Trader’s Narrative

With US dollar sentiment at historic lows, the dollar continues to be about as popular as a leper. In contrast, the yellow precious metal continues to be the belle of the ball. Today it closed at a new, all time high at the Comex. The December futures contract closed at $1045, decisively higher than even the intra-day high in March 2008 (when the fall of Bears Stearns lead to a panic).

Here is a short video covering the recent move and a look ahead at what’s coming up at the hard right edge of the chart (make sure to watch till the end for a bonus):

It wasn’t too difficult to anticipate a successful break above the hitherto challenging $1000 level. An analysis of the investor sentiment in gold revealed a mostly bland response to its advance this time around. Unlike previous rallies.

As well, gold’s seasonality was the wind at the back of its uptrend. However, as you’ll notice from the seasonality chart in the previous link, a pull back is to be expected for gold in October. At least, that’s what has been average historical pattern.

Checking in with the K-Ratio (the ratio of the price of gold to the Philadelphia Gold Bugs index), we see it in neutral territory:

This recent move helps to cement the long term uptrend for gold, however it isn’t smart to chase it higher. Once a decisive break through tough resistance like this is made, it is typical to see a pull back to that level again as it acts as support. With the seasonality weakness about to kick in, that’s what I’d expect to happen. So keep watching this market for a good opportunity.

Also keep in mind that there are many ways to play this. You don’t have to buy gold futures or the Gold ETF (GLD). There are many highly leveraged mining companies that provide a fantastic proxy for this precious metal. The K-ratio still has room to move higher, which means that relative to gold, gold equities are not expensive.

Finally, the bigger picture is the slow decline of the dollar. I expect a rally in the US dollar, especially as the sentiment is so extremely pessimistic. But the long term trend is clear. There are some rumblings in the background that oil producing Middle Eastern countries, along with China and Russia are working together to stop pricing crude in US dollars. As well, the Reserve Bank of Australia wins a gold star for being the first among industrialized nations to start on a tightening cycle.

As a corollary to yesterday’s deflation discussion, I thought I’d cover the consequence for gold and gold stocks. The relationship between gold and deflation is a contentious one so I don’t think it will ever be put to rest. In any case, I wanted to point out an interesting relationship which you’ll be hard pressed to find elsewhere.

Referring back to the chart in our previous discussion on the consequences of deflation you can see that we’ve had several periods of negative real interest rates. Naturally, these are when the inflation rate is higher than the nominal interest rate.

These periods coincide with great opportunities for buying gold and gold stocks. For example, in early to mid 1970’s and again in 2003. This doesn’t always hold true however. For example, the gold mini-bull of the mid 1980’s happened without a negative real interest rate environment.

In the 1970’s inflation was rampant and pushed real interest rates below zero. Until Volcker’s ‘take-no-prisoner’ style of monetary policy choked off inflation and brought real rates above zero. But of course, the situation in 2003 wasn’t that we had excess inflation but that nominal interest rates were being kept much lower than they should have been by the Federal Reserve (and we all know how that played out eventually).

Since deflation usually arrives at times of economic slack, one way to try to measure the relationship between the performance of gold and deflation is to look at how it did during recessions. Click the thumbnail to the left to take a look at a spreadsheet showing this data since 1945. The data is courtesy of EWI - they are also giving away a free 60 page eBook on Understanding Deflation which is chock full of similarly interesting tidbits.

The average performance of gold during recessions since 1945 is a miserly 4.8%. What about this most recent recession? We know the start of it but while many are prognosticating its end, we don’t have an official end date from the NBER. So let’s see how gold has done since December 2007:

That’s much better than the average but much lower than the outlier from the mid-1970’s. Still, it is not even enough to marginally move the average over the past 11 recessions. So according to this, holding an investment in gold during deflation is not usually a smart idea.

Trading gold and gold stocks however is still lucrative. One of my favorite indicators is the K-Ratio which is a ratio of gold stocks to gold itself. Here are two long term charts of the K-Ratio (using the Philadelphia Gold Bugs Index and the CBOE Gold Index to approximate gold stock prices):

Right now, the K-Ratio is trading mid-way and not really giving any signals. If it does fall again to previous lows, then we could have another set up for a ramp higher. Until then, I’m not too excited about gold.

While everyone’s attention was on a head and shoulder pattern completing on the Standard & Poors 500 index, another head and shoulder formation was taking place in gold. As the magical $1000 marker acted as strong resistance several times, a consolidation pattern emerged below it.

Here’s a good video update of the recent price action. Click the chart below to watch the video:

While head and shoulder formations are usually considered to be reversal patterns, they can also act as continuation patterns. This is less common and fewer technical analysis students know about it, which makes it more likely to complete. As we’ve all noticed by now, the head and shoulder formation in the equity indexes was noticed and watched closely by everyone and their uncle. Which is why it turned into a bear trap.

The other possibilities are that we could get an irregular head and shoulder pattern. This is a variation where the shoulders are not symmetrical. For example, we could have two shoulders form in the right hand side. The whole pattern would still be valid but it would take longer to play out.

Also, we could see a sideways trading range which would then suggest a large cup and handle pattern instead. Either way, if the price of gold continues to trade within a short distance from the $1000 resistance, the probability of it breaking up increases.

Finally, we can look at the K-ratio to get a sense of the gold market. This is a ratio of the gold equities compared to the price of gold itself. It was first proposed by the technical analyst Jay Kaeppel and I estimate it by using the Philladelphia Gold Index (HUI) and the futures price of gold - instead of the original formula of Barron’s Gold Mining Index and the Handy & Harmon price. There is a minor difference in the two but the important thing is keeping things consistent by picking one method and sticking with it:

According to the K-ratio, the best time to buy gold stocks was in late October 2008, when they were almost as cheap as they were back in 2001. Of course, we now know the 2000-2001 era as a generational opportunity to buy gold - just as the majority were preoccupied with the technology sector. You can also see that the 200 rate of change for the ratio was confirming the buy signal. Right now they are both in neutral territory. This presents a bullish opportunity because if the price of gold breaks through the long term resistance, the K-Ratio still would have room to move up before becoming overbought.

Last Call
You can still get in on FREE week over at EWI’s commodity junction. All you need is an email to get in - but do it right now because it is only available til July 22nd. If you’re interested to trade commodities or are an experienced trader and want to learn about how Elliott wave analyses these markets, this is your chance to get a sample of their work for free.

Here’s a chart of an index of stocks which recently rallied more than 65%. Can you guess which one it is?

For the answer keep reading…

Continue reading ‘Guess Which Index Rallied 65%’

As the market races to the bottom, corporate insiders are racing right along buying with both hands. For the past four weeks, insider activity as monitored by InsiderScore, corporate executives and board members have been in what can only be described as a buying frenzy.

According to InsiderScore, “insiders are more bullish now than at any time since the two weeks immediately following the Black Monday market crash of October 1987“:

Source: InsiderScore.com and SentimenTrader.com

I checked with a similar service that tracks Canadian stocks: Canadian Insider and not surprisingly, the Canadian market is showing a similar pattern of insider buying.

The pattern was especially noticeable for Canadian REITs. And I’m not referring to ESOP where there is a preset schedule. REIT insiders are going out into the market and buying of their own volition. RioCan REIT, which I mentioned a few days ago, had 11,440 units purchased just on November 19th and November 20th, as an example.

The same can’t be said about precious metal stocks. For example, Barrick (ABX) and NovaGold (NG) do not show any buying interest from corporate insiders. If anything, there is a slight bias of selling. Which means that while insiders as a group are very bullish, they are still being selective. The k-ratio fell to 0.23 and has rebounded with Friday’s move in gold. That’s getting close to an attractive level for gold stocks, but if we are headed for a deflationary spiral, gold doesn’t stand a chance. But so far, the Philadelphia Gold Bugs Index (HUI) has bounced off the 175 level which I mentioned would act as support.

There’s Always a But…
A caveat to consider: in September 2007 insiders were enthusiastic buyers. Although not nearly as now. That uptick in buying was, of course, not very profitable since most stocks topped out shortly afterward. The question now is, does today’s frenzy mean that insiders see real value or will we simply see the market fall more and insiders get even more excited about buying?

Whatever the answer to that, the solace that the current buying pattern does provide is that insiders are not selling. The worst possible scenario after all, would be to see the “smart money” insiders bail out after the market’s face melting 50%+ decline.