Preparing for Volatility Part 1

August 29, 2009 · Posted in Strategic Insight

This weekend we are posting two related articles on preparing for what we believe will be a sharp increase in volatility in the weeks ahead. The first, which you are reading, surveys the technical landscape of US equities, bonds, the US dollar, the VIX index, and gold and concludes that multiple interlocking markets are presenting consistent, complementary pictures of an imminent direction changes in equities, bonds, and the dollar.

In Part 2 to be published Sunday we will examine our strategy for playing this. Part 2 will be a Members Only Post. If you are not a Member the Become a Member page has instructions.

Summary: In the charts that follow we show that US equity markets, binds and the US dollar are all apparently signally direction changes. The VIX index, a measure of volatility, is also showing distinctive chart patterns indicating that volatility is set to rise and rise perhaps significantly. Taken together, these markets all paint a consistent picture. That is, that we are going to enter a period of declining equity prices, rising bond prices (lower interest rates), and a rising dollar. This is a counter trend move for the dollar and, if it materializes, will be a shock to most and a devastating shock to those short the US dollar.

Why do we conclude this? US equities are forming what is termed a rising wedge (see the S&P chart below). This is bearish and indicates a market that is tiring of a prolonged move. Corrections are infrequent and shallow. Price action becomes one sided for an extended period of time and the volatility of that price action declines. This is what we are seeing in US markets. No one wants to sell and take profits as the markets just keep heading higher. No one wants to short because the market just moves higher. This is a lovely situation for bulls but alas it never lasts very long. The DOW, S&P, NYSE, and Nasdaq are all exhibiting the same pattern. This typically predicts that we will see a sharp break below the lower trend line of the wedge - again, sometime in the next two weeks. Could this pattern fail? Yes, it could if equities stage a massive rally and rocket significantly through the upper line. But we emphasize a significant move is required. Just inching up another week or so merely will adjust the line, not fundamentally alter the pattern.

Recently binds have been rising along with stocks. This is unusual only if it persists for any length of time. Typically one expects that when bond prices are rising stocks are declining. Looking at the TLT chart below, where we use TLT as a proxy for bonds, we see that TLT appears to be re-testing a resistance line with a rising set of higher lows under it. That is, TLT appears to be indicating that it may break to the upside shortly. Such a break and a rise in bond prices would be consistent with a period of a direction change downwards for stocks. That is, bonds appear to be technically supporting the thesis that stocks will head lower.

What about the US dollar? Looking at the dollar chart below we see that it is forming a descending wedge that is a bullish sign. Wait a minute…isn’t the dollar supposed to drop like a stone at some point? Yes, but nothing goes straight up or down. The long term view we have expressed on these pages regarding the dollar’s future still holds but that does not mean we cannot get a strong counter trend rally in the meantime. That is why we advocate trading more actively rather than simply taking the strategic view and holding on to it come hell or high water.

If the dollar breaks higher that would also be consistent with declining equities and rising bond prices assuming that global equities follow our markets (China is already correcting) and that the flight to liquidity trade re-asserts itself.

Finally, what about gold? If you examine the price chart below you will see that gold is continuing to go sideways in the face of continuing declines in jewelry demand, stagnant investment flows and drought in India which may well sap much of the world’s largest gold market’s strength as prices rise for basic necessities. We need to see inflation or a strong drop in the US dollar for gold to make any headway in the absence of the usual buyers. Right now those factors cannot be found in the current economic data. So we think that gold is more likely to be in stasis until the selling starts. The symmetrical triangle pattern has progressed too far towards the apex to be reliable now. Barring some significant event gold will either tread water or decline.

Nothing is certain in markets which is why we are not entering 100% leveraged short positions. Should the massive sums sitting on the sidelines actually enter the finally market then we could see an explosive leg up in stocks. So we need to time any short entries well. One wonders what would draw that sidelined money in if the huge rise in the indexes so far hasn’t done the job.

Please examine the charts below thoroughly as they will form the basis of our trading decisions. Again, Part 2 will be available for members tomorrow.

SPX 08/28/2009

TLT 08/28/2009

US Dollar Index 08/28/2009

VXX 08/28/2009

Gold 08/28/2009

Finally, Doug Kass wrote a very interesting article on TheStreet.com earlier this week. We urge you to read it HERE.

If you are not a member of Murdock Global Insight the you are missing half of the content and indeed, the most important half. It is in the Members Only section that we discuss how to trade these markets and specifically what we are doing with our personal portfolio.

To view previous Members Only posts simply follow the instructions under the “Become a Member” tab and select the “Two Week 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 Two week Free Trial and your e-mail and address will not be shared with third parties.

For those who are following the looming dollar crisis we urge you to read our free post Watch Out For Sterling where we raise the case that a precipitous fall in Sterling could serve to elevate the dollar near term and trash trading positions betting on an imminent dollar collapse.

Readers should take a look at our post The Most Important Question Facing Investors to understand the risks we are currently facing.

We wrote recently in “The Character of the Dollar Collapse” on the risks to investors in any asset of a dollar collapse.

Murdock Global Insight began discussing the dollar’s impending demise in January when the dollar was still generally strengthening How the US Dollar Will Lose Reserve Status. Now, in August, the idea that the dollar is destined for significantly lower levels at some point has entered the mainstream. The US fiscal position is increasingly being seen as untenable. Interest rates are surging for a variety of reasons but he massive debt issuance by the US is one primary cause. We have established the Murdock Strategic Portfolio for the purpose of growing our wealth in the face of a dollar collapse/surging China scenario The Strategic Portfolioand we have written about the risks that a free fall in the dollar could cause to those investments The Most Important Question Facing Investors.

To find out the details look at our strategic portfolio scorecard. The Strategic Portfolio is how we are investing in the global trend of dollar depreciation and Asian recovery and trading around that trend to ensure we stay profitable. Take advantage of the Free Two Week Trial and read it. We have also update the scorecard for today’s action.

The Strategic Portfolio

Portfolio Scorecard 08/17/2009

In addition, we strongly recommend reading The Most Important Question Facing Investors as recent action illustrates directly what we are faced with if the dollar decline turns into a free-fall.

To view previous Members Only posts simply follow the instructions under the “Become a Member” tab and select the “Two Week 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 Two Week Free Trial and your e-mail and address will not be shared with third parties.

The following additional posts are highly relevant:

The Strategic Portfolio

The Most Important Question Facing Investors

On the Edge of the Empire, Dollar Influence is Declining

The Dollar and Gold Near Term

How the US Dollar Will Lose Reserve Status

Chinese Gold British Debt

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

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

“The Coming Bond Debacle”

Fundamental Trends