Clearly the investment world is unclear about the next market direction as virtually all commodities have been contained inside sideways price ranges for months wondering if the past deflation trends will persist versus the long awaited launch of US Fed credit tightening.
US Dollar Peaking?
The US Dollar had been on a rampage higher since last July rising from under 80 to 100+ in March. This very strong move is eerily similar to the 2008 Dollar surge from July 2008 to March 2009 from 71 to 90. Both were about 26% up moves over the similar 9 month periods. History may not repeat, but it does rhyme.
Aside from the interesting coincidence of similar exhaustion moves in the US Dollar in 2008/09 and 2014/15 we have more evidence of a possible reason for a $ correction when observing the commitment of trader positions. Normally at these extreme net long positions held by Large Specs and net short positions held by Commercial hedgers we witness significant price corrections (see below). While the Dollar has powered through the past couple of high risk price zones, we believe the action in trader positions in various currencies and metals which coincides with expected resistance near 100 in the Dollar allows for better odds of a pullback near term.
A further upside target near Dollar 105 remains as the energy deflation bet has potential to reassert itself this summer which will bolster the Dollar. Falling consumer prices translate into a more valuable Dollar translation into other currencies – as the same Dollar buys more goods and services. For now however the Dollar trend may work lower allowing Hedge Funds to liquidate a modest amount of their record long Dollar contract positions.
All That Glitters Is Not Gold
This Shakespearean idiom infers that not everything that glitters like gold is precious. As Gold glitters more in the current rally it tarnishes the Dollar . Currently Large Spec Gold Hedgers as of mid-March have liquidated enough of their long gold contract positions to increase the odds sharply that another one to three month rally phase would occur. Precious Metals and the US Dollar typically move inversely to each other and we suspect that this modest uptrend in Gold will coincide with a lower Dollar near term. Should Large Specs increase their holdings of Gold toward 150,000 to 200,000 net long contracts in this 2nd quarter then it will likely be a time for Selling Gold once again, as we have often favored over the past few years. Gold price seasonality also favors a 2nd quarter top in Gold and a low in the June – August time frame.
Gold peaked in the $1900’s back in 2011 and several large triangle breakdowns since then have all been satisfied except one (see below). With our ideal ultimate downside potential for a technical Gold bottom in the 930 to 960 zone, we would prefer to see resistance on the current rally contained by the maximum price swing target of 1300 to the 1330’s prior to the next leg lower. Any move beyond the 1300 – 1330’s implies the medium term price structure has confirmed an uptrend. It’s no coincidence that Gold broke down when the ECB began draining its reserves sharply in 2013 while Europe was back into a recession causing interest rates and consumer prices to deflate. In early March Europe kick started a new round of monetary stimulus through Quantitative Easing (QE) to “add” reserves. Thus far Gold and Silver are rallying on the hopes of a reversal in the current price deflation trends. Should Oil inventories surge again this summer triggering new lows in energy prices, then Gold will likely fall back down as it traces out a new sideways pattern in the 1100 to 1300 zone.
Euro Mirrors Dollar
The Euro currency, which moves opposite the US Dollar, is moving higher in an upward consolidation similar to the Dollar’s move lower into congestion. Despite the massive easing program and potential currency devaluation begun by the European Central Bank (ECB) the Euro is rallying on data that is showing economic strength. Combined with the recent weakness in US economic data it allows for this 2nd quarter to support a higher Euro on the perception of a stronger Europe and rising interest rates. When the US returns to accelerated growth rates before mid year (or so we think), then it’s likely the Euro will peak and the Dollar will head higher again.
Sideways Trends Abound
Soybeans, Corn Wheat and other commodities have been indecisive in recent months stuck in a sideways pattern. Perhaps the most conflicted commodities that have been stuck in narrow ranges for months are the Canadian Dollar, Crude Oil, Japanese Yen and Stock Indices.
While the previous trend can be your friend resolving in a downside breakdown for the Canadian $, we see modest excess long positions by Commercial hedgers that support an upside breakout in the Canadian. The current rally in Crude Oil (thanks to Saudis raising prices) has lent support to the Canadian. For now the Canadian $ is very in sync with Oil.
Speaking of Crude Oil: This sideways action remains in force until West Texas (WTI) Oil moves back into the upper 50’s. The Saudis have spurred prices higher this week claiming that good demand from their Asian customers has earned them a higher price. However, if US inventories grow further and our Bullish seasonality ends in May, then the Saudis will have have little effect on the weakening US produced WTI Oil. As we have shown before there is little correlation with declining Oil Rig counts and lower Oil production as was the case with Natural Gas since 2008 when over 80% of the rigs were taken out. US production should remain elevated.
Recent commentary has made the specious claim that Oil price crashes are always followed by “V” shaped recoveries in price. As just mentioned the Natural Gas price to production history since 2008 starts to crack that argument open. Fact is there have been very few Oil price crashes on par with what we have seen since last summer. It happened in the early 1980’s and again in 2008 when Oil peaked above $140 and fell quickly into the 30’s and back up again. What those past 2 periods have in common is they occurred as the economy was heading into a severe recession. The current Oil price crash of almost $70 a barrel has occurred during a growing global economy and rising Oil demand. Sometimes we forget our history when innovation or new resource discoveries in Oil and Gold or new technologies such as Ford’s assembly line reduce cost of production with a corresponding increase in supply. The US innovation in fracking has changed the Oil supply and demand balance for the better. Long term this technology has room to create a boom in shrinking production countries like Mexico to keep increasing global supplies faster than demand. However, never underestimate the power of Government to meddle with Carbon taxes and EPA mandates shutting down Coal and eventually Oil industries. For now we expect the long term price of Crude Oil to stay well under $100 a barrel and closer to the 30’s to 70 range over the next year. The caveat is if the EPA withstands Legal and Political resistance, then they will shift Coal demand to Oil and alternative energy sources and raise energy costs across the board. Eventually Oil may go the way that Coal has been the past couple of years as power plants are being forced to shut down. We will worry about this major political factor at a later date.
A Yen For Your Thoughts
The Japanese currency has been a devaluing carry trade staple supporting higher US stock prices since Japanese Prime Minister Shinzo Abe embarked upon QE to infinity and beyond back in 2012. Their stock market exploded higher and the Yen has been moving down a steady waterfall lower. In 2014 the Yen moved sideways for 6 months from February to August before crashing lower again as Abe doubled down on monetary stimulus. Thus far we are 4 months into another sideways pattern that should break by mid year. Commercial hedges are now at levels where modest Yen tops to Sell have occurred this past year. Even though we know the Yen can rally as Commercials liquidate more long positions, we favor a downside breakout eventually which will support US stocks. Like the Canadian $ however, we will respect either direction out of this congestion period. The fact is the previous tend is down, the Japanese economy has been weak and their Central Bank will keep trying to devalue the Yen to generate the dormant animal spirits of inflation and higher risk investment spending.
Stocks Mired In Uncertainty
For almost 5 months Stock Indices have been mired in a relatively tight range. The back and forth of economic data and uncertainty is pervading many markets as highlighted above. There is considerable risk this year that we are unwilling to stay fully invested for given the 6+ year run higher in prices, slowing earnings, persistent investor optimism and risk of a reality check when US monetary policy finally shifts. For now the Bulls see a Yellen silver lining around every corner. They think the Fed will either delay the expected 3rd quarter rate hike or it will be a one time and one time only hike – which would be the same as no rate hike at all putting off the day of reckoning for when the 2nd hike occurs. This market logic buys more time the Bulls will assume and maintains excessive positive sentiment. We will respect any new uptrend, but we will also assume every short term sell signal or break of key support levels now carries a greater risk of triggering an out sized 20% or greater correction. Such signals or breaks of price supports will cause us to raise more cash than the 10% currently in our long term portfolio
We spent some time on the long term picture in last weekends Exec Spec and remain encouraged by the job and income trends as well as consumer and more importantly small business optimism trends – as modest as they are. Our background in small business manufacturing however can still confirm that we are missing the key confirmation of economic data that is needed to reach the 2nd half of an up cycle. Capital spending on machinery and new industrial factories is flat. QE has shifted the priority to buying back company stock with the excess cash vs expansion, but thus far the cap ex boom is like the wage growth boom: there is a rising trend, but far below expectations for 6 years into an expansion. In 2004 and 1996 we saw the small business lights turn on like a switch and the boom portion of the cycle began. We will let you know when such a phase has arrived again. Until it does, there will be more global QE and further delays in US rate hikes to reduce Central Bank reserves. It looks like you can enjoy your sub 3% 15 year mortgage a bit longer.
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