Carry trade unwinding

Carry Trade Unwinding!!!!!

Japanese Yen/Aussie Dollar Currency Pair

Since the Earthquake in Japan the carry trade has been unwinding, especially today. THIS IS HUGE NEWS FOR THE STOCK MARKET. This generally shows up pretty well in the Yen/Aussie Dollar Currency pair. When it rises risk assets fall, including the stock market. For a description of what the carry trade is and its implications check this, this, this, this, and this.

Gold vs. Silver

This post is strictly going to be analyzing the price of gold vs. the price of silver. Is one overvalued vs. the other? Are either of them good investments at the moment, or at they just bubbles? These are some questions I'm going to try to answer very briefly with a few charts that I think tell the tale.

• The first chart I will post is the Gold vs. Silver ratio (Figure 1). This chart goes back to 1982 with monthly prices and show how cyclical the price of gold is vs. the price of silver.
• The two commodities trade in cycles with the economy. Essentially, silver outperforms gold when the economy is improving and gold is a flight to safety when there is economic uncertainty.
• As you can see the ratio bottomed (good time to buy gold) around the year 2000, which was the peak of the Dot.com bubble. The ratio then bottomed again in 2007 which was the peak of the housing bubble that led to the financial crisis. Right now the ratio is in the same zone that it has bottomed at in the past, does this mean that we could be going into another period of tough economic times in the near future? Probably.
• With the current ratio where it is I would be a buyer of gold before I would be buying silver. Historically the time to be buying silver is when gold is trading above 75x the price of silver and the time to be buying gold is when it is trading for less than 48x the price of silver, it is at 40x right now.

Gold vs Silver Ratio Long-Term (Figure 1)

The second round of charts are the long-term monthly prices of gold and silver (Figure 3 &Figure 4). Theses two assets are clearly in bubbles. However, as the old saying goes, "markets can stay irrational longer than you can stay solvent." I wouldn't be a buyer of either of these assets right now, but I also wouldn't even think about shorting them. They can go way higher before they eventually collapse. The problem I have with buying is that when the collapse comes its going to be quick and I don't want to get caught in the rush to the door. Another problem these securities have right now is that hedge fund margin debt is at the highest since July 2007. What this means is that hedge funds are borrowing more money now to buy stocks and other assets than they were before the financial crisis. A drop in the stock market, which is very likely now after the Japan quake, will force liquidations of everything to meet margin calls, including gold and silver. This is similar to what happened during the crash of 08' when gold and silver both fell over 30%. The margin debt chart is shown in Figure 2.

• From Zerohedge:

"Everyone is now purchasing on margin and the level of investor net worth is the lowest in over 3 years. Which means that should the market decline from this week persist and the Fed be unable to stop it, the margin calls will start coming in fast and furious, and unwinds in otherwise stable products like gold and silver are increasingly possible as hedge funds proceed to outright liquidations."

Margin Debt vs Total Net Free Credit (Figure 2)

Here are the charts of gold and silver.

• As you can see in Figure 3, the chart of gold, it is nearing uptrend channel resistance. This area has been a great time to sell and take profits in the past. I would bet it is a great time again too.
• The uptrend has been weakening in strength since the high made back in 2008 during the crisis. Eventually this loss of strength is going to have some effects on price.
• There is no major support underneath the gold price except for the lower channel line until all the way down at $1000/oz. If I wanted to buy gold I would wait till at least a pullback to the lower channel line. If that breaks I would load up the truck with gold near $1000/oz.
• As for silver, it's experiencing the same problems as gold. It's recent run-up has been way stronger than that of gold and it is starting to get overextended. The monthly bar it is painting right now is a reversal candle, bouncing right off of channel resistance. This is setting the stage for a drop in silver.
• The first place to watch for support is near $28/oz, but on the long-term outlook the biggest levels of support will be the lower channel line and support from the 2008 high around $20/oz.

Gold Long-Term Monthly (Figure 3)

Silver Long-Term Monthly (Figure 4)

The last part of my analysis will focus on the major driver of the prices of both gold and silver, the US Dollar. When the dollar falls it spurs inflation worries and drives up the price of both gold and silver because these are seen as safety against the central bankers printing presses. When the dollar rises, as it did in 2008, we experience deflation and the prices of gold and silver fall. However, in a severe deflation like the one experienced in the 1930s gold does in fact act as a safe haven asset. Figure 5 shows the weekly chart of the US Dollar going back to late-2007.

• The dollar has been consolidating for a few years now. It is currently sitting at support from the bottom line of the triangle and from the lows of 2010. Downside momentum has been waning and the dollar is due for at least a moderate bounce to the upside.
• On a fundamental note, Europe is struggling with its debt situation once again. If this comes to a climax sometime soon the Euro is going to get rocked, sending the dollar skyrocketing. I believe this will happen sooner rather than later due to the Japan catalyst. See this, this,this, this, and this for more information on the Euro crisis.
• Also, there is a lot of talk going around about the dollar losing its reserve currency status and how this is going to set the dollar down into oblivion. This is simply not true. Our reserve currency status is secure for the moment. Sure, we will not have the reserve until the end of time, but we will have it for the foreseeable future. Also, losing the reserve status isn't the end of the world. The British pound had the reserve status until we took it from them. Britain didn't get economically "blown" off the face of the Earth when this happened and it won't happen when we lose the reserve status either. See this for more info.

US Dollar Weekly Chart (Figure 5)

In conclusion:

• I would not be a buyer of silver or gold right now, especially silver. Why?
• 1) The gold-silver ratio is suggesting to buy gold rather than silver. It is also suggesting that the economy and stock market are likely going to weaken again rather soon. 2) A fall in the stock market, as suggesting by a number of indicators, will likely trigger margin calls at most hedge funds and force the liquidation of a number of their largest holdings, including gold and silver. 3) The long-term technical picture of gold and silver are both suggesting a pullback. They are both very overextended and overbought and have little support below them. 4) The US Dollar is likely to experience a bounce in the short-term (3-6 months) that will push down the stock market, gold, and silver. This could be caused by a technical bounce in the dollar or the European Union debt crisis heating back up, I think this is very likely.

Anyway, hope you enjoyed the analysis. Good trading.

Freeport-McMoran Short Update and Nightly Reads

Freeport-McMoran (FCX) Daily Chart

As I posted here on February 24th - Freeport-McMoran looks weak here.... - FCX has traded down to my first price target around $47. Today looked like an "indecision" day and we could see a couple of days bounce out of Freeport from here. However, copper and gold are both still looking ugly and the downtrend in FCX should resume quickly if the market continues to experience weakness.

If FCX breaks the $47 zone and the 200 day MA at $47.49 the road is clear for another drop of $9-10 dollars per share down to the August 2010 swing high of $37 dollars a share. Good luck, set your stops, and don't let your emotions get in the way of some good trades.

Here are some interesting articles worth a read for this lovely, rainy Thursday night.

• From Zerohedge: Mike Krieger On Why 2011 is Not 2008 - Why it is Much Worse - And on Dow-Gold Parity:

  "This is not 2008, it is much, much worse and far more dangerous. This will not simply be the collapse of the banking system (although I fully expect that), rather it will be the collapse of the central banking system."

• From Econ Browser: What will Saudi Arabia do?:

  "If all of Libyan production gets knocked out, we'd need 1.8 mb/d to replace it. If the Saudis weren't able or willing to go above those production levels in 2008 when oil was selling for over $140 a barrel, why would you expect them to do so now with West Texas only at $106?"

• From Hussman Funds: Quantitative Easing and the Iron Law of Equilibrium:

  "Technically, the Fed is buying Treasury securities and creating currency and bank reserves to pay for them. This would simply be an asset swap were it not for the fact that the U.S. is running a budget deficit of about 10% of GDP, so the Fed's purchases don't even absorb the amount of newly issued Treasury debt."

• From CNBC: Europe's Debt Crisis May Boil to Surface Friday:

  "Before the Germans will agree to pump in extra cash from their taxpayers, backed by the French, they want each leader to agree to legislation at home that will limit the size of their future national deficits. The Greeks are already refusing point blank. Things may boil to the surface at an extraordinary summit on Friday."

Have a good night. See you tomorrow for a mid-morning market index update.

Bonds finally catching a bid vs. equities

Bonds vs Stocks Ratio

• This chart shows the ratio of long term treasuries vs the S&P 500.
• When it moves up it shows that bonds are outperforming stocks, and the inverse is also true. When it moves down stocks are outperforming bonds.
• As you can see stocks have been outperforming bonds for almost a year now. This chart is now finally starting to register caution signals for the equity bulls. Just looking at the movement of the ratio I would be positioning myself defensively against stocks.

S&P 500 breaking down...

The S&P 500 is currently breaking down out of its short term triangle pattern. Watch for a continued move down to at least 1275. If that breaks watch for a move lower to around 1220 which was the highs last year before the Flash Crash.

Market internals have been weakening over the past few weeks to months. This could indicate a larger pullback in the making and buying the dip should be taken with caution.

Also, Spain's downgrade this morning has people remembering that Europe isn't exactly out of their mess yet. In my opinion I think their sovereign debt crisis is just beginning. Check out these articles if you want some further information.

• Europe Debt Crisis May Boil to the Surface this Week (CNBC)
• Caught in the Euro Trap: Internal Opposition Grows to Further Bailout Measures (SPON)
• European Debt Crisis Intensifies (The Globe and Mail)
• Moody's Downgrades Spain to Aa2, Outlook Negative (Zerohedge)

S&P 500 Index Daily Chart

S&P 500 breaking down...

The S&P 500 is currently breaking down out of its short term triangle pattern. Watch for a continued move down to at least 1275. If that breaks watch for a move lower to around 1220 which was the highs last year before the Flash Crash.

Market internals have been weakening over the past few weeks to months. This could indicate a larger pullback in the making and buying the dip should be taken with caution.

Also, Spain's downgrade this morning has people remembering that Europe isn't exactly out of their mess yet. In my opinion I think their sovereign debt crisis is just beginning. Check out these articles if you want some further information.

• Europe Debt Crisis May Boil to the Surface this Week (CNBC)
• Caught in the Euro Trap: Internal Opposition Grows to Further Bailout Measures (SPON)
• European Debt Crisis Intensifies (The Globe and Mail)
• Moody's Downgrades Spain to Aa2, Outlook Negative (Zerohedge)

S&P 500 Index Daily Chart

S&P 500 breaking down...

S&P 500 Index Daily Chart

The S&P 500 is currently breaking down out of its short term triangle pattern. Watch for a continued move down to at least 1275. If that breaks watch for a move lower to around 1220 which was the highs last year before the Flash Crash.

Market internals have been weakening over the past few weeks to months. This could indicate a larger pullback in the making and buying the dip should be taken with caution.

Also, Spain's downgrade this morning has people remembering that Europe isn't exactly out of their mess yet. In my opinion I think their sovereign debt crisis is just beginning. Check out these articles if you want some further information.

• Europe Debt Crisis May Boil to the Surface this Week (CNBC)
• Caught in the Euro Trap: Internal Opposition Grows to Further Bailout Measures (SPON)
• European Debt Crisis Intensifies (The Globe and Mail)
• Moody's Downgrades Spain to Aa2, Outlook Negative (Zerohedge)

Right now there are a number of things that could spark a sharp market downturn. Rising interest rates, ending of the Fed's QE II in June, Euro Debt crisis, inflation scares, rising oil prices, housing double dip...... you name it, it's out there. Hedge accordingly.