Market Analysis 3/2/2012

 I’ll be considering where I see these markets going in this commentary from just a technical vantage point save for a few fundamental comments in the Gold section.  This will also be a shortened commentary but with many charts 

Stocks – I’ve been giving much attention to the Russell 2000 on my blog this week and anyone who has been regularly following my posts knows I’ve been monitoring a trading range on the Russell that finally appeared to break down on Friday:

(click on all charts for larger image)

If we see another few days under the channel that formed in the first week of February we would be looking for a correction to the 775 level as seen on the weekly chart below:

Here are some breadth charts that demand our attention:

The above chart is the McClellan Summation Index which is simply a running total of the McClellan Oscillator values (bottom panel). I’ve highlighted the market activity since the August 2011 nasty decline. The McClellan Oscillator is a breadth indicator derived from Net Advances, the number of advancing issues less the number of declining issues. Subtracting the 39-day exponential moving average of Net Advances from the 19-day exponential moving average of Net Advances forms the oscillator. 

First, notice the point from which the decline in the index fell last August.  It was above the zero line (red horizontal line) at about +500.  It quickly nosedived less than zero and settled at about – 600 before we experienced a “dead cat” bounce.  The September decline was not as deep, settling at about -400.  The next decline took place in November and it was in positive territory (above the solid red line) before the turn upward in late December.  The present decline started in the second week in February but notice the slope of the decline is not as steep as previous declines.  Also notice the oscillator in the bottom panel is not showing the sharp deep thrusts that the previous downturns exhibited. 

My point in posting these charts is to show that based on the price action and the breadth indicators, this market will most probably suffer only a minor, garden variety correction. 

The chart below is another breadth indicator I believe supports my thesis.  It’s the ratio of New York Stock Exchange up volume to total volume.  The red arrows and labels correspond to the McClellan Summation Index above and you can see that the present situation is very different from the previous three corrections:

Treasuries & Commodities - stubbornly refuse to validate the most recent uptrend in stocks.  As I’ve stated in more than a few blog posts we must be much more cautious of this rally because of the ongoing non confirmation in these two asset classes.

When I study commodities I focus on the industrial commodities because they either confirm economic strength or portend weakness in the global economy.  And I like to use the Goldman Sachs Industrial Metals Index that tracks Aluminum, copper, lead, nickel and zinc:

As you can see, there was an uptrend that started in December and stopped abruptly at the 50% Fibonacci retracement level, corrected, and then we had a mini rally up to the same Fibonacci level where we’re stuck again (blue circle).

Treasuries are a puzzle.  Here’s the weekly chart of the iShares Barclays 7 to 10 Year Bond Fund which is a proxy for the “belly” of the yield curve:

Clearly weakening momentum is gaining steam and we have a broadening channel formation after a challenge of the previous inter week high in September (black arrow). 

We know the FED is actively suppressing rates in this area of the yield curve but it is impossible to know whether their efforts are keeping treasuries in this tight range.  As I’ve stated in previous commentaries, the bond market is gargantuan and no one entity (even the FED) can manipulate its direction in anything other than a short term time frame.

Gold –   Gold took a real beating this week and the press laid blame at Bernanke’s comments on Wednesday on Capitol Hill when the market perceived that any quantitative easing facility like we saw in 2009 and 2010 was remote.  But I’m not so sure that this is the reason.

I’ve had a bullish outlook on precious metals for a decade but I’m having doubts surrounding the following points:

1.       That the prices at this time may already reflect all present and future central bank easing, especially since the price action has been muted after the ECB pumped over a trillion Euros into European banks in the past two months.

2.       That Bernanke will never again provide the monetary stimulus like we saw in QE1 & 2.  We’ve seen consistent restraint out of the ECB (sometimes to the detriment of the global financial system) and the FED seems to be cognizant of the risk of further QE.

3.       Interest rates appear to be ready to rise.  While I don’t see a rise above 2.5% on the long end of the curve any increase could further roil the precious metals.

Here’s a daily chart of Gold.  It isn’t pretty.  We can take it as a positive that it seems to have support at the 1700 level but the chart formation is not encouraging.  We have a failed breakthrough at a previous resistance line (white dashed lines).  

We have some support at $1,675.00 but if that breaks we could drop to the $1,575.00 area.  Notice also a possible “bear flag” forming.

The Dollar - many are calling for a stronger dollar based on some cogent fundamental reasons and here’s the daily chart below going back to late August 2011:

It’s clear we have an intermediate term uptrend going as the chart above manifests a series of higher highs and higher lows.  However, all the price action in February has the Dollar hovering around the 61.8% Fibonacci retracement level.  I’ve drawn a steep resistance line (brown dashed line) and the price action butted up against that resistance line on Friday (green arrow).  If the Dollar can pierce this resistance line (likely) and get out of this trading range to the upside the intermediate term uptrend will continue.

ANALYSIS

My analysis will be brief this week.  And my comments will be predicated on the following inter market relationships we’ve been following since I started writing these commentaries almost two year ago:

                                                Inflation               Deflation

If the Dollar                          corrects                rally

Then Stocks will                   rally                        correct

Then Treasuries will          correct                  rally

Commodities will               rally                        correct

Then Gold will                    rally                        correct

These inter market relationships have been valid for most of the past decade and when there was a discontinuity between these asset class relationships the tension eventually resolved itself according to these relationships.

Right now we have tension in these relationships as commodities have diverged from stocks starting in late January and Treasuries, throughout the rally in equities that commenced in December, have maintained their strength.  However, Gold has responded exactly as our inter market relationships dictate.

In many past commentaries I’ve stated that if you want to know where asset classes are going watch the Dollar.  And while that’s still true I believe Gold is giving us a foreshadowing of market direction in the coming month. 

One of these days I’m going to focus on Gold, either in one of my blog posts or even an entire commentary.  But to understand what Gold is telling us by its price action in the past week we need to understand why it has acted the way it has for the past almost twelve years.

Gold has been in a bull market since it bottomed in April 2001 at $255.80.  At has been seen primarily as a hedge against inflation in the past decade but secondarily as a “safe haven” out of concern about central bank fiat money printing.  And we saw it respond in a tremendous way after the FED embarked on QE1 and QE2.  The metal did seem to have a “blow off” top in September 2011 and has not been acting the same since.  It responded reasonably well to the ECB’s first LTRO but sold off on the second this past week.  Its adherents still proclaim the bull market is intact but with all the reverberations in Europe toward the end of 2011 we actually saw heavy liquidation of the “yellow metal” and a flight to the leading “fiat” currency on the globe; the Dollar. 

I believe this week’s vicious sell off in Gold is predictive of a higher dollar and also higher interest rates.  I believe the Gold market is sensing the end to central bank intervention for now and subsequently the rampant or out of control inflation so many “gold bugs” have been predicting.

I’ll go one step further and really stick out my neck and say that we could be in the beginning of an intermediate term change in the relationship of the Dollar to stocks.  In the past decade, a strong Dollar has meant a weak stock market but that interrelationship was not always so.  In the 1980’s and 1990’s the Dollar was mostly positively correlated to stocks.

In the short term, I’m looking for more sideways consolidation in stocks to work off an overbought condition and we might even get a short term sell off toward the end of the week going into early next week.  I would use this weakness as a buying opportunity to load up on your favorite stocks.

We’ll see if my prediction regarding the Dollar is correct but I don’t want anyone to think that any strength in the Dollar will be permanent.  As long as we keep running trillion dollar deficits the day of reckoning for the Dollar is coming.

Have a great week!

NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'SWHO IS NOT A LICENSED INVESTMENT COUNSELOR OR BROKER.