The Federal Reserve acknowledged this week that its confidence in the economic recovery had diminished and announced that it would use the proceeds from its huge mortgage-bond portfolio to buy long-term Treasury securities (thus creating additional demand for long-term bonds causing their price to rally, and consequently trying to push the long-term interest rates lower).
With the recovery losing momentum (as measured by the stock market), this was a change of heart by a central bank that has spent most of the last year winding down its aggressive measures to support the economy. The Fed pledged to keep the amount of assets it holds unchanged at $2 trillion rather than allow the level to taper off over time. Again, the decision should help keep long-term interest rates, such as those for home mortgages and corporate loans, a bit lower than they otherwise might have been. The larger significance of the decision is what it signals about Fed officials' view of the economy, and about their willingness to do more if economic conditions worsen.
The announcement was a signal to the markets that the Fed was concerned about the pace of the recovery, and had shifted from its more optimistic assessment earlier this year, that economic growth was sufficiently strong to begin thinking about how to gradually return to normal monetary policy.
The day after the announcement, shares on Wall Street retreated with stocks falling 2 percent or more just before noon. Investors had also been looking for signs that Asia can pick up some of the slack but data from China and Japan came in weaker than expected on Wednesday, reigniting concerns that the global economy is recovering at a less robust pace than hoped. It seemed like bad news was coming in from all directions.
Mohamed El-Erian, CEO of PIMCO, the giant bond fund, yesterday wrote in a guest column in a Financial Times blog that there are three US related drivers to the sharp sell-off in equities on Wednesday, together with a further rally in US government bonds.
The first is the obvious one, Tuesday's FOMC statement that confirmed that the US economic recovery has lost momentum. Wednesday's export numbers amplified the message given by recent employment, housing and retail sale reports.
El-Erian suggests that there are two other, less obvious factors:
Expectations of outcomes have evolved in an interesting manner - from the more familiar bell curve (a dominant mean and thin tails) to a much flatter distribution with fatter tails. In such an expectation world, short-term news can have a disproportionate impact on market valuations.
Perceptions of fatter tails - just witness the increasing talk of a double dip and deflation - also speak to the third factor behind Wednesday's violent market moves: when you are potentially on the road to deflation, a small change in probability will have an amplified impact on markets.
In a way - this is a sophisticated way of saying what we mentioned last week - that the general stock market is at the crossroad, and whichever way it finally decides to take could take it far - in that particular direction.
El Erian says that in his opinion the risk for deflation is now 25 per cent and that is also having an impact on markets. He says that most likely, markets will remain nervous and volatile in the weeks ahead.
We should expect further downward revisions in analysts' growth, revenue and earnings projections. It will take time for markets to adjust to the reality of a flatter expectation distribution and fatter tail. And the probability of deflation will have an impact even though it's not dominant.
El-Erian asks an interesting question about the issue of deflation:
Would you accept a lift from a person who has a one-in-four chance of getting into a really bad car accident?
Just how low can interest rates go?
Buying more Treasury bonds has its own pitfalls. In effect, the Fed will be printing money to fund U.S. budget shortfalls, which could fuel fears that the central bank is making it easier for Congress and the president to continue running large deficits. That in turn poses the threat of inflation getting out of control.
The Fed is able to pump money into the economy by buying bonds -- in effect, it creates money out of thin air and uses it to pay investors for the bonds. This helps push interest rates down, which should make it cheaper for Americans to consume and invest (except investing in bonds of course). However, if Americans lack confidence in the future, low interest rates may not be enough.
Bill Gross, a managing director at Pimco, said the jobs report strengthened his argument that the economy and the job market would remain weak for the next few years. He calls this unhappy situation "the new normal" for the American economy.
The lower interest rates are good news for people borrowing money, but bad for those squirreling it away in bank accounts and money market funds. The average one-year certificate of deposit now pays 1.3 percent a year. Such meager returns are particularly painful for people living on fixed incomes.
But rates are unlikely to turn higher soon, economists say (and we agree). In fact, they could fall even further. While the Fed cannot lower its official federal funds rate much more -that rate has been stuck at 0.25 percent all year - it can ease credit in other ways.
The Season for Gold is Fast Approaching
We believe that the best place to park your money is in gold and precious metals. We're quickly approaching the Indian post-monsoon wedding season, which starts in September and has historically been a bullish time for gold prices. In November we look towards one of India's most important festivals, Diwali. Also, during the fall, jewelry makers in the U.S. and Europe stock up in advance of the Christmas shopping season. And in China, there are two big gold giving opportunities: the weeklong National Day celebration starting October 1, and the Chinese New Year in early 2011. Generally, the abovementioned events are visible in the seasonal charts - which at the same time suggest further consolidation until the end of month.
A Sign of Things to Come?
Colorado Springs, Co., is shutting off street lights, flipping the switch on about one third of the city's 24,512 street lights hoping to save $1.2 million in electricity. The city slashed by 75 per cent the budget for the city's parks, even taking away the garbage cans. The city's citizens are supposed to remove their own garbage after the family picnic. All the restrooms have been closed. There'll be very little watering, and gardening crews will mow the grass just once a month instead of weekly. The city even trimmed its police and fire budgets and is reportedly considering auctioning three of its police helicopters on the Internet.
Essential services that American citizens have come to expect for generations are slowly disappearing as cash strapped municipalities and states are facing bankruptcy.
"The lights are going out all over America - literally," wrote Paul Krugman in a rather dramatic essay in this week's New York Times column.
Most cities depend on sales taxes for revenue, and Americans just aren't spending like they were a few years back. Across the country, cities will have to fill budget gaps totaling up to $83 billion through 2012, according to the National League of Cities.
Krugman wrote the following harsh words:
Everything we know about economic growth says that a well-educated population and high-quality infrastructure are crucial. Emerging nations are making huge efforts to upgrade their roads, their ports and their schools. Yet in America we're going backward. America is now on the unlit, unpaved road to nowhere.
With September just around the corner let's see how we expect gold to perform in the upcoming weeks. Let's begin this week's technical part with the analysis of the Euro Index. We will start with the long-term chart (charts courtesy by http://stockcharts.com.)
Euro and USD Indices
We must begin this week's technical analysis section with a comment on the long-awaited correction, which alas is clearly seen in the week's long-term Euro Index chart. After a move above a key resistance level, confirmation did not occur, and subsequent days saw a decline below this level.
In last week's Premium Update, caution was suggested and a period of consolidation was termed likely. "For the short-term we remain skeptical towards a continuation of the rally in the Euro Index until we see confirmation for a breakout or consolidation. The latter still appears more probable."
Once again, applying hard and fast rules as part of our technical analysis and interpretation resulted in the right call rather than unwarranted optimism. The reason for this comment is that we would like to emphasize the need to wait for a confirmation instead of chasing the market.
The short-term Euro Index chart this week provides a clearer picture of the correction we mentioned above. Note that the RSI has moved below the 50 level and the Euro Index itself is very close to the first Fibonacci retracement level which is based upon the previous rally. The long-term declining resistance level will now likely become a support level, as it intersects with the key 61.8% Fibonacci retracement.
This means that there is a strong possibility that the euro will decline again in roughly the same amount as we have already seen. This will result in a target bottom, slightly below or at the 125 level. At this time, it does not seem likely that the bottom will move to levels seen last June, but we surely can't rule that out completely. Indications are that 125 is an accurate minimum target for the current decline. This seems to be about 50% likely with a 25% chance that the bottom will be above 125 and a 25% chance for moving below this level.
In this week's long-term USD Index chart, we see a slight rally, which was expected in view of the Euro Index decline. This is consistent with what we stated in last week's Premium Update. We identified a possible profit opportunity for FOREX traders with a rise in the dollar likely. This turned out to be right on the money.
From a precious metals perspective, there is little to be said at this time. The impact of the currency markets this week has been minimal, yet positive. However, it is still possible that gold and silver will move higher in the next few days and this will be discussed in depth later in this update. Additionally, it is still likely that the precious metals sector would decline towards the end of August.
In the recent past, gold, silver, and mining stocks declined slightly when the USD Index showed a strong rally. This was followed by a consolidation for the USD, which coincided with a precious metals rally. All in all, the precious metals sector has shown strength in relation to the dollar.
There is a possibility that much of this is simply a result of gold's inevitable rise to levels seen last December. There is still a high probability that any near-term rise will be followed by a subsequent decline later this month. As always, we will continue to monitor the situation and report to you accordingly.
In this week's short-term chart, we see a higher, broader and bigger target for the short-term rally in the USD Index. The strong momentum seen recently has been surprising and our prior target range has already been reached. It is possible that the USD Index could move as high as 84. Its next turning point may be seen relatively soon. A top in the USD index will likely correspond to one for precious metals as well.
Other than the above, the relationship between gold, silver and mining stocks and the dollar remains unclear at this time. Turning points may coincide, but it is a situation, which must be continuously monitored. As always, Sunshine Profits will be up to the task.
Summing up, last week's view for the short term was quite accurate and we now see a possibility of higher USD Index levels in the coming week. The Euro Index will likely decline again in the week ahead, continuing the trend, which took hold during this past week. Precious metals are likely to move slightly higher in the short term but we remain bearish for the next few weeks in advance of an expected late summer low in much of the precious metals sector.
General Stock Market
In the long-term chart for the general stock market, we see major developments this week. Stock indices failed to break above the declining, blue resistance line. Last week we stated that the market was at a crossroads, and it seems clear at this point that the lower road has been taken. We have seen several days of consecutive lower closings.
This may, in fact, be a continuation of the head-and-shoulders pattern, which seemed finished last week. Movement during the month of June, which was thought to be a right shoulder formation, may in fact have been a continuation of head development. Likewise, late July to early August possibly formed the next shoulder. In any case, we cannot yet close the book on this important technical stock pattern.
This is, of course, a bearish development for stocks in general. It is possible the SPY ETF will decline to the 90 level. We are, however, not overly bearish. Declines have been small, except on a very short term basis, and in reality, the declining black line has not yet been touched in the above, long-term chart. Although high volume levels have been seen confirming the downward move, it is uncertain at this time whether a bigger decline is likely. The next few weeks should clarify this.
In this week's short term chart, volume levels have risen as prices have declined. This is a significant development. The SPY ETF is presently above the support line, which lies slightly below the 106 level today. The RSI is far above 30-level which often signifies a local bottom. For these reasons, the short-term trend is likely to be down. There is simply too much evidence to ignore in support of further declines.
Gold, silver and mining stocks responded positively to recent moves in the general stock market. This could be viewed as a bullish sign as could be a result of investors hedging their bets by buying positions in precious metals stocks. It is too early to draw conclusions from this phenomenon. Decreasing stock prices and elevated prices for gold must be analyzed further on an ongoing basis in order to accurately forecast likely trends.
So let's look at what is likely to happen next. Perhaps once stocks move below SPY ETF 106-level and precious metals move higher, a turning point will be seen as stocks bottom and precious metals reach a local top. At this point, however, this is pure conjecture. We will continue to monitor gold, silver and mining stocks for more reliable indications as to the next direction for the sector as a whole.
This week's the Broker/Dealer (XBD) Index - proxy for financial stocks - confirms the direction taken from last week's crossroads. It is possible that the week ahead will reveal another assault in this index on the 110 level, but at this point we see no signs of a bottom
Summing up, the general stock market is now slightly bearish with likelihood of becoming much more bearish. This does not influence gold to a great extent, but it does influence silver and - to some extent - mining stocks. It seems that the next local top in the precious metals sector could form along with the next turning point in the main stock indices.
Correlations
This week's correlation matrix confirms points made earlier in this update. There are no clear signals gleaned from neither USD nor general stock market coefficients. Precious metals are strong relative to what we've seen in these other markets, and in the very short term, this is likely to lead to higher prices for gold, silver, and mining stocks.
Many of the correlation coefficients in the table are lower than 0.5, which indicates the correlation is quite weak. Even gold and silver show low correlation for the past 10 days when compared to prior periods. These two metals often move together, but this has not been seen recently. Silver has followed the general stock market trends more so than gold and therefore has shown a greater decline in price. This confirms that silver is more vulnerable to weakness in the general stock market.
Summing up, the correlation matrix doesn't provide us with clear evidence of any short-term tendency at this point, but it doesn't invalidate the statements made earlier - that the next turning point could take place at the same time for gold, silver, mining stocks, USD Index, and also the general stock market.
Gold
The long-term gold chart this week shows little change from our last update. Volatile sideways trading has been seen and our previous suggestion for exiting this market appears to have been on target.
The next local top is likely to be formed soon and the RSI levels confirm this. Normally, after an initial period of decline, the contra-trend rally will show an RSI in the range of 60. We are presently just above the 58 level. The fact that we are close to 60 suggests that a local top is near. The Stochastic indicator also suggests a top is possible quite soon.
In the short-term chart this week, we see more details supporting our previous discussion. This chart provides likely target levels and allows us to make more detailed calls as to entering and exiting the market. It seems possible, at this time, that gold may approach the previous December 2009 highs before declining - and yellow metal's response to the action in USD Index and main stock indices supports this idea. We are monitoring this situation and will continue to do so as we seek further confirmation of this possibility.
High volumes in the GDX SPY ratio or low volumes in gold or gold stocks along with higher prices would surely increase the probability of such a move. We have yet to see these signs.
At this time, we have not seen sufficient evidence to allow us to state that gold is likely to reach levels seen late last year. Most notably, volume levels have been within normal trading ranges. We will continue to monitor the markets for signals and as always keep our Subscribers informed with a Market Alert or subsequent Premium Update.
Based on analysis of previous technical indicators, such as trend direction and seasonal factors, it seems probable that we will first see a local top around the $1,225 level, then lower prices until the end of August or perhaps early in September, and then the next big rally would form.
From a non-USD perspective (valuable for instance to Investors/Traders watching gold priced in the euro, sterling, or rupee), it also seems that gold is approaching a local top as is gold in USD. The 50-day moving average seems to be a resistance level. This average has provided strong support or resistance on many past occasions, so we shouldn't ignore it here.
Keep in mind that gold in non-USD currencies will likely trend similar to USD gold markets, that is local tops may very well coincide. Regardless of currency, gold Investors and Traders will be impacted in a similar fashion and Market Alerts will be issued when warranted to advise Subscribers of important developments in any and all world markets.
Summing up, higher gold prices are likely in the short term and a subsequent decline is expected to follow. The top is likely to be seen soon (perhaps close to the $1,225 level) with a bottom possible around the end of August. The formation of another rally would likely be possible in early September.
Silver
In the very long-term chart this week, emphasis is given to the TRIX indicator, which has declined somewhat in the past weeks. This is a bullish signal for the long-term as important developments usually occur after the TRIX reaches zero. There is a possibility that this level may be reached in the relative near-term, possible once we've seen the end of the summer decline that we've described in the gold section. A sharp decline in sliver's price could cause a substantial decline in the TRIX, which would be a healthy and normal development for the market. The decline might appear scary at the first sight, but if it does materialize - please keep in mind that it's something that will allow the market to move even higher in the long run.
Previous "second" rallies for the white metal have often been followed by declines after silver failed to move above previous highs. After that we've used to see corrections that took silver much lower - correcting 50% of the preceding rally. Silver may or may not get this low in its next decline.
The current retracement level is based on the 2008 low and the 2010 high. Since the 2008 decline was generally an unordinary development, the $14 target (as visible on the chart above at the 50% retracement) might be too low, and perhaps the $16 level would hold.
In fact, this level could be reached on an intra-day basis only, with the closing price slightly below $17 - at the rising thick blue support line. Recent weakness in the general stock market is contributing to the weakness in the white metal. A plunging stock market will likely cause a severe decline for silver and the TRIX as well. However, this would be truly healthy for long-term silver investors.
From the speculative point of view, a move lower is likely but it is probable that silver will move slightly higher (not necessarily above the early-August high) before declining. As far as downside target is concerned - indications are that a decline slightly below the $17 level is very possible.
The analysis of volume confirms this bearish outlook as low volume has accompanied price increases and higher volume coincided with declines. The Stochastic indicator and the RSI also point to the same outcome.
Summing up, silver is likely to move slightly higher and then to decline significantly in due to influences of the general stock market and also from its bigger brother - gold. The first support level is around the $17 level, and the next one at $16. We'll have to see how silver performs relative to gold during the decline to state which of these two levels is more likely mark the final bottom for this summer.
Technically, lower silver prices will be healthy not only for silver but also for gold and mining stocks as well. We have seen massive rallies quickly follow severe declines in silver's price. This may, in turn, eventually lead to higher silver prices, possibly the next rally would take silver to $25 - $35 area.
Precious Metals Stocks
The HUI Gold Bugs Index shows that mining stocks moved below the rising trend channel and then failed to move back into the channel, thus verifying the breakdown. Once confirmed, much lower prices are possible.
Mining stocks have held up well with the general stock market in heavy decline and the USD index rallying strongly. Overall, mining stocks have been impacted minimally during periods, which saw silver decline and gold move slightly upwards making it somewhat "middle choice".
Expectations here are similar to what we stated for gold as a slight increase is likely to be followed be a decline to late summer lows. Confirmation is needed before opening speculative short positions for instance by buying put options.
One of the things that we are looking for is confirmation from the GDX:SPY ratio.
As mentioned many times in the previous updates, a highly reliable sell signal is provided when the ratio moves higher and encounters a resistance level, and it takes place on huge volume. Moreover, if the RSI is close to the 70 level, the odds that we've just seen a top increase further.
The RSI in the week's GDX:SPY chart is very similar to what was seen at the end of 2009 and suggests that declines will be probable once we move just a little higher - thus causing the RSI to move closely to the 70 level. Based on the relative strength shown of late, an additional small increase is likely before the local top is reached.
Presently, the RSI is above 59 and within striking range of 70 relatively soon. Higher prices in the GDX ETF and lower prices in the SPY ETF along with high volume in the ratio will likely provide a sell signal. Obviously, this situation will be monitored closely and we will report to you accordingly.
Summing up, the situation in mining stocks is similar to the one described above for gold and silver - we are likely to see a small upswing in the next few days, followed by a bigger decline, which would then end around early September.
Other Information
We have received several interesting questions from our Subscribers this week, and while most of them were answered in other parts of this update, we would still like to comment on one of them separately. The question is what impact is this [the scenario, in which we would not see a meaningful correction soon] likely to have going forward into the autumn months (typically rally months)? Does the absence of a meaningful correction bode well or does it suggest a stagnant price window? In all of this ... when would you suggest an optimal "long" entry point would be?
Beginning with the latter part of the question - it seems that the next buying opportunity will emerge in early September. This may change as we get more information in the following weeks, but based on what we have today, it appears to be the most probable outcome. Should the meaningful correction not materialize, we would need to reassess the situation and look for other clues, but generally - the lack of decline would not make the following rally less probable. However, in our view, it could make it less spectacular - meaning that gold would move higher, but not necessarily above $1,500.
Summary
The USD has rallied since our last update and is likely to continue in the week ahead. In turn, the Euro Index declined and indications are a further decline is likely. The general stock market movement of late, with a slightly bearish bias.
Recent strength shown by mining stocks may result in some upward movement in the very short-term. The same holds true for precious metals in coming days. However, it is important to note that these moves will likely be temporary and followed by declines downward to the long anticipated summer lows. This may, of course, provide a great opportunity to bet on lower prices soon, and - once the decline is over - to add to one's long positions.
The local top may be close (perhaps around $1,225 for spot gold - very-short-term targets for silver and mining stocks are unclear), but we need to wait for more signals before we suggest betting against the major trend (which of course is up for the precious metals sector). As always - we will keep you updated.
This completes this week's Premium Update.
Thank you for using the Premium Service. Have a great weekend and profitable week!
Sincerely,
Przemyslaw Radomski
