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).

But what about technicals? The above chart is of the weekly etf of gold. I like to use the GLD etf to avoid having to create a continous contract of the futures. The GLD is close enough. You can see blue moving averages have remained bullish through the entire chart, and that whenever prices approached the blue line that a good entry point on the long side presented itself. We are once again sitting on that blue line. However, the last weekly candle is perhaps too large to expect support to hold. The middle indicator is the double stochastic and it defines cycles fairly well. Upturns from oversold, or the lower dashed line, represented good long entries. I use this only to enter in the direction of the trend. However, sometimes will use the overbought readings above the upper dashed line to exit, especially after a break of the upper dashed line. The lower indicator is the adaptive CCI. It has stayed above the zero line for the entire chart. When it is above the plus 100 line, which is the line that the indicator is still holding above, this suggests that the trend is strong. However, when the indicator crosses above the plus 200 line, which is the upper dark cyan line, prices are usually extended and ripe for either a pullback or a pause in the uptrend.

It would be very bullish in my interpretation of the gold market if that blue support line were to hold and then the cycle (middle indicator) were to turn up along with the CCI remaining positive. I really don’t expect this to happen because of the severity of the decline. It seems that the bubble still has more air to let out, but that’s just a feeling. Until the uptrend as been structurally broken on this chart, I’ll still trade from the long side, even though I would rather from gut feel be on the short side. I’ve learned not to trade against the trend, and that is still up according to the weekly chart, despite the huge drop last week.

But back to reality in sleepy little Seattle. Real estate prices seem to keep dropping. I see people still turning over the keys to the bank, with the bank offering at what seemed like unheard of prices a short time ago, with still few buyers to snap up the bargains. If they do transact at those low prices then comparables in the area will be lowered, thus driving down prices even further. I have no idea if a bottom is at hand. It seems like a good time to buy with low prices and low interest rates, but all I see are for sale signs. A few years ago you’d see a for sale sign and a week or so later there would be a sold sign attached to it. Now all you see is a new price sign (polite way of saying price was too high and now trying a lower price for the third or fourth time) and this seems to go on for a year or more for many properties.

So how does one make a case for inflation. If there are few jobs and housing prices probably not enabling tapping equity, where will pricing power come from? Will conditions improve if Republicans take over part or all of congress? The stock market seems to think so. There seems to be a bullish bias according to some studies when a democrat president has a congress from the other side of the aisle. Gridlock is good when it comes to government it seems. The general stock market seems to like the poll numbers and probably will until earnings start being released soon. But gold is entering what seems to be a vulnerable price area in my opinion. I will point out that I’m always way too early in seeing bubbles. It is very difficult to judge when greed will become overtaken by reality. It is much easier to identify a panic bottom. Tops can give many false divergences as traders are more complacent as they are making money from a rising trend. I think the bullish argument on gold makes sense from the standpoint of currency and fiscal irresponsibility. Perhaps there is hope that a change in congress will create change we can believe in regarding spending. Not sure how long that hope will last even if congress changes hands. If the past is any indication it will probably just turn out to be more broken campaign promises. But whatever happens with the election, the markets, and especially the gold market, still has to deal with the real risk of continued deflation, continued high unemployment, continued near zero interest rates with fear of rising rates at some point accompanied by a rising dollar, and an over crowded bullish trade in gold particularly, and in some other sectors of the market.

When I first started trading gold there was no gold market in the United States. One had to either trade silver, numismatic gold coins, or gold mining stocks. Back in those days there was an understanding of a normal ratio between gold and silver, and a leverage assumed between the price of gold (in London as US prices were fixed) and that of the price of the stocks of companies that mined the stuff. Many of the better trading gold stocks had about a 3 to 1 leverage to the price of gold. Most of the gold bull market letters (there were few serious stock analysts following the stocks of the barbaric relic) would advocate buying the best quality companies. The better companies had the lowest cost per ounce to mine the gold. But during the great gold and silver bull market of the late 1970′s, the best mining stocks had relatively mostest upmoves. The big winners were the crappy stocks that had very high costs per ounce. They were much more sensitive to changes in the gold price. So it is difficult to determine how much a particular stock should move based on a price change in gold, as they all moved at a different rate. But it was assumed that the mining stocks would in general lead the price of gold, both up and down. That relationship, like many inter-market relationships, seems to have fallen apart in the current environment. If relationships and ratios were stable it would be easy to make rules and systems and trade accordingly, but even then the edge would soon be lost.

Some will make the case that now there are many more vehicles to chose from if one wants to participate in the gold market, so mining stocks have less importance now than in previous cycles. One can buy an ETF without the risks of rising labor costs, environmental restrictions, unstable governments, BS from the CEO (the biggest risk imho), etc. But being from the old school of thought, I still like seeing confirmation from the mining stocks. This rally sure seems to be lacking that. The above chart shows the ETF for gold in the upper graph, and the gold stock mining index in the lower part of the chart. The last few weeks have pushed the mining index higher along with gold, but the index is still lower than the peak drawn back in March of 2008. If one were to look at an index of gold mining stock that did not hedge their production, one would getting a little better correlation between the mining stocks and the metal. Some companies sell forward some or all of their output to lock in the price, which would be fine except if the price keeps rising like it has lately, those companies hurt their earnings. But even factoring in the hedging, few mining stocks are showing leverage to the price of gold. Some of the newer mining stocks are doing better than the older blue chips as they are seen to be in their growth phase. It seems unrealistic to think in terms of growth when analysing a gold stock. It is difficult to think of long term growth for a gold mining company, at least in the sense of a Microsoft or Google when they were in their growth phases, when a company just has a hole in the ground and is depleting their limited assets every day. Well, maybe it is not as simple as that, but I think you see my point.

The relationship between the price of gold and the price of the companies that mine gold is only one piece of the puzzle in trying to figure out where prices might be heading. I read in Barron’s this weekend that one analyst now thinks gold won’t be in a bubble until it gets to over $5000 per ounce. I thought I heard people saying $2000 just a short time back. It seems when bubbles get going the numbers keep getting bigger and bigger. When markets go exponential it appear there will never be a reversion to the mean. But the mean market always does, and if it is a bubble popping it can overshoot to the other side by an even greater degree. But that’s just my opinion.

The chart above is of the S&P etf. The uptrend starting with the reversal bar on February 5th has been a steady march higher through March, with only very few down candles. The adaptive CCI indicator under the price candles shows a persistent reading over the plus 100 line, which is bullish and shows trendiness of the trend. It is rare that the adaptive CCI stays this long over either the plus or minus 100 line. It is usually prudent to not fight the trend when that indicator is beyond either of those lines, even when it seems a bit extended as it does now. A more normal pattern on that indicator looks more like on the left of the chart. The middle indicator is one version of the Chaikin money flow. It incorporates volume in its calculation, and you can see it is weakening a bit. This is not enough to turn bearish. It is just an indicator indicating something, but is not a forecast or signal on its own. The bottom indicator is share volume on the S&P etf, which clearly shows increasing volume on the downtrends, and generally declining volume on the uptrends. Bulls will argue that the public is not yet in this market so volume remains low. Bears would argue that this is a divergence. These divergences can go on for a long time.

One argument I’m hearing is that the market is shrugging off bad news while it continues higher. The health care bill passing has been recently offered as an argument that something very bad for business and the economy failed to produce any down movement in the market, therefore the market is bullish. This is a rule offered in many textbooks on trading. I find fault with this. It is true that in an extended trend there is validity to the concept that if a market fails to respond to news that should further the trend, that trend might be ending. For example, a stock that has been declining for many months on declining earning has an increasingly dismal earning report, and then the stock price fails to continue lower and instead has a large move higher, a reversal to an uptrend might be indicated. In that case the stock has over discounted the worse possible news. But with many months into an uninterrupted uptrend I’m not sure that theory works. On the contrary, as a contrarian I would view any positive news that fails to move the market yet higher to be a sign of a possible top. So far that has not happened, but I am keeping an eye open to the possibility.

It will be interesting to see how the market reacts to the employment report released yesterday. The index futures market was open for a short time during and after the release of the report and they moved somewhat higher. Most of the news media is reporting the report positively, despite the fact that the unemployment rate did not improve, the U-6 actually inched higher, much of the newly employed were temporary census workers, and hourly pay declined. That probably means nothing to this market. If viewed positively or negatively the market seems on an unending move to the moon. Some traders act as if this uptrend is something new. Many markets that get overextended exhibit similar characteristics. But they usually occur when that market is making new highs or lows. Gold recently had a similar move, as did the dollar on the downside. Stock indexes have had several similar moves over the years. What seems different is that this move is only retracing a portion of the previous down impulse rather than probing into new high ground. It seems like the move will never end. Momentum traders keep piling on the bandwagon no matter how crowded it gets, despite relatively low volume. These urgent, almost panic type moves seem to occur more on the downside than the upside, at least in equity indexes. If this trend would just pause long enough to catch its breath and digest some of the gains the trend would appear healthier. The way this is proceeding the resolution could be to the downside with a larger move than a market that allows itself to breath in and out.

One thing I think this market is missing is the threat from Obama. Obamacare passed without so much as a hiccup from the market. The cost to business will be huge. There are already businesses that have announce huge write-downs, and they are being questioned by the government for making those announcements. Isn’t that what they would do under someone like Castro or Chavez? Taxes will rise for everyone. The market doesn’t seem to care. The government will take over a huge chunk of the economy and eventually force private insurers out of business. The market is looking the other way. I believe the next step in Obama’s plan is to attack Wall Street, much more than he has done already. Obama knows that he will be rendered impotent if the republicans take over congress in the elections later this year. He knows that his healthcare takeover is not popular and as things stand now his party stands a good chance of losing both the house and the senate. He must divert attention from the health care mugging and the shady tactics used by the progressive democrats in congress. The news media has already vilified Wall Street. It doesn’t matter that the public should be mad at the government influence over Fannie Mae and the like, as well as strong suggestions to banks that they lend to those they shouldn’t lend to. Reality doesn’t matter. The public is like a school of fish that can simultaneously change direction in an instant. Obama is a gifted speaker. He is smart and shrewd. He can create anger against Wall Street and the anger against Obamacare will be seen receding in the rear view mirror, just in time for the mid-term elections.

Another fear is that the teaparty movement could split the republican vote. If candidates split from the republican party to run on a teaparty ticket, that would greatly help the democrats, obviously. If the progressive democrats can hold congress through the balance of Obama’s term, they will most likely be able to pass immigration reform, therefore allowing millions of new voters to vote, and they will of course vote for democrats. If that should happen the republican party may as well call it a day and go home. They will never be able to win another election. This country will move so far to the left it will become even more unrecognizable than it is today. We may as well just become good buddies with Castro and Chavez. Freedom and free markets will become a distant memory. The coming mid-term election may well be one of the most important elections in this country’s history.

This is one time that I truly hope I am wrong in my forecast. This country is at an important crossroads. If we take the left fork in the road we will go down a path of no return. I don’t think the stock market understands the bigger picture yet. It will.

Also, I just received an email from INO. They are offering a free 2 week trial to their market timing service. Included is some information on candlestick charting and another ebook by Adam Hewison. I don’t think a credit card is required for the trial, but not sure. Their service is worth a look. If anyone is interested click here.

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.

However, when warning signs occur it is best to be on one’s toes. The above chart of the daily gold etf in the upper sub-graph shows the beautiful breakout of the triangle (red lines) that was displayed on this blog several posts ago. One short digression here: when I posted this chart back when the triangle was forming, prices were at the upper region of the chart window. It has always been difficult for me, and I know many traders agree, that when a buy signal comes in after an already extended move, and prices are bumping their head on the upper edge of the chart and monitor screen, it is difficult to visualize prices extending further upward. It’s a psychological problem. To overcome this I tried centering the last price so there would be lots of room in both directions, but it squeezed the price bars too tight. Now I just keep in mind that there is room above what I can see on the chart. In this case, after prices broke out of the triangle, what looked like a high price now looks like a low price. This may seem simplistic, but it is important to keep in mind that the markets can move to levels that are difficult to imagine, especially when looking at the confines of a chart window. Perhaps my use of range bound indicators has caused this visual impairment. But I am aware of the problem and fight to overcome it when viewing charts in extended uptrends. But I still looks for clues to indicate exhaustion.

The chart in the lower sub-graph is the XAU, an index of gold stocks. You can see the divergence between the recent push to a new high in the gold price, and the failure of a new high in the gold mining index, as seen by the diverging yellow lines. I’m not one who generally believes in inter-market analysis, as I’ve seen far too many long standing relationships get a divorce. Even like minded markets like gold and silver, or wheat and corn, can have fundamentals that cause them to separate. And there certainly are fundamentals that can cause the companies that mine gold to not participate in excalating gold prices. Some factors are bad hedging practices by the mining companies, labor problems, environmental issues, and a long list of many other issues. For many years the XAU has been a good leading indicator of gold prices, and with the impulses in the miners having quite a bit of leverage to the actual gold price. Many more products are available today to participate in that market, so perhaps that relationship is changing. But it is still worth keeping an eye on failures to confirm new highs or lows between the metal and the stocks that mine it.

Another divergence is indicated in the chart above of the gold price in Euros instead of US Dollars. (Chart courtesy of research.gold.org. Click chart for link to that website) Much attention has been made of the move to new highs, but the price of gold is not yet making a new high if prices in Euros, or in Australians Dollars, Yen, and many other currencies. The main impulse move from 2005 to the previous peak was generally made across most all of the currencies, so this last push really only seems to be a result of the dollar falling. This can change, but so far the story only seems to relate to gold prices in dollars. If this holds and the dollar should rebound, gold could come down hard. I’m not forecasting that by any means, but it is something to keep an eye on. It is just a piece of the puzzle.

Finally, the S&P made a nice correction, but appears to be resuming the uptrend. The chart above shows a large uptrend that was recently broken. I normally don’t like to use rigid lines for a trendline. The market is more fractal in nature, but rigid trendlines are used my most analysts. The red line shows three lows where the trendline can be connected. The red line was clearly violated a couple of weeks ago. It is common for trendline breaks to rebound to retest the breakdown point. So far the market has rallied back up to that point. I also drew a linear regression channel from the spike low to the recent high. The channel width was determined by the low in about the middle of the chart. The most recent low supported almost to the tick on that lower channel. If the market can roll over hear I’d expect that channel to be broken to the downside. This market has shown much resilience, so nothing would surprise me. Another leg up is possible, but it seems this market might need a rest. At the moment it seems to be sitting at a crossroads. I will let the market tip its hand before picking a direction and strategy. The trend indicators are starting to roll over, and have done so on many individual stocks. If the trend turns down I’ll look to go short rallies. But that is a big IF at this point.

On the political background, there is big vote coming on communized health care in the house. That would be a plus for Obama, who has had a rough week. Despite Nasty Pelosi calling the Tuesday election a victory for democrats, there does seem to be a shift of sentiment. In other words, the Obama kool-aid seems to be wearing off as evidenced by the many republican victories last Tuesday. Also, you may have seen this article from of all places a Chicago NBC (National Barack Channel) reporter. It is on his insensitivity to the horrible shooting in Texas. If you haven’t seen it please click here to read article. It is truly astonishing that this man got elected. I don’t think I need to say more. The actual video is widely available.

Also, there was a good segment on Glenn Beck with Lord Monckton discussing the global warming hoax. It is broken up into seven short segments, and the last one is a little jumbled, but it is worth viewing. Click here to view.

Here’s a longer term view of the etf of the S&P 500. In a previous post I had a weekly chart showing the same Fibonacci retracement levels. The chart above is a monthly chart giving a little better picture of the large, smooth uptrend preceding the much faster and urgent retracement. It is interesting to see how long and steady the bull market was from the 2002 and 2003 lows to the highs in 2007, and how quickly the entire move was retraced. Also, there has been an urgent and steep climb back up almost exactly half way. I also have a green line on this chart that is a strong area of support. You can see several rejection lows back in the 2002 to 2003 period, as well as one large rejection tail in March of this year that launched the current rally. Most traders draw the line on the lows of those bars, but by viewing these bars as candlesticks and drawing the the line on the body of the candle it is much easier to think of those spikes down as areas of price rejection, especially on the monthly chart. Any resumption of the downtrend will likely find many chartists expecting support again at those levels. Being a contrarian by nature, I would disagree.

It seems most traders are capitulating to the bull move and jumping on the bullish bandwagon. First, I view the steepness of the previous downside as ominous since it retraced the entire previous impulse move up. It took back almost five years of upmove in about 17 months. It is common for downdrafts to be much steeper and faster than upmoves, but this move erased all of the gain which puts into question a bull market from a longer term perspective. And now the retracement back up is just as steep and urgent and the previous downmove. It just feels like there will need to be some retesting of the downside at some point. The trend is still down. The fundamental backdrop has many pitfalls. The fast move back up seems more like a retracement of the previous downtrend that it does a new bull market. The views of this market on the daily and weekly charts appear more bullish, but the monthly chart is less convincing, at least to me.

It seems a bit too convenient that price has move just up to the 50% retracement level, and the double stochastic in the lower sub-graph is starting to roll over from a very overbought area. This indicator can sometimes just indicate a slowing of momentum rather than a reversal. There is no pattern of divergence on this chart to indicate a more serious reversal pattern. But it is just an indicator. It doesn’t predict prices will fall just because it is in the overbought zone. But with the trend indicator (blue lines) still down, the price patter still down, and the indicator overbought, it is something to keep an eye on to at least temper some of the bullish enthusiasm.

A word about the Fibonacci retracement level. I use a tool in TradeStation that can snap to the high and low of an impulse move, and then calculate various levels within that range, or even calculate extensions beyond the range. The basic Fib retracements are .382 and .618. The middle line is the .50, or 50% level. In other words, half way back up from the distance of the previous drop, in this case. I know many trader put much emphasis on Fibonacci retracements and extensions. I studied this approach many years ago, and I found it to be completely useless. I’ve seen all the charts with perfect retracements or extensions right to the tick of some Fib number. Of course all the examples you will find will be in hindsight. It is much like Elliot Wave. If a pattern or Fib number doesn’t fit, there are many alternates available to fit the past prices to show a perfect fit. It is a little more difficult to do in real time, if not impossible. Traders will often try to find clusters of Fib numbers with starting and ending points at various swing points. Traders will also add many more permutations of Fib numbers to create in between points with the result a chart of so many lines that one of them will be bound to be hit and turn the market around. But if it does it is just a coincidence. I have drawn lines randomly on a chart with my eyes closed, and sure enough one of them will be bound turn the market around. I think such study of the market is a waste of time for the trader, but there are many services that profit from offering advice and eduction using such methods. I could be wrong, but based on much study in that area it is a conclusion I’ve come to from experience. With that being said, I do find the 50% retracement area interesting, and do at least keep it in the back of my mind when analyzing price swings. I don’t think there is any magic to a 50% retracement other than the fact that so many traders look at that area as a target to end the correction of a previous impulse. I think it simply becomes self-fulfilling. Nothing more. But there are many instances on a chart when you will see a 50% retracement of a previous impulse. But in real time it is not always clear which swing points to use in calculating exactly where the previous swing starts and stops.

So that was a word on Fibs. Now a word regarding those price rejections under that green line. Technicians do use previous swing points, or pivot points, to use as a guide to see how a markets will test those levels. On a short term basis this makes sense. The market will move up to a point and then pull back. Then it will move up again and test the price area where rejection occured and previously stopped the market from moving higher. On this test the market will either reject that price again or if enough buying accepts that price, then price can move higher to find another level that again attracts selling and stops the upmove. This process happens in all time frames in both up and down markets. The swings that seem random actually have meaning and purpose. However, how far back will those swing or pivot points still have meaning? Regarding the current market, the March 2009 low will probably have significance if it were to be tested in the near future. If those lows are approached or equaled, and prices were to reject that area and move higher, then the market would look healthy. If those lows are accepted and trading continues at those levels, prices will likely move lower. But how relevant are those lows back in 2002 and 2003. It does appear on this chart that those price levels were where the market decided to stop going down. It may have been a coincidence, or may be that enough traders decided to step in at those lows as they perceived value where prices got rejected in the past, however far back that may have been. It seems that prices on an index that far back should not be relevant today. There is much re-balancing of the stocks in the index. There are inflation and currency adjustments, as well as dividend and interest rate considerations. The further back you go it seems there should be little influence on the current market, other than psychologically or by being self-fulfilling. But then again, what should makes sense logically doesn’t always have to in the markets.

My next post will be the first week of November. I’m taking a much needed rest from the market next week.

When these trends are as persistent as they have been recently, it is financially dangerous to attempt to call a top, or at least call for a meaningful pullback. Obviously a pullback will have to happen at some point. It always does, especially at a time when it looks like it never will. “This time is different” is never different. Bulls will argue that the pullbacks on the charts have been bullish, thus creating a self-correcting uptrend, which is healthy for continuation. So far they are correct. Uptrends have to breathe. They always have backing and filling when the trend is progressing. It is only in the final exponential blow-off that the price ticks seem to only go in one direction. So far we have not seen that, although at times on the intra-day charts it seems like that is the case. On the chart above I have a red line drawn at the high pivots on September 23rd. There was a clear breakout on the S&P in the upper sub-graph. There was a pullback Friday toward that breakout point, which could be a normal re-test of the breakout. If it holds and momentum resumes to the upside then all is well with the S&P. In the lower chart of the Nasdaq the breakout of the same pivot was less successful. The breakout was only by a very small amount, and the close of that bar was a tick or so under that previous high pivot. Over the next two days price was unable to reclaim that breakout point. What is left so far is a double top. This divergence between the two indexes could easily resolve itself to the upside, of course. But the divergence is worth watching. In certain market environments the Nasdaq can lead and give import clues around divergences between indexes and with divergent momentum indicators. So far this seems to just be a warning and something to keep an eye on. So far the uptrend will be intact until or unless the low pivot on October 2nd is taken out. Obviously a new higher pivot can form if the uptrend continues, so the October 2nd low is only meaningful related to the current upswing. As long as higher highs and higher lows continue, then all is well for the bulls. But watch out for low pivots being taken out. The divergence just pointed out can be an early warning signal of the possibility.

What is disturbing to me about this uptrend, apart for the persistence of the direction without meaningful corrective action, is the disconnect between the price action and the fundamental background. I made an attempt in my last blog post to offer a possible explanation. That explanation is based on the assumption that the market in its efficiency can effectively discount the future. Of course there is a problem with that assumption.

Theories often read in books or listening to market gurus suggest that the market is always correct. They treat the market as if it were a living organism that knows all, and that can see into the future. They think the market is efficient and a perfect discounting mechanism. Nothing could be further from the truth. The market is made up of individual humans, each with different objectives and biases. The collective buying and selling of this very large group will set the current price of any given market. Much of the trading volume on any given day is made up of traders who create liquidity by their very short term methods, so they should probably be excluded from this explanation, contrary to what some politicians think who want to tax their activity. However, the outside paper, that is the buying and selling interest of longer term traders and investors, are what create the directional price moves seen on the charts. (And directional can also mean sideways, not just up or down.) It is assumed these trends are caused by fundamentals, such as company earnings, economic policy, or by political decisions. And certainly a big company news item, a huge change in political policy, or a big economic event can cause a change in the major trend. But does a trend always suggest or imply something about the future? I don’t think so. Is the market always right? I would say no. It can be wrong to stand in front of a major price trend, even if that trend is based on a false assumption. But that doesn’t mean the trend is correct. A trend is based on the prevailing buying or selling of the market participants, disregarding the short-term activity of those providing liquidity. Those market participants have biases that can influence the trend. The important point is that the trend will influence many more market participants, thus perpetuating the trend. There is a belief by most analysts that the trend is seeing something down the road that is not yet in the news. But is the market really seeing anything? Once the trend is visible there are many participants willing to jump on board the bandwagon with the hope that the fundamentals will merge with the existing price action. There are many technical traders and large funds with technical models that will jump on board these trends, without any concern about what is causing the trends. Therefore, it is often the case that the cause of a trend is the trend itself. A trend will often grow by feeding on itself, and doing so without any insight into the future.

One of the great books on the market is “The Alchemy of Finance” by George Soros. His description of price trends as explained by his theory of reflexivity is well worth studying. A quote that stuck in my mind the first time I read it many years ago is a better explanation of trend than anything else I have seen.

“Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited.” George Soros

Of course recognizing the trend is the easy part. Riding the trend can be difficult. Exiting the trend at the right time is the hard part.

There are many bright people trading the financial markets. Many are considered gurus, at least for a short time. But few I would consider a genius. I do consider George Soros a genius. His writings on the market are beyond anything else being written or discussed. However, there is a fine line between genius and insanity. I think Soros straddles that line. His views on politics seem to cross over that line. They seem to contradict his core beliefs. They contradict the system he works in and the system that allowed him to become wealthy. He has written negatively on Marxism and communism, yet he backs extreme left wing causes. He will give money to Air America and Moveon.org, among many others. He backs many anti-American and anti-capitalist movements. I attended a speech he gave prior to the 2004 election. His thinking seemed irrational and distorted. There was bias and falsehoods in his thinking that seemed similar to what he defined for financial trends. At the end of his lecture I expected him to say he had to leave as his spaceship was waiting. That’s how nuts he sounded when discussing politics, however his views on financial markets are brilliant and deserve close examination.

It really annoys me that many people profit greatly from the very system they trash. The list would be very long if I were to name them. They would include most of Hollywood, a few on Wall Street, many current politicians all the way up to the top job. One that stands out is Al Gore, that very annoying close call from nine years ago that refuses to go away. When he lost the election he was estimated to be worth about two million dollars. Personally I don’t think he is worth two cents, but that is how much money he was estimated to have had then. Now he is estimated to have over one hundred million dollars. That’s over a hundred million is about nine years. Is he a genius? I would say yes. Here’s a man who took some sketchy evidence that there could have been slight warming of the Earth’s temperature over the last hundred years. Of course over the last ten years the temperature has declined, but we won’t address that. He built up a theory that the world was going to end as we know it if we didn’t take drastic measures to control many aspects of our lives. Measures that would decimate the economy and destroy capitalism. At the same time he was preaching to all of us how we should live, he was flying around in private jets, riding in limos, and using many times the amount of electricity in his mansions that anyone else was using, and he enriched himself by over a hundred million dollars in the process. He refuses to debate the issue. Recently he cut off the microphone to a filmmaker trying to point out as fact that the polar bear population was actually increasing, when Big Al said the opposite. End of debate. Facts don’t matter. He has major corporations and politician on board his crazy theories. The public doesn’t seem concerned about the consequences of his proposals, or the fact that he refuses to debate the facts. He is a genius. He is pulling off one of the greatest hoaxes in history. It will eclipse Bernie Madoff. He is a genius in a negative sense. There is also a very long list of genius that had a negative impact on the world. If he pulls this off he will join that list, laughing all the way to the bank.

Weekly S&P

This stock market rally has been quite persistent. It seems every attempt at a pullback is quickly met with buyers rushing in. There seems to be an urgency in their buying. You can even see it on the intra-day tape. There are few downticks that have any persistence. On the weekly S&P ETF chart above you can see the straight line of the uptrend from the March lows. There was one pullback in July that brought prices right down to the moving averages (blue lines). This created a sort of lopsided bullish inverse head and shoulders pattern – a pattern that once seemed to have predictive powers but now is too wide followed with reduced edge, but seems to be working in this case. The red horizontal lines are the fibonacci retracements, which in my opinion are worthless, however the 50% retracement, which is the middle red line, was an interesting level. It initially stopped the rally in September, and that level corresponded with the huge gap down from almost exactly a year ago. That gap was fill recently and prices dropped back to the faster moving average (cyan line). That pullback brought the double stochastic (black line in lower sub-graph) to oversold, and the rally this week caused momentum to turn back up. The technicals are almost working like a beginning text book on technical analysis. It’s almost too perfect. Something has to break down. Certainly some of this action was most likely self-fulfilling, as common chart point or popular moving averages can cause some degree of buying or selling, usually without lasting moves. But something just feels insidious about all this. Maybe it’s just my contrary nature.

It’s difficult to understand this trend with the economic and political background. The stock market can often seem to defy logic and reason. Markets are discounting mechanisms, so often the current conditions and current news are at a disconnect with current perceptions of valuation. The stock market doesn’t really care what the employment numbers are today, although employment reports can have a huge effect on prices around when those numbers are released. Market makers need to run stops in both directions and reports are an excuse to do so. But the market is more concerned about where employment numbers will be a year from now, not today.

So does this market see better times ahead? I think the political environment holds the key to one piece of the puzzle. I know it is annoying to some readers to digress into politics when trying to analyze the market, and I have a tendency to do that often. And I don’t want to anger readers that have political views that are opposite of mine. But the political climate can have a huge impact on the direction of the market, so to not discuss it would be leaving out an important element, obviously.

The stock market suffered a huge drop as we all know, and that drop accellerated just prior to the election. The culprit was of course the bust in the housing market and the resulting credit problems. That snowballed into many other problems, most notably the lagging indicator of high unemployment. The timing of all this seems suspicious to me. And it seems strange that the obviously overvalued housing market correction could have snowballed into such a huge problem that would have required bailouts, huge market losses, and the destruction of the currency. All this seems to be getting worse as the market marches ever higher, as if it doesn’t care. One explanation is that corporate profits are improving. But are they really improving? Are they improving from depressed levels? Are they improving from cost cutting? Is it the drop of the dollar toward zero? The consumer has to come back into the market for profits to improve and grow in a sustained way. They can’t tap into home equity anymore. Ultimately employment will have to grow to get the consumer confident enough to start buying things again. Yet the stock market doesn’t seem to care. So what is it discounting?

I think part of the bear market last year was the perception that the country would take a giant leap toward socialism. It was obvious that a democrat would be the next president, and congress had already switched back to the democrat side. It was clear that a radical left president with a congress lead by Reid and Pelosi would probably be able to pass any leftist agenda they wanted. In the beginning the more moderate by comparison Hillary looked like a sure thing. The market was trending down a bit but not aggressively. When Obama took the lead the market accelerated down in a more meaningful way. This might be a coincidence. I’m sure the Obama supporters will think there is nothing to this. But price action on the charts don’t lie. The housing crisis was totally to blame by the media, but this still shouldn’t account for such a severe drop in my opinion. Uncertainty about the future direction of the country could explain part of it. Obama was very clear and honest about his intentions and about his vision for the fundamental change he wanted to make. His views on politics were clear for all to see. His associations and political affiliations were well known. His lack of experience was also clearly known. The public didn’t seem to care. They just wanted anyone other than a republican in the white house. The news media really created and accelerated this condition.

Now the Kook-aid is starting to wear off. It is clear now that the socialist agenda of the extreme left is not a sure thing. All of Obama’s plans, all the things he promised during the election seem to be put on hold. The public is waking up. Reid and Pelosi still hope to Rahm these policies through. Obama said during the election that anything he voted on would be posted online for the public to read. That will not happen. That has been voted down. They know the public would not stand for what they are trying to accomplish. There is now less transparency than ever. The public is not taking this sitting down. As poll numbers are dropping and the public is becoming more worried and involved, there is a greater chance that the mid-term elections next year could change the balance of power once again, and render Obama’s Marxist vision of this country nothing but a close call. This happened in 1994 to some degree. Hopefully it will happen again. But this time it is more urgent as the stakes are much higher.

I believe that the stock market would suffer irreparable damage under a socialist system. It can work in Sweden and other smaller countries to some degree, as long as there are other capitalist countries available to lean on. But it cannot work in the US. It would destroy most of the essence of this country. We can’t turn our workforce into an ant colony. What Obama wants is fundamental change we can’t and shouldn’t believe in. I think the neutering of his ideas is what the stock market is seeing a year down the road.

 
Here’s the Nasdaq 100 ETF weekly chart. This has made a clear breakout. The CCI has made a nice bounce up off the +100 with the cycle indicator on the bottom turning up with all uptrend intact. My gut feeling is that this is getting overdone, but I’ve learned my lesson trying to step in front of these kind of moves. As with the S&P would look to take a counter trend scalp off the daily chart on a clear momentum divergence, but my longer term perspective is still up, but with much caution. A shakeout could be nasty. But that’s just my feeling which has nothing to do with how the charts look. I just reloaded the charts to make them look a little shorter. A friend on a MAC thought the charts look a little small, but on a PC they looked fine. I have my screen resolution set to 1280×1024 and it works fine. I may put that in the footer if I can figure out how.