Precious Metals, Gold And The Equity Markets

I believe the last significant post on gold was July of 2007 when we highlighted Newmont Mining around $38. At that time we said gold would have to rise or oil fall in some variation of a relative pricing relationship. That very week was the actual turning point in the gold & oil ratio as measured by the oil index and Newmont. As we expected the strength of gold increased. In fact gold has risen by nearly 50%. Much more than I expected. But, the size of the move simply validates the global imbalances we have been talking about. This is not a housing crisis or a subprime crisis. Those were simply the first measurable outcomes. This unfolding environment would have come to pass even if there weren't a subprime or housing crisis. In other words, this is an unfolding economic crisis whose foundations really have nothing to do with subprime. Therefore, market discounting has yet to be realized.

How about another gold update. This time let's look at the top performing precious metals fund over the past five years; U.S. Global Precious Metals. The fund has had unique pricing action of short bursting rallies rather than sustained trending action over this cycle. Rallies were followed by resting then rallies then resting. Notice that positive pricing action in the fund happened in 2001, 2002, 2003 and 2005. Do these dates have any significance to you? Anyhow, I expect the next big move to be in 2008. And I expect that move to be down. Of course, I am anticipating fundamental factors leading to this move and I'm reasonably comfortable with these fundamentals developing into a tipping point. (More on this in a later post.) It's simply a matter of when. On that note, the fund attemped a false break out of this recent resting period back in December. It failed rather substantially. Watch the current consolidation or resting box pattern for a break above or below the consolidation box. You can follow the pricing action over the coming weeks and months at the chart link here.

As I wrote, people are looking to the 2000-2003 bear market for guidance on this market. And, that using it as a template was erroneous because technical analysis is a function of fundamentals and the fundamentals have nothing in common. In other words, looking at market measurements is not really useful over the long term unless one understands the 'why'. This is one reason why technical analysis has a poor reputation and weak track record over decades. Fundamentals really determine technicals. Were we following the last bear market script, we would have already seen a very sharp and significant rally in the S&P 500. Yet, we have seen nothing. If we do get a sell off in gold, I expect global asset markets to make another major push down in sympathy. Exactly when? That's the big unknown but I would guess some time before summer. I expect any move to be sooner rather than later given the market is storing up significant energy for what will likely be a big move within the next two weeks. Given we are nearing the end of the month, I don't discount a move up followed by a move down or a move down or a move up. But, to date, there are no buyers. So, for any positive move, we would need to see a miraculous epiphany that value exists at these levels by investors heretofore not willing or able to partake in this market since July of last year. In other words, unless buying picks up substantially we are going to see that energy resolve itself to the downside. Frankly, as I wrote before, I'm not sure buying can pick up. A reflection of fundamentals rather than chattering that the market is oversold. Of course it is oversold. A point not lost on anyone. Yet still no rally.

My trading model is still short and that supports a position of down being a likely outcome. Most everyone is calling for a rally because we are 'oversold' or a generally trendless market that makes little movement in either direction. My work is showing a spring is being loaded that is likely to pop soon. There's another reason I am short term concerned and I'll try to get it posted soon if I have the time. But as of right now, the bulls are still trying to shove higher. There was alot of buying into the last four weeks but the door has been slammed hard. Returns in the S&P are negative since the day following the mini crash last month.

The consequences of this virus are substantial, well beyond what is generally being discussed, and immediate. One need only look at the crisis developing in the Russian banking system we discussed earlier this year to see how severe, rapid and far reaching this economic crisis is. If the Russian banking system, as an example, teeters, the world as we know it could very well be over for the Russian economy for some period of time. Just one example. In the U.S. we've already seen the Institute for Supply Management reading have the largest one month decline in its history. And, just like the retail numbers we talked about a year ago as being some of the worst on record, we hear much of the same apathy responding to the ISM numbers. That being, generally that this ISM number is not to be trusted as it dropped too rapidly to be accurate. A confirmation of foolishness.

To wrap up, short term predictions are very difficult but a rather unpopular position here is that we are going to see another large push down. Nearly everyone who is anyone is citing sentiment surveys or oversold stocks and their historical accuracy pointing to an imminent rally. Show me a macro environment such as today and I will show you how these anecdotal tools failed repeatedly. How quickly this downturn unfolds depends on many factors. Weeks, months, years? Yes to all is probable. Rallies in the interim? Maybe. Maybe not. Ask Japan about stock market rallies during their economic unwinding.

One final comment. I've heard people recently stating that the Transports are picking back up again and signaling an economic recovery. We've heard this before. Right near the market top last year. I wrote about Dow Theory in 2007 here. Dow Theory is anecdotally interesting-and being misinterpreted by many-but let's be very clear, the only equity index that matters in this market is the S&P. Period. When I see something constructive in the S&P, I'll re-evaluate my short term outlook.