Trader’s Narrative

A little while ago I tried to separate the effect of the weakness in the US dollar on the price of gold to determine whether gold’s bull market could actually stand on its own: US Dollar’s Weakness or Gold’s Strength?

There is a better index out there to determine this very question. The Kitco Gold Index is the price of gold measured not in terms of US dollars, but rather in terms of the same weighted basket of currencies that determine the US dollar index: Euro (57.6%), Japanese Yen (13.6%), UK Pound (11.9%), Canadian Dollar (9.1%), Swedish Krona (4.2%) and Swiss Franc (3.6%).

So instead of pricing gold in the unit of a US dollar, the chart below charts it in the the same unit that we use to measure the US dollar index:

Source: Kitco Gold Index

This is the one year comparison but you can also see a 5 and 10 year chart (follow above link). These both tell the same tale. There is definitely a bull market in gold. But, it has been aided and abetted to a large degree by the weakness in the US dollar. Seen through the lense of other currencies, the gold bull is much more tame.

If you look at a very long term chart of the comparison, it becomes obvious that there are periods where the price of gold in US dollars shoots up only to come back in line with the currency basket. Right now is one of those times.

As you can see, the price of gold in the currency basket has yet to breach the high it set earlier this year. This was something I pointed out when others were focusing on the breaking of the nagging $1000 resistance: Major Non-Confirmation in Gold.

Also, the purest equity proxy for gold, the Philadelphia Gold Bugs Index (HUI), has yet to surpass its highs from last spring (March 13th 2008 - 515). According to the k-ratio analysis of the gold sector, this suggests that gold is ‘overvalued’ relative to gold stocks.

Last week we looked at the breadth of the gold stocks which showed about 80% of them closing above their short term moving average. Here’s an updated chart:

While gold stocks managed to eke out another positive day, breadth slipped from almost 90% to below 80%. Usually, in the past, when breadth has been this stretched, and heading down, there is a good chance that a short term top has been already made.

Last week I wondered if the strength in gold was due to the implicit strength of the precious metal itself or whether it was merely a by product of the weakness in the US dollar: US Dollar’s Weakness or Gold’s Strength?.

It is obvious now that the US dollar is being thrown to the carry trade wolves in order to save the economy. This is the same play that central banks made several years ago with the exception that back then it was the Yen that was sacrificed.

In any case, gold continues to walk higher on the chart - it reached $1,064.20 today at COMEX. The distinction may be a moot one because as long as it continues, those on the right side of the trade will profit. But since there was some questions regarding the way I tried to strip out the US Dollar effect on gold price, here’s another chart which uses a slightly different method:

Source: Elliott Wave Intl

The song remains the same. Gold hasn’t reached a new high when we strip away the effect of the dollar. The second chart above looks at gold relative to a basket of other currencies (Yen, Euro, Swiss Franc, Australian Dollar, Canadian Dollar and the Pound).

Also, as noted previously, large speculators have crowded into the long gold trade. The most recent COT shows them to have 50% of open interest. But in general sentiment towards gold is relatively muted - especially considering the many times it was unable to climb above $1000.

From a purely technical point of view, this is a gold bull market. But I’m trying to deal with some nagging questions. For example, if there is inflation on the horizon, why hasn’t it registered on the CRB? After all the commodity index is rading below its 30 year average and it is flat since June 2009.

Honestly, I can’t see any signs of inflation anywhere. In fact, you don’t have to look hard to see deflation almost everywhere. So the gold story is one written on the back of the US dollar. And with the US dollar sentiment so incredibly negative, it makes me cautious on gold - bull market conditions notwithstanding.

Earlier in this month’s sentiment overview, I mentioned a lesser known sentiment indicator called the “Daily Sentiment Index” (DSI). It is compiled and disseminated by Jake Bernstein’s firm through various “proprietary data collection methods” which include internet, telephone and/or email.

Since the objective is to arrive at a contrarian signal, pains are taken to only access retail traders and investors and to avoid professional traders. Also according to Bernstein, they do their best to survey the same base as much as possible. The resulting data is available daily on major global indices and commodities without lag by 4pm the same day. Overall, it has proven itself to be a very good contrarian measure.

Here is a recent chart of the US Dollar index along with its DSI:

Similar to other, more well known sentiment indicators (such as the AAII weekly sentiment survey), a simple question is asked: are you bullish, bearish or have no opinion. But unlike the AAII survey, the DSI is a considered ‘a proprietary indicator’ and there is no detailed disclosure of its exact nature or methodology. While you might think this opacity would make people reluctant to rely on it, the DSI has a large and loyal following, especially among the institutional crowd who don’t balk at paying almost $2,000 a year for a subscription. You can get more information on the DSI at Bernstein’s website.

For some perspective, here’s a very long term chart of the US Dollar Index with the two extreme lows in sentiment:
Continue reading ‘US Dollar Sentiment: Contrarian Bullish’

No question, this was a financial shock that leaves everyone grasping for superlatives. But as measured by the TED spread and other financial health metrics, it is all but over:

Unlike the CBOE VIX volatility index which reached record territory, this spread has been higher actually. I’ll scrounge up a very long term chart. But the important thing is that the TED spread has now come down so much that even if it blips up, it has put in a lower low. So while we may see an uptick or two since nothing every goes up or down in a straight line, the chart suggests that things have calmed down.

But what the shock has resulted in is just getting underway. A complete re-ordering of the financial landscape: RIP the carry trade. Now watch as the currency markets drive the equity markets. They are after all a zillion times larger.

Can you tell which chart is the S&P 500 and which the Euro Yen cross?

A dozen spoos points and a slightly singed Swingline stapler to the first lucky guesser.

I’ve been “contrarian” bullish on US dollars ever since it cracked its long term support. It seemed to me that everyone and their uncle was short the dollar and although for good reason, it seemed like too easy a trade.

But sometimes you can over-think these things. And it looks like this was one of them:

Now everyone from the uber rich (Jim Rogers and Warren Buffet) to better looking uber rich (Giselle Bundchen and Jay-Z) are shunning the US dollar. The Brazilian supermodel is asking all her contracts to be paid in Euros and the rapper flashed Euros instead of greenbacks in his music video for “Blue Magic”.

You have to step back and wonder if this is all getting too much. When the public starts to make it emotional rather than rational, I start looking for the inflection point. But I’ve been wrong while they have been right.

The dollar didn’t even so much as pause on its way through long term support. And I mean really long term support. That technical support line goes back to 1990.