chart showing a weak commodity I thought it would assist if we looked at the biggest importer of commodities to China, Australia.  Australia, as well as Canada, are the world's two greatest resource based economies.  But it is Australia that would be most effected by a Chinese economic slowdown.

The chart below is actually three charts, Australia's All Ords Composite Index ($AORD), the Shanghai Composite ($SSEC), and a commodity chart many of you are familiar with who read my blog, the Goldman Sachs Industrial Metals Index ($GYX).  These are all weekly charts which serves to give us a more comprehensive, long term view of these markets and economies:

I've stacked the indices for easier comparison.  Suffice to say there are many talking points we could take away from this composite chart (like the incredible surge in $GYX from the 2009 bottom to 2011; no doubt the result of central bank quantitative easing) but I'd like my readers to focus on the right side of each chart. 

The All Ords Composite Index is beginning to form an Ascending Triangle which is a bullish formation and the MACD indicator above is indicating increasing momentum.  The Shanghai Composite (middle chart) broke down out of the long term consolidation pattern that formed from its 2008 bottom and is clearly in a downtrend but it has recently consolidated; having pierced the downtrend line on the chart (blue dashed line).  GYX is presently consolidating around the 38.2% Fibonacci retracement level.

There's always a tendency to be subjective when looking at these charts because of preconceived notions of where one believes these markets are headed.  This tendency toward subjectivity is exacerbated when money is on the line!  Nevertheless, what these charts are telling me is that the China slowdown is not as serious as some on "the street" would lead us to believe.  If the All Ords Composite breaks out of the formation I've identified above, that will mean exports are picking up to China.  And if exports are picking up, China has bottomed and is consolidating at these levels.

Please understand, I'm not telling anyone to "buy" China at this point.  My thesis is just that; a thesis.  But I feel comfortable that the present weakness in China will not be a major market mover for US stocks.

As far as Gold goes, the right shoulder of the inverse head and shoulders formation I identified in my blog post of 3/16/2012 is still forming.  I'm feeling a bit better about Gold this week as long as this potentially bullish formation does not break down.  No chart this week. 

I want to conclude this commentary with a look at oil.  There's presently a lot of pain at the pump and there's lots of people out there predicting $150.00/barrel oil (Brent Crude closed Friday at $125.13/barrel).  I want to point out a few things about oil and then make a bold prediction :-).

First of all, depending on who you listen to there's between $10.00 and $25.00/barrel built into the price of oil due to tensions with Iran.  Secondly, I don't disagree that the present supply/demand imbalance will contribute to higher prices in the short to intermediate term.  But I also want to point out that, as far as US oil dynamics are concerned, the price of oil has a great deal to do with the value of the US Dollar.  Oil, as a commodity, is largely priced in Dollars because the Dollar is still the world's reserve currency.  The chart below illustrates this relationship:

I know this chart is busy, but just bare with me.  This is a one year daily chart of West Texas Intermediate Crude Oil with the US Dollar Index behind it (brown solid line).  The bottom panel shows the correlation of the US Dollar to the price of oil.  You can see that, for the most part, the Dollar was inversely (or negatively correlated) to the Dollar up until September and since that time the Dollar has been mostly inversely correlated but less so.  I've highlighted with vertical blue lines the obvious extremes where a weak Dollar was congruent with spiking oil prices.  This is another chart with many talking points.  But to the present focus, as long as this inverse correlation holds (as it has for the past decade) and the Dollar remains weak, we will have continued upward pricing pressure on oil and by extension, gasoline prices.  Where are gas prices then going in the short term?  Here's the daily chart of UUP, the ETF which tracks the US Dollar as of Friday's close:

The ETF has broken a steep uptrend line and violated the 38.2% Fibonacci retracement level.  All other factors being equal, we should see higher oil prices in the immediate future.  However, this weakness in the Dollar also means higher equity prices.

And now for my bold prediction.  With the recent exploration and drilling in the Bakken Shelf in North Dakota it's estimated that there's enough oil alone (not even addressing NATGAS) to supply this country, based on present needs (which are actually decreasing) for 200 years!  The key will be constructing the necessary pipelines across the country, especially in the Northeast, to get the crude to local refineries.  Right now, the East coast is largely captive to the higher Brent North Sea Crude price.  And with the NATGAS fracking technology which is making NATGAS dirt cheap, any movement toward converting gas fired engines to NATGAS (NAV, WPRT, CLNE) will only extend this supply.

Saying that the economic implications of the oil and NATGAS supply in the Bakken shelf are significant is a gross understatement!  If we can find some balance with the environmentalist fringe in this country gasoline should be under $1.00/gallon by 2020.  We have enough oil and NATGAS in the Bakken shelf to break OPEC's back! 

Have a great week!