Market Update 03/04/2009

March 4, 2009 · Posted in Weekly Posts

Global equity markets bounced today on favorable news from China and oversold conditions most everywhere. The news from China was two-fold. First the Chinese government is adding even more funding to their massive stimulus plan. Their plan, unlike ours really focuses on improving their competitiveness, building out and improving their infrastructure, bringing health care to the villages and investing in technology. Anyone who listened to the Chinese Premier at Davos understands that they have a far more comprehensive, strategically focused plan than the gab bag we have. Nonetheless, the news was greeted so positively because we also heard that the Chinese purchasing managers index climbed for the third month in a row indicting that there is some early trend emerging of improving conditions. Given the oversold conditions world wide and the continuing spate of bad news this was enough to ignite a global rally. Wonderful but..we don’t think it has legs. Volume was ok but nothing that great and the markets in the US retreated into the close unable to keep their gains - yes, there is no pleasing some people.

Here is the chart of the S&P:

S&P 500 03/04/2009

If you compare the behavior of the last two days with the bottom Oct 10th and the other bottom in late December the previous two down days do not look as cathartic as during the previous two bottoms and today’s rise looks weak as well. We still are of the view that US equity markets are fundamentally impaired and so we are not participating. The importance of the US equity direction is what it implies for the markets that we do care about and that we believe are fundamental to the trajectory of this crisis namely the US dollar, Treasuries and gold.

Treasuries retreated today helping our short positions extend their gains. Here are the plots for PST and TBT. Note the back and forth action over the last few weeks. The up days in both are when the bond market is worried about supply, the down days are worries about either economic weakness, Fed intervention, or the proverbial “flight to quality”. Talk about a market that cannot make up it’s mind! However, in both cases we see an uptrend beginning after they have both held their support levels very well. What we expect is that there will be some form of breakout to the upside (bond price decline, bond yields rising) in the next few days. This may be caused by the supply issue impacting the auction next week (yes, another auction and another $60 billion or so in new debt for the US taxpayer) or it could be money flowing out of Treasuries to support an equity rally. We’ll know more when it happens but technically we look good for these positions moving forward.

PST Leveraged 7-10 Year Treasury Bond Short

Leveraged 20 Year Treasury Bond Short

Technically, the triangles drawn on each of the plots typically mean the price will move in the direction of the previous trend when it breaks out of the triangle. In our case, the trend was up.

What about gold? Gold looked healthy right up until it didn’t. As we stated earlier in the week we eliminated our long gold and gold stock positions Monday and went short on Tuesday. We are still short. Gold has declined for 8 days straight and today’s action did not look like a bottom. Looking at the charts for the past few months it would be reasonable to expect gold to re-test the 880 level. That could occur Thursday or Friday as spot gold actually broke 900 briefly today. If it breaks that then we are looking at the 700’s for the next major trend line. Gold mining stocks went down hard Monday, worse than the S&P, and have found little support since then. We expect they are in a strong move down now as well.

What has happened is that the market has gotten ahead of itself. The high price has attracted a huge amount of scrap gold to come to market (old jewelry largely). This volume of gold entering the market has been double the amount of buying from the ETFs. Even though the demand for gold coins is high and mints world wide are running at capacity it is their manufacturing capacity that is limiting coin production and increasing coin price, not the gold price. In an environment such as this any relaxation in buying by the ETFs, which began happening last Thursday, results in a vacuum of demand and the price drops hard. Fortunately, the inverse ETFs offer a great way to play this. We are using DZZ which is a double short giving 2X the move. We still believe that global concerns for fiat currencies will drive gold much higher before normalcy returns to the markets but that is clearly not going to happen in the next few weeks. Until then, we are short. We will identify potential rally points as we find them in both the miners and the metal.

Here is gold’s continuous contract for today:

Gold Continuous Contract 03/04/2009

Long Term Gold Continuous Contract 03/04/2009

Looking at the short term chart above (the first one) we see that gold will come back to its near term trend line around 880. This is a region that it has fought to get through and stay above in the past. However, looking at the second chart we see a longer term picture that is more ominous. This chart shows that the longer term trend would put gold back into he low 700s. Some are calling this a double top in gold. We’ll see. What we need to realize is that gold has experienced some very precipitous falls in the past. This may be one of them.

Gold’s behavior may be telling us that the first chapter of he economic crisis is ending and that we are entering a period of greater stability though economies continue to worsen. Time will tell.

Finally, what about the US dollar?

Here is the chart of the US dollar index as of today. The blue lines show a necking down of activity as the index moves higher. This can go further certainly but the necking down does give an indication that we may be getting near a top.

US Dollar Index 03/04/2009

So how does all this square with our fundamental views that we would see a dollar decline and a flight to precious metals globally? We still think this will be the case but the path to get to that point is more circuitous than anticipated. We have seen the Yen lose its reserve currency status and begin what is expected to be a long descent. The Euro is at risk of failing. Both of those events, together with the ructions in Eastern Europe have sent money into the dollar and into gold. Despite the dollar’s strength Treasuries have lost ground, indeed they have experienced some of the worst weeks in history lately for bond investors. Gold, though a proxy for safety, has been swamped by hot money treating the ETFs as a short term stock. The buying of bullion and coins is continuing unabated so the safety and wealth preservation trends globally are still very active but that buying and “sunk” supply is not yet sufficient to make the metal scarce. We have no inflation, and though doubts have been emerging about paper currencies, they are not sufficient yet to drive gold to the stratospheric heights some believe will occur.

Readers should remember that our thesis rests on a vastly inflated US debt dragging down the dollar and driving Treasury bonds substantially higher. Gold will play into that but it is not the cornerstone. It is the recipient of the move, not the driver. In the meantime we will treat it as we would any asset class that is important to our world view. We will listen to the market and trade accordingly.

Coming Up:

We recently published two additional Members Only posts.

The first is “Gold In Depth” where we look at the health of gold’s bull run and examine in detail the risks gold investors need to be aware of. This is especially relevant now as many of the risks we highlighted have come to fruition.

The second post is an “Update on China” as a lot has happened in the past two weeks.

We have recently published two additional Members Only Posts China: Part 1 dealing with how to time the entry point into the Chinese equity market and China: Part 2 dealing with the interaction between China and the US in the areas of bonds, the dollar and inflation.

We recommend the following posts as especially relevant at the moment:

China: Part 2 - Bonds, Dollars, and Inflation”.

“The Fed and The Bond Market - Will Intervention be Effective?”

“The Coming Bond Debacle”

Fundamental Trends

“How a Reserve Currency Collapses”.

“Gold - Reluctantly”

“Why is the Dollar Going Up (and When Will it Stop)”

To view previous Members Only posts simply follow the instructions under the “Become a Member” tab and select the “One Month Free Membership” when you get to the Products page. You must complete the checkout process in order for the Membership to complete. Registration is not sufficient. You are under no obligation to continue beyond the One Month Free Trial and your e-mail and address will not be shared with third parties.

We are entering a critical period of time in the bond and dollar markets staying plugged into what is happening and the likely ramifications is especially important now - stay informed with Murdock Global Insight.

We hold the following positions as of 03/04/2009:
Short Treasury Bonds through PST and TBT*

Short gold through DZZ

Long Australian dollar through FXA**

*ProShares leveraged short ETF. Investors need to understand thoroughly the risks associated with these leveraged products in light of their personal investment needs and risk tolerance. They may not be suitable for all investors.

** Position is currently in loss but we are sticking with it as we believe the fundamentals are in our favor.