President Obama's administration has not been aggressive enough in fixing the root causes that led to the near economic collapse. In a recent speech, Federal Reserve Chairman Ben Bernanke said that it was regulatory failure, not low interest rates, that were responsible for the housing bubble and subsequent financial crisis.
Bernanke denied any Fed culpability for inflating the housing bubble and blamed the "under-regulated" financial sector which had designed and sold unconventional and exotic mortgage products which later turned out to be toxic.
One may ask why the Fed didn't do anything to limit the use of these mortgages if they were so dangerous. In addition, the biggest issuers of these mortgages were Fannie Mae and Freddie Mac, both government sponsored entities.
Bernanke conveniently ignores the relationship between the popularity of these mortgages and the low, short-term interest rates that made them possible in the first place. It can be argued that without the ultra-low interest rates provided by the Fed, the vast majority of these problem mortgages would never have been issued.
Regulatory reform to curb the banks' voracious appetite for risk-taking is moving through Congress at a snail's pace. While the Treasury has forced banks to raise capital, many still remain thinly capitalized and vulnerable.
Banks have been unwilling to sell bad assets and take a loss. They are stuffed with risky commercial and residential mortgages and consumer debt. While returns for investors last year were zero percent at best, hundreds of thousands of bankers paid themselves hefty bonuses profiting from the taxpayers' largess. For the bankers its "heads," they win, "tails," you lose.
The dose of medicine that the American economy received this past year may have soothed some of the symptoms, but did not treat the root disease. That would mean taking a long-term view, and politicians want short-term results. A major opportunity to make far-reaching changes is being wasted. It was Rahm Emanuel, White House chief of staff, who famously said, "you never want a serious crisis to go to waste." Although he was criticized for being flippant, he was certainly on to something.
As Nobel Prize winning economist, Paul Krugman, wrote in his New York Times column last week, reform will probably not be able to prevent bad loans or bubbles. But it can go a long way in making sure that when the bubbles burst they don't take down the entire financial system with them. The 1990's stock bubble, for example, didn't rouse a financial crisis because the risk was widely distributed across the economy. Here's how Krugman explains it:
By contrast, the risks created by the housing bubble were strongly concentrated in the financial sector. As a result, the collapse of the housing bubble threatened to bring down the nation's banks. And banks play a special role in the economy. If they can't function, the wheels of commerce as a whole grind to a halt.
Why did the bankers take on so much risk, Krugman asks. Simple. It was in their self-interest to do so.
By increasing leverage - that is, by making risky investments with borrowed money - banks could increase their short-term profits. And these short-term profits, in turn, were reflected in immense personal bonuses. If the concentration of risk in the banking sector increased the danger of a systemwide financial crisis, well, that wasn't the bankers' problem.
It is precisely because of that conflict of interest that we have bank regulation, but rules were relaxed and were not expanded to cover what Krugman calls the "shadow" banking system, such as Lehman Brothers that had began to perform bank-like functions. Everything was fine as long as housing prices were going up, with finance accounting for more than a third of total U.S. profits as the bubble was inflating. When it collapsed, it was government aid on an unprecedented scale that pulled the financial industry back from the brink of disaster.
Many commentators argue that unless the Obama administration changes the rules, the incentives for bankers to continue doing business as usual will still be there. Like we said, it's "heads" they win, "tails" we lose.
Krugman argues that banks must be transparent on how much risk they are taking. And finally, reform should limit the financial industry's compensation practices. The American public is justifiably fed up and it will be that much harder to get Congress to approve another bailout if another bank crisis unfolds. Regardless of what Bernanke says, as long as interest rates continue to hover at zero, the risk of other financial bubbles forming around the world remains.
If you have confidence in the policies of President Obama, Bernanke, Congress, and the various central banks around the world, then you can rest easy that the world' s economic future is in good hands. If, on the other hand, you are worried that the politicians and economists don't know what they are doing and that the only growth industries are government itself and the dollar printing presses, than you should definitely own gold.
Moving on to the technical part of this week's commentary let's begin with the gold market (charts courtesy of http://stockcharts.com.)
Gold
Much of what we've written last week regarding the gold market is still up-to-date.
The price of gold moved higher this week, but it was stopped by the resistance level created by the small December top. The history suggests that the gold market often corrects in the form of a zigzag, and the one that we have seen so far is in my opinion too small to say that "that was it".
Please compare the December 2009 downswing to the similar moves in the past that I've marked with red rectangles. Each time correction had two stages, and even the smallest one (June-July 2009) had the biggest upswing within it, than what we've seen in the mid-December 2009. This alone suggests that the current move up is in fact an upswing within a move lower.
The rally in gold was indeed stopped by the closest resistance level and price has been trading sideways since that time. Please note that the performance of the RSI and Stochastic indicators is currently very similar to the way they both behaved in March 2009, after the initial stage of the decline and the following small rally. This suggests that the gold market may need to move lower once again, just like it was the case in the past.
The abovementioned phenomenon is even more visible on the short-term chart.
What was not visible on the long-term chart, but is noticeable on the short-term one, is that gold has been trying to move above the rising support/resistance line (thin rising line) but finally failed to do so. Gold moved visibly above it on Monday but this move took place on a relatively low volume, which usually means that the price will soon reverse.
This is exactly what happened - gold moved substantially lower on Tuesday. Moreover, the downswing materialized on high volume, which is generally a confirmation of the move.
Again, points raised a week ago are still relevant today:
The history repeats itself or at least it rhymes - is one of the old sayings that the technical analysis is based on. The reason is that the human psychology is one of the most stable phenomena involved in the markets. Economies, currencies, even countries' borders changed throughout the history, but the fact that people want to act on reason when their money is at stake, and usually end up acting emotionally is present at all times. Of course, the above is just a general rule, but it can be partially applied today.
One of the time-frames to which the current situation on the gold market is similar is the June-July 2009 downswing, and the similarity is not limited to the price itself. Another thing that serves as a connection between these two situations is the way the RSI Indicator is behaving. In the middle of the previous year, RSI lowered at/around the 50 level after having declined from over 70, and this is also the case today.
(...) I've marked the point in the past (at the end of June), which seems to be the analogy to where we are today. The implications are bearish in the very-short-term, and bullish in the long-term, which is in tune with what we wrote previously.
In one of the e-mails that we received this week, a Subscriber asks if we still believe that gold is likely to reach the long-term price targets that we provided in the November 6th, 2009 Premium Update. In other words - does the current short-term bearish situation somehow invalidate the long-term projection of gold going to $1,500?
In short - the answer is no, the long-term price projections did not change because of the current situation on the PM market. The December 2009 downswing and the subsequent rally may seem a big development from the daily perspective, but taking the whole bull market into account, we see that the recent downswing is really small, and it doesn't change much on the long-term picture.
Moreover, since the upswings in gold tend to be very rapid, the $1,500 area (marked with red ellipse) may be reached regardless of whether it will move up today, or even in a few months. Therefore, the short-term bearish implications of several signals that we feature in this update do not mean that we are less bullish from the long-term point of view.
Silver
The situation on the silver market confirms points raised above. Silver often confirms gold's moves (and vice-versa), and this time the situation isn't any different. Again, points made in the previous Premium Update are up-to-date also this week.
The tendency for the silver to correct in more than one stage is even stronger for the white metal than it is for the yellow one, especially after big upswings. This has a lot to do with the fact that silver is generally more volatile than gold, but I don't want to get into details of this mechanism in this particular essay. The point here is that what we've seen up to date is most likely just a first part of the decline. We doubt that the second part would take us much below the recent low, but it appears likely that it will take some time (a week or a few of them) before the final bottom for this decline is put.
Please take a look at the situation in the Stochastic indicator. During past corrections it formed some kind of double-bottom, after which it rallied to/above the 80 level only to correct soon after that. This is where we are today - at the moment Stochastic indicator has just moved above the 80 level. Should the history repeat itself once again, silver may move lower soon.
Based on silver's performance during similar corrections, it currently seem that it may need to move lower - to the $16 level in the SLV ETF - before it moves higher once again.
The cyclical tendencies on the silver market suggest that this may take place relatively soon.
Silver moved much higher during the past few weeks, but it is now moving lower.
Please note that the volume during the Thursday session when silver rose, was small, which suggests that the buying power is drying up and there might soon be nobody left to push prices higher. Without that, price would fall temporarily.
As far as the RSI and Stochastic indicators are concerned, the situation is analogous to the one on the gold market. Namely, there is a significant similarity between today and March 2009, which suggests that one more move down is to be expected from here.
PMs usually move along with the corresponding equities, so analyzing both markets is useful even if you are interested in trading / investing in only one of them.
Precious Metals Stocks
Once again, there are virtually no changes in the long-term picture of the HUI Index, so we will just include the previous comments, as they are up-to-date also today:
Please take a look at the thin blue lines coming from the same price/time combination. Each of them was pierced, before the final bottom was put in, and this is what I expect to take place this time.
(...) taking the historical performance of the gold stock sector, it seems that PMs will need to move a little lower before putting in a bottom.
The HUI Index has just moved to the rising support line, so if it manages to break below it, this may mean that the final downleg for this correction has begun. Let's turn to the short-term chart for details.
The analysis of the short-term chart suggests that the PM sector might have already begun the second part of the decline.
First of all, please take a look at the volume, which failed to increase along with higher price on Monday. The volume did in fact increase, but during the move lower on Tuesday, which is a subtle clue that these declines are something more than just noise.
We have emphasized in the past that the corrections on the precious metals market often take form of a zigzag, which by itself suggests that another move lower is likely. Moreover, in case of PM stocks, the second part of decline tends to be similar to the first one. Therefore, we have extrapolated the previous move to the current one (assuming that the decline began on Monday), and the result for the GDX ETF is that the bottom is likely to be put in a few weeks at around the $42 level, which is slightly lower than the previous bottom.
Naturally, things may change (and often do) very fast on the market, so we will keep you updated. One of the ways to detect which change may take place is to check what other market might influence prices of a given asset in the future, and then analyze it with appropriate (here: precious metals) perspective.
Correlations
Our correlations table provides details as far as the strength of the influence from USD Index and the general stock market is concerned. These are the two main driving forces behind the short-term (!) price swings.
In the previous Premium Update we wrote the following:
(...) the fact that in the past 30 trading days PMs moved on average in the opposite direction to the general stock market (which is NOT in tune with the historical norms for PM stocks and silver) is very important. These numbers suggest that right now (!) we should not rely on the signals from the general stock market as far as timing PMs is concerned.
The correlation coefficient for silver and S&P 500 is now positive, but it's so low that it practically equal 0. This means that a breakdown in the general stock market does not need to have a direct influence on the precious metals market.
Conversely, the USD Index is still an important short-term driver of PM prices.
USD Index
The USD Index moved lower to the November 2009 high and stopped at the support level that this particular high created. Since it was not broken, the short-term trend remains up, and the dollar is still likely to reach the 80 level, possibly at the end of January / in early February.
Additionally, please note that the dollar's recent decline didn't cause a rally in gold and silver. This is one of the most reliable short-term indicators - if PMs fail to move higher (or even move lower) despite additional few days of lower values in the USD Index, the odds of a further decline in gold, silver and mining equities will be very high.
The short-term USD chart suggests that the next top might be reached in the first week of February. Naturally, the cyclical tendencies that are used on the above chart are not supposed to provide exact time/price combinations, but rather indicate when the next turning point is likely to materialize on a "near" basis.
Clearly, the point made above (the dollar is still likely to reach the 80 level, possibly at the end of January / in early February) is not invalidated by the above chart.
I've mentioned above that the analysis of the general stock market is not very important given the current market juncture, but we would like to provide you with the analysis of this market in case you do decide to own some of the popular stocks. Additionally, it will allow me to maintain the continuity of the analysis.
General Stock Market
The situation in the main stock indices didn't change much from the last week. Back then we wrote the following:
The long-term chart of the SPY ETF (proxy for the general stock market) informs us that the 50% Fibonacci retracement level has been taken out, although the testing took about 2 months. The volume did not increase lately, so points made in the previous Premium Updates are still up-to-date, namely, that the buying power is drying up, which means that the top is likely to emerge sooner or later. The key question remains - when, and exactly how high.
Since the 50% Fibonacci retracement level has been broken, the next serious resistance is just above where we are today - in the $116 - $118 area. The upper border of this range is created by the most classic Fibonacci retracement level - 61.8% - the $117.87 level. The lower border is created by the July 2008 bottom - the last visible bottom before the major plunge. Additionally, this area is the place where the price used to trade just before the dramatic fall.
The SPY ETF didn't move above the levels mentioned above, and other points made a week ago are also relevant at this moment, so last week's comments are up-to-date also this week. Let's look for confirmation/invalidation on a short-term chart.
On the short-term chart one can see that the SPY ETF moved above the short-term and verified that breakout. This is a short-term bullish signal (even though the last session was not characterized by high volume, and it corresponds to the points raised earlier - namely that the SPY ETF may need to move to the $116 - $118 area before the top is formed.
Another confirmation that the main stock indices are likely to move lower sooner or later comes from the Nikkei 225 Index.
The Nikkei Index has been rallying after a substantial decline. The particularly interesting thing about this behavior is that it moved substantially lower along with relative strength in other world stock indices, and is now outperforming. We've already explained why it may serve as a bearish indicator, but since it was over a month ago, we believe are reminder would be useful.
Assuming that the performance of the S&P 500 is average, we can speak of NIKKEI as the worst performing index, and other indices featured on the above chart as outperformers. Generally, markets have fractal nature, meaning that they are self-similar. The pattern that is visible on a daily chart may be visible also on a monthly chart, and often research done on one group of assets becomes useful on a totally different occasion, given that some similarities are preserved. This time, the relative performance of indices can be analyzed very similarly to the performance of individual stocks. I have already written about the specifics of this analysis while describing details of calculations behind one of our unique indicators, so I will just focus on the current implications without explaining the same thing all over again.
The point is that pros usually own the best stocks (also those from the main stock indices), enter the market early, and leave early. The general public often does the opposite - people pick lagging stocks (often with weak fundamentals) in hope that they will catch up, and do so near the end of the rally. This is why laggards often "outperform" during the final stage of a particular upswing. Consequently, best stocks are often first to top out, while the worst (given similar market capitalization of companies, because good, small companies also behave like weak, big ones) thrive near the end of a rally. The more evident this phenomenon is, the closer a particular market is to a top.
Now, keeping the abovementioned points in mind, please take one more look at the chart of the main stock indices. The strong indices failed to move to new high
s - they are acting weak, while the laggard - NIKKEI - has just rallied. Consequently, we have another confirmation of the bearish situation on the general stock market. Before asking "so why are the prices not moving down right now?", please note that this is a long-term top that we are talking about here, not a short-term one, so it takes a considerable amount of time for the top to be formed.
Juniors
There is one more thing that I'd like to comment on this week, and that is the situation in the junior sector. While this is nothing new to you, if you've been following our commentaries for over a year, it seems that it may prove useful to remind this part of our analysis to new Readers. In the essay posted on September 19th, 2008, we wrote the following:
(...) junior/senior ratio is reasonably correlated with the general stock market. This is another thing that justifies the severity of this decline. As the stock market fell, the junior/senior ratio plunged as well. The marked rectangles on the chart are periods where juniors rallied relative to the HUI Index - it was accompanied by a rise in the general stock market. The question is what will happen next on the main stock indices.
The juniors have been rallying recently, but so did the general stock market, which is another confirmation of the points raised over a year ago. Since the general stock market is likely to move lower sooner or later, it may mean that the juniors' outperformance will also disappear for some time.
Please note that the correlation matrix also includes details of influence USD and main stock indices have on juniors (CDNX - the Toronto Stock Exchange Venture index is used as a proxy), and numbers imply that the general stock market has a very strong influence on the junior sector.
Consequently, if you are heavily invested in juniors, you may want to consider switching at least a part of your holdings into big, senior PM stocks, bullion, even cash (depending on your investment preferences). If you are risk averse, switching from juniors into physical gold/silver, seems to be a good idea. For more information about structuring your portfolio, please go through the Key Principles section.
Moreover, please note that our SP Junior Long-term Indicator is likely to suggest moving out of the junior sector with at least a part of one's capital (indicator is above higher dashed line and is about to fall below it).
You will find more information about this indicator on the bottom of this page.
Naturally, there much more to the junior sector than just the high correlation with the general stock market, but the latter is currently too important driver of juniors' prices to ignore it. Other factors, such as the accelerated appreciation of stocks that are priced very low on a nominal basis are likely to come into play once PMs are considerable higher - above the previous high.
Summary
There are no big changes since last week's analysis was posted. The very-long-term price projections are still in place and paint a bullish picture for long-term investors holding gold, silver, and corresponding equities. On the other hand, the short-term outlook remains bearish for the precious metals market. Based on the most recent data, the next speculative buying opportunity is likely to emerge at the end of January or at the beginning of February.
The situation on the general stock market doesn't appear to have large influence on the short-term direction in which metals or big senior PM producers go, but it does influence the junior sector. Consequently, you may want to consider limiting your exposure to this sector in the following days.
On an administrative note - the next two Premium Updates will be posted earlier (on Thursday, 21st Jan, 2010, and on Wednesday, 27th Jan), because of my travel schedule. Thank you for understanding.
This completes this week's Premium Update.
Thank you for using the Premium Service. Have a great weekend and a profitable week!
Sincerely,
Przemyslaw Radomski
