Of course these very low yields are for the perceived safety of government dept. There’s little intrinsically safe in any government dept other than the fact that they can print their own money when they run out of revenues, unlike everyone else. But there is a wide spread between government dept and various levels of corporate dept, especially in the lower rated issues. Investors are being paid high yields relative to the risk on the lower rated corporate side. These are unusual times, and they may be around a bit longer than most traders think.

It would seem obvious that with governments running up dept like crazy, with the eventual need to monetize that debt, that inflation would be starting to get priced into these markets, with yields starting to rise and bond prices dropping. Yet just the opposite is happening, so far. Bernanke has said that interest rates will stay at these low levels for at least another year or more. But markets tend to discount the future and so far they aren’t discounting much inflation.

Perhaps deflation is the larger fear. Perhaps the analogy of pushing on a string is still relevant. Until jobs and spending resume it will be difficult to have any pricing power no matter how much the governments around the world try to destroy their currencies. The resumption of more normal times may be a long way off.

Most traders I know, and some very smart traders, are heavily short bonds with very large and mounting losses. They all seem to have thrown their money management out the window. It seem so obvious that this bubble will soon burst, but what seems so obvious is usually wrong. The weekly chart above shows that the trend is still up. The momentum indicator in the middle sub-graph got a bit overbought and has kinked down, but the trend indicator is still up and the adaptive CCI in the lowest sub-graph is still hovering around the +100 line, indicating the trend is still alive. Meanwhile, I’m leaving the short side of this market alone from a trading point of view until these indicators indicate that the trend has changed direction. And I’m parking some money in the high yield end, as those spreads seem to be well compensating investors for the risk, especially in diversified bond funds (as boring as that sounds).

This is a specific type of trade to do during a specific type of market action. Just to be clear, I’m not in any way suggesting this type of trade after a bubble bursts or during more normal or range bound markets. It is only a tool to keep in mind when a market has a speculative bubble such as was the case in silver recently, or another type of unusual movement. This information is for educational purposes only and no trade recommendation is implied or should be inferred.

Now that the uptrend in silver has been broken it would be normal to expect rallies up to resistance. But where is resistance? It is difficult to find logical reference points when the previous uptrend was of a parabolic nature. I will be watching the moving average (darker blue line in SLV chart above) for a clue. There is no magic in the formula for this moving average, but it does attempt to adapt to the current cycle of the market and offers a good reference point when there are few other clues.

One thing I noticed is the symmetry of the two impulse moves defined by the two red lines over the price bars in the above chart of the silver ETF. These lines have been drawn both as regression lines and are of the same length. The little pullback in between these lines is subtle, but I think it is enough to suggest that these two impulse up-moves should be counted separately. If so, the current impulse may be at or approaching an end, not necessarily the end of the bull market, just the end of the current impulse. Before reading too much into this, I’d caution that these symmetrical impulse moves do seem to jump out of the charts when they succeed, but the failure rate is high, and all patterns seem to disappear from notice when they fail. It is easy to become fooled by randomness. But these symmetrical impulses, like other chart patterns do get my attention and often they do become a piece of the puzzle in reading market clues.

The above chart looks at a similar situation from a longer term perspective. This is the weekly chart also with two longer-term impulse uptrends described by the red regression lines. In this case there is a larger pullback that occured for most of the month of January. This time the first impulse to the left is of a longer duration than has occured so far on the current impulse to the right, suggesting this impulse has more to run if symmetrical impulses are in the works. On the other hand, the angle is quite steep, which could suggest this impulse could become unsustainable. There’s always an “on the other hand” when analysing charts. Again, the adaptive CCI is strongly bullish, as it would be with this strong of a move, and may not give much of a warning of a turnaround .

Another thing I always look when trying to figure out the precious metals market is divergence between the metal and the companies that mine it. The above chart shows Silver Wheaton in the lower part of the graph, which is a popular silver miner. You can see how this mining stock has failed to participate in the current uptrend in the underlying metal. Pan American Silver has even shown more weakness, and was down 93 cents today with silver being up by as much. Of course, many company specific issues can cause these divergences, but this seems to be occuring in many of the silver miners. However, (on the other hand) these divergences seem to be less reliable than in years past, probably largely due to the effect of the ETF market.

As I’ve said many times on this blog, it is dangerous to try to pick tops and bottoms. It is much safer to trade pullbacks once a trend is established, and clearly the trend is up in the precious metals. But it is also dangerous to overstay a position in an extremely crowded market. I’ve know many people who have been burned by the silver market over the years in previous bull runs. Almost as many as those burned during the great bubble dot com bust of a little over a decade ago. At least the precious metals market is based on something other than hot air, as was the case with most of the dot com stocks. This is most likely a very long term bull market, that will persists as long as politicians do what they do best. Maybe it will end when we get change that we can really believe in. But don’t hold your breath.

The chart above is the weekly silver ETF. After an extended period of consolidation this market broke out to the upside, and has more than doubled in a few months. And that launch was a couple of months prior to the announcement of QE2 (not the boat). You can see how the adaptive CCI (middle sub-graph) quickly went above the bullish plus 100 line and has stayed there. Also, there was an oversold inverse head-and-shoulders in the double stochastic indicator in the lowest sub-graph at the start of the big move. There was one consolidation, forming a bull flag at about the mid-point of this trend. Now the stochastic is in over-bought territory and turning down a bit, along with a still bullish and trending CCI. The daily chart (not shown) shows a very similar interaction with these indicators, however the daily bar show an outside reversal day to the downside, which has a bearish implication if one believes in these patterns. Like all patterns they work about the same as a flip of the coin, but they are interesting to watch as they do sometimes precede spectacular reversals.

So what does all this mean, if anything. For me, as much as I think this market is long overdue for a correction, I don’t want to try to pick a top and go short, at least not yet. I prefer to let someone else pick the top, and to wait for the trend to turn down and then sell the rallies back up to the moving averages. Of course the downside of this thinking is that sometimes the market just collapses and good entry points just don’t materialize. If one were to look at the great silver bull market of the late ’70s to early 1980, one would see a run from $5 an ounce all the way past $50, at least in the futures market, and then a straight drop all the way back down. Of course this was a different time. The market was being cornered, and then regulators changed the rules at the peak, with the peak only lasting a short time, and then limit moves for many days to the downside. Now we don’t have anyone cornering the market, but we do have a fed chief who is engineering inflation and destroying the currency, and money is pouring into just about everything solid, well, maybe with the exception of real estate. But what about supply and demand? Is there a silver shortage as there seems to be in some commodities? There may be a shortage due to the demand to have physical silver back each share of the ETF. But keep in mind that this shortage can quickly turn into a surplus if holders of the ETF reverse their trade. So things are different this time. But they are also the same.

As bullish as I am on the long term fundamentals of both gold and silver, I try to keep an eye on how crowded the trade is, and know from lots of painful experience how quickly greed can turn into fear. I don’t know, and nobody else knows, if this market is putting in a top. This market was under $10 near the end of 2008 and went past $40 last Friday. That was enough for me to take half my silver eagles to the coin shop Friday after the close to lock in some profits. There were many people there buying. I asked the coin shop guy if there were more people buying or more selling, and how high they think silver will go. He said everyone was buying and that silver should go past $50 by next week. After hearing that I felt like getting the rest of the silver out and selling it.

I hear many justifications for higher prices, and of course the destruction of our currency is a legitimate and sensible reason for a continued bull market, but markets can and do become overheated and test prices beyond what the fundamentals can support. The idea of buying high and selling higher works for a while, but buying low when nobody want it, and then selling when they are all waiting in line to buy seems like a more sustainable strategy. And one more point: I’ve been hearing on the radio nearly double the number of ads for silver than for gold. One common justification I hear is that gold historically sells for 16 times that of silver, therefore silver has to climb to way over $100 an ouce just to get back to that ratio. That is utter nonsense. Each market trades on its own fundamentals. Inter-market relationships, even in so-called highly correlated markets, tend to fall apart as differences in supply and demand shift and change in each market. And of course that 16 times ratio theory doesn’t take into account what would happen if gold fell rather than silver climb to achieve that ratio.

And one final point is that the fed has nowhere to go regarding any further lowering of interest rates, and it’s unlikely there will be more QEs. If there is not to be a QE3 and QE4 and QE5, and if the inevitable interest rate uptick happens, especially if unemployment is still high, these asset bubbles could all pop very quickly and be followed by deflation. Uncle Ben surely understands this, but what can be done to prevent it? I sure don’t have the answers. But I do know it’s easier to get out of bubbles as they are inflating rather than waiting until they pop.

When analyzing accelerating trends on numerous charts from the past a few observations can be made. First, in markets with large public participation the character of uptrends and downtrends are substantially different. In commodity markets where the participants are mostly professional traders and commercial interests the difference is not as great. But in popular markets the public is oriented toward the long side, and will react one way to greed, and react in quite another way to fear. Despite what you might read on gold oriented web sites that are always bullish, the gold markets that are traded on exchanges have mostly public participation on the long side. When markets accelerate to the upside greed can take over and the bandwagon effect is in full force. At some point the bandwagon will knock off most of the speculators who are not strong hands. But the character of the bandwagon effect can take two different forms.

Consider scenario #1. A healthy uptrend will occur after a period of accumulation. This can be characterized by a sideways trending market where the smart money is quietly accumulating their position. Usually there is little chatter or mention in the popular media or on many of the trading blogs. The general public is often looking the other way. There is little momentum to chase. The market is not bearish, but it is also not in favor at the moment. Such a condition occurred in the gold market while it was building that large triangle that I pointed out in a previous post on this blog that started in February, after a large run-up, until the breakout on the 2nd day of September. Once the breakout occurs the momentum chasers and eventually the public gets on board the bandwagon as the smart money starts to sell to those now entering the trend. This can last for some time as the public and late money pours in. By this time the smart money is usually gone. As usual the dumb money gets left holding the bag. The bandwagon tips over as the market enters a correction. If the longer-term uptrend is not violated there will most likely be a new area of accumulation where the smart money re-enters the market and picks up bargains from the public that sells out near the bottom. The whole process of accumulation repeats. And then on the next breakout the momentum chasers and public re-enter, and the whole process repeats. On each of these impulse moves prices most likely will accelerate a bit into the cycle high, but then get pulled back by the inevitable correction. As long as this process occurs in a somewhat orderly fashion the trend is probably still alive and well. The impulses up followed by reactions back down are healthy for the trend and suggest continuation of the primary trend.

Consider scenario #2. The same accumulation occurs as in scenario #1 above. However this time the bandwagon keeps getting more and more crowded. Instead of prices backing and filling, prices accelerate at an even faster pace and become parabolic. There is little downside. Maybe there is a down day here and there, but almost every day is up. The media gets on board and discusses the uptrend at faster intervals the higher prices go. All the news is bullish. Dissenting voices are mostly absent. Gaps start occurring on the chart. It looks like a straight moonshot where there will never again be a downside to consider. At some point, without warning, the market makes a quick reversal down. I’ve seen this occur numerous times in commodities where there would be limit up day followed by limit up day, and then on one of the limit up days the market would suddenly be limit down. At first this looks like a bad print. But after being locked limit down it is obvious that the market has quickly reversed. Often this is followed my numerous limit down days. In stocks and many commodities a limit move is not a consideration, but the same effect can be experience by a huge gap down on an opening, when stop loss order are useless. Usually following such price destruction there is disbelief because all the news is still so bullish. Most traders think the drop is temporary, but if the market retraces most of the last impulse move up, it is most likely that the bull is dead. Usually there will be some small bounce or even a retracement a third to a half of the way back up. But in most cases these markets enter serious bear markets that can last for a very long time and it will take a brand new bull market to get any kind of meaningful uptrend to start. We have seen many examples of this type of blow-off move in many popular stocks and futures markets in the last several years. Silver is a good example. It went to $50 in 1980 and it quickly went all the way back down to $5 after a series of limit down moves. It has never returned to the $50 level, and has taken nearly 30 years to regain about a third of the previous high price. Dry Ships is a more recent example of a stock that went parabolic all the way up to $131 two years ago, and is now priced at about $6 and trading flat.

So the question now is which scenario does the gold market belong to. Is it in the exponential, parabolic blow-off stage, or is it just make a nice impulse move higher that will correct at some point and eventually continue on its way within a secular bull market? At the risk of sounding indecisive, I would say we are somewhere in between the two scenarios. There are various forces economically and politically at work in the gold market.

Gold can move up temporarily in time of uncertainly or disaster, but for a long term bull market gold really needs inflation. As I see it, right now we have a government that is devaluing the currency at an unprecedented pace. The printing presses are running overtime. Interest rates are down to zero. Conventional wisdom would suggest that inflation should start picking up at any moment. But how can inflation pick up when there is oversupply of just about everything and at the same time demand is shrinking. Of course this is a result of rising and persistent unemployment and falling housing prices. Until the employment situation improves on a sustained basis there is little hope that the supply and demand situation will turn around. There is just too much supply of just about everything you can think off. Obviously there is a huge supply of real estate and autos and just about every other piece of merchandise. Prices are falling on nearly everything. If the sticker price doesn’t fall, then there are sales and then sales on top of the sales. Even oil is in excess supply, although prices don’t always come down based on supply demand in that market. And of course gold has a huge amount of supply. How can that be when 321gold and other bullish gold sites claim there is a shortage because they don’t have enough to mint coins? Nearly every ounce of gold ever mined is potential supply. Very little is used up or consumed in the sense of a pork belly or barrel of oil. It simply transfers from the ground into a vault somewhere. It is all potential supply at some price, or at the perception that future prices will fall. Remember when central banks were dumping gold, thus depressing prices? They kept selling regardless of how low prices went. Every ounce of gold that was available for supply back then is still available as supply now, at least at some price.

So at the moment there is an overactive printing press and deflationary forces at work. There is a huge amount of debt that will obviously have to be monetized at some point. The destruction of the currency will have to eventually result in inflation, but at the moment the deflationary forces are a counteracting factor. This does not mean the situation is stable. Far from it. Once employment turns around, and it will, prices are certain to rise. Is it possible gold is seeing that far ahead to justify the current price? That’s a difficult question to answer. I think it is obvious that gold is looking at the inflation component, but I think it has gotten way ahead of the fundamentals by not taking into consideration the deflation component.

My feeling is that we are still in a primary bull market in gold. I say that because of politics. We have a two-year election cycle that can change the landscape dramatically. Of course it is a four-year cycle for president, but there are also mid-term elections that can change congress. And hopefully it will next year. But it may not help much. The current crop of republicans aren’t much better than the democrats. If we could elect people that understand the economy and would treat the economy and spending in a responsible way, then the currency would be strong and gold would have less interest as a store of value. But with a short-term election cycle politicians would rather have a quick fix to try to boost up the perception of a good economy so they can get re-elected. To do the right thing would probably cause serious dislocations that they would be blamed for. I’m not optimistic that this will change anytime soon. Therefore the long-term irresponsible nature of politicians that don’t understand economics and don’t really care about fixing it for the long term will insure that gold should enjoy many more years of a secular bull market.

But what about the short term? It looks parabolic. And gold has had a multi-year run. It started the bull market from under $300 and it almost hit $1200 today. Markets can obviously go much further than seems logical. I still think that is the case short term for gold. It appears to be in a bubble, in that it has gotten way ahead of its fundamentals and appears to only be discounting potential inflation. Also, it is mostly just moving inversely to the US Dollar, at least in this last part of the impulse. Interest rates will likely stay down as long as the employment situation stays bad, but any uptick in interest rates that would also cause an uptick in the dollar could tip over the gold bandwagon. The dollar is only low in relation to currencies of other countries that are perceived to have a more responsible government. That is another factor that could change. It is difficult to imagine any government more reckless or irresponsible that the current one, but anything is possible.

This market seems ripe for a major correction, in my opinion, but not a new bear market. You can see on the chart three red linear regression lines drawn on the last three impulse moves. They are fairly even in length. Line #3 is a bit less steep, but has already achieved the duration of lines #1 and #2. Prices over the last three weeks (this is a weekly chart so the three candles on the right) have moved parabolic, with gaps, and have moved far away from the regression line. It would seem logical for there to be some reversion to the regression line, although that line will become steeper if prices stay up here. A re-test of the March high at the end of impulse #2 is not out of the question. If prices continue higher from here I would view it as a negative sign, as it would suggest we are entering scenario #2 described above. But my gut says we’ll have a healthy correction, a new accumulation base will form, and there will likely be another drive to much higher prices in the future. At least that is my hope. I’m a long time bull and don’t want to see this market enter a final blow-off stage that will take years to rebuild. But the market will do what it wants. Entering new long positions at these levels could prove to be very dangerous. The smart money buys when there is little interest, and sells, often too early, to those chasing momentum.

Trying to trade the downside of this market can be tricky. In my earlier trading days I would often try to pick tops and bottoms. I had some success, but there were many losers, especially trying to pick tops. Most markets bottom more quickly and decisively. Tops are more difficult. Bulls seem much more difficult to kill. However, there are a couple of ideas using option spreads that may help reduce the risk of a net short position in gold or a net long put position. Some of these spreads can be constructed so a maximum gain can be achieved if the market does break, but can still offer a profit if the market continues higher. There is a zone of loss in the middle. This post is getting a bit long so I will try to give examples of those spreads over the long weekend.