Quantitative Cocktails

Picking up where we left off last week - here's another look at the latest "Quantitive Cocktail" to explode.  

"It's safe to say that both silver and the Nikkei were THE risk cocktails for each periods pronounced gains; whereas, the markets monetary handlers had brought participants noses back to the trough to feed (through a perceived weakened currency) - then gallop, in the asset meadows that would most benefit its yield."

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As was the case in 2011 with silver and the commodity led risk drive, the impetus for these pronounced periods of boom and bust were largely psychologically driven phenomenons, motivated by what initially was perceived as radical central bank interventions. Should the rally in the Nikkei meet the same fate as silver, the weakness in the targeted currency will prove to be ephemeral as well as its primary benefactors. 

Connecting the Dots - 6/14/2013

It seems like yesterday that markets rose and fell like a synchronized swim team - floundering through a tired routine. Back in 2011, markets were so tightly correlated that if a "swimmer" fell off-balance in trend, snap reversions could be arbitraged quickly - assuming you had a handle on the markets flow. For example, if you had good intuition on what was going on in the currency markets, you could trade with greater execution and frequency through the commodity and equity markets - and vice versa. In 2012, that extreme in correlations began to thaw; although still historically tight and most notable between some of the long term drivers between the currency and commodity markets. 

Year to date, the correlation environment continues to shift which has translated into some confusion as expectations pass through the markets many gear exchanges. As noted - and to a large degree expected; long-term relationships have been skewed towards some rather strange bedfellows. The bond market sells off - the stock market sells off. The dollar weakens - precious metals weaken (not expected). The bond market sells off - the dollar sells off. Whether its an artifact of increased intervention from a variety of different motivations and interests, or just nature's way these days - we've come along way since 2011. What we can do for bearings today? Continue working with those assets that have wagged the system with greatest affect. 

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A few weeks back, we had commented on the similar asset structures and motivations of risk appetites between QE2 and QE3. We had highlighted silver during the buildup and bust of Bernanke's second salvo and the SPX during the bolus of his third. 

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In hindsight, the SPX did pivot lower where the study had expected it would. However, the closer comparative - both in magnitude of gains and corrective structure to silver's blowoff run in 2011 - is the Nikkei today. 

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It's safe to say that both silver and the Nikkei were THE risk cocktails for each periods pronounced gains; whereas, the markets monetary handlers had brought participants noses back to the trough to feed (through a perceived weakened currency) - then gallop, in the asset meadows that would most benefit its yield. What's noteworthy with the latest behavioral whip, is the overlap between what the Fed attempted with QE3 and the secondary and more explosive intervention in Japan with the introduction of Abeonomics in November.

Going forward, we will be keeping a close eye on the Nikkei and add it to our comparative series with the yen which has pointed for several months to a material pivot higher in this timeframe. In the short term, the comparative calls for a retest of the Nikkei's 50 day SMA.    

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All things considered, you could make the argument that although QE3 appeared to be floundering coming into the end of last year; through the backdoor of the yen - the SPX succeeded in breaking through the Meridian's overhead resistance. Although it might not have been organically sowed, QE2 brought the equity markets back to kiss long-term resistance in 2011 - and the enunciations of Carry Trade Abe helped bust through the hedgerow this year.  

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Despite languishing in some reversionary weeds, we still expect the gold miners to follow the yen higher over the intermediate time frame.

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Taking its time and consolidating with the equity markets, Apple looks poised to take another leg higher soon.  

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As expected (although the precious metals have little to show for it so far), the US dollar index continues to get hit with both of the biggest mallets from the euro and the yen. 

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We are keeping very close tabs on the CRB to see if it confirms the shift in perspective of the US dollar. Discrete positive divergences in momentum and strength have recently been noted.  

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*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology

Thoughts on the Yen

Derivative of our GDX:GLD comparative with the BKX:SPX ratio, circa 2009 - the yen has taken to the streets with considerable reversionary vengeance. 

In the beginning of 2013 and very much along the lines of the downdrafts in Apple and the gold miners et al., the yen had cascaded with very little traction despite the sharp positive RSI divergence that we warned (with the BKX:SPX comparative) against being lured by.  

Despite taking its time in finding what we perceive to be the low in the yen this year, the comparatives next momentum trait appears to be taking shape as it springs out of the upside pivot. 

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Although not yet present on the daily timeframe, momentum has reversed polarity to positive on the 60 and 120 minute series - as evident in the stochastic becoming entangled from the top rail. This is an early indication - and similar to the BKX comparative, that the condition will eventually replicate through to the daily and be supportive of a material change in trend higher.  

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Lighting an Escape Fire

While we agree that the optics and assumptions between 94' and today are worlds apart; whereas, the element of surprise was much greater before the Fed became painstakingly transparent and the bond bull matured into the market patriarch it is today - the degree of speculation attached to that assets one way street still has considerable and like potential to disrupt and influence markets through distortions of flows as it did in 1994. Considering the perversion in correlations we've witnessed recently, and as noted last week with our expectations for further dollar weakness - the comparative has more harmonies than dissonant chords for now. 

It's safe to say many had expected a range in yields within trend this year, but were tempered by the gathering disinflationary tide and the perception that Bernanke would continue to be influenced by the specter of deflation that still haunted the Fed's house. If anything, and considering the Fed's preferred measure of inflation (PCE) flirting with historic lows - or even our inflation expectations construct framed by the long:term silver:gold ratio; it seemed more likely that the Fed would at the very least extend the expectations of stimulus - rather than curtail. In this sense and apparent in the bond markets quick ignition, the element of surprise so crucial to a central banks efficacy appears intact - and to boot has come from the opposing side of the field. 

Whether lighting the brush in the bond market here was a sign of desperation, brilliance or causal coincidence is hard to say at this point. We are reminded of the true story of the Mann Gulch Fire, that although tragically took the lives of thirteen young firefighters in Montana in 1949, rewrote the training protocols for dealing with a fire that was imminently about to overtake its handlers. To make a long but fascinating story short, a creative and desperate smokejumper named Wagner Dodge lit a fire directly in front of himself before the rapidly approaching forest fire overtook him and his crews position. After lighting the fire, he then motioned for his men to step into the newly lit area. Unfortunately, likely believing he had lost his mind - they refused and attempted to outrun the fire which was burning quickly up the hillside. In the end, Dodge survived nearly unharmed - while the fire killed thirteen of his men.   

Reigning in expectations of stimulus by the Fed in the face of inflation data flirting with historic lows and a global economy dangerously close to stall speed might appear reckless at face value. With that said, the Fed perhaps succeeds at killing two birds with one stone by reigning in risk appetites at large, while also changing the perception from one of disinflation to inflation's right around the corner. 

Reflexivity burns bright - assuming we don't perish in the fire. 

What Lies Beneath

"I measure what's going on, and I adapt to it. I try to get my ego out of the way. The market is smarter than I am so I bend." Martin Zweig

Despite ones own confidence and intuitions, the very best any of us can hope for in markets as dynamic as these is the ability to adapt early enough to a potential pivot and position yourself accordingly for the next drive. Adapt or die - although the truth likely lies much closer to - adapt and thrive. It's as simple and as difficult as that. We've learned long ago, and as many weathered traders and participants have practiced, the wisdom of working confidently with a position while holding a number of opposing perspectives in your head at the same time. This has aptly been referred to as - strong opinions weakly held.   

What we try to impress through our comparative work is the ability to both use them as intuitive guides within correlation trends, as well as a contrasting blueprint and mirror to where and when a market could potentially diverge. By utilizing both sides of perspective and adapting to current market conditions, we have arguably presented some of the more prescient independent research on the US dollar, euro, silver, gold and the CRB index over the past two years. Our method of comparative analysis typically does not just look at price itself - but the flow of momentum within a given pattern and the contrasts and congruencies it may impart towards future market expectations. In essence - what lies beneath. It is the appraisal of that potential energy which most interests us when placed in the context of current market conditions - e.g. sentiment, commitment and potential catalysts. We recognize it is by no means a guarantee, steeped in subjective reason and always a moving target to assess. In this sense, and one that we enjoy - it's an art form of puzzle pieces and perspectives. 

Connecting the Dots - 1/27/2013

Back in January and December of last year,  we had focused our opinion that the USDX was becoming discretely built with upside momentum - despite the euro's considerable strength. This was most evident in the large positive divergence in momentum relative to price. Coupled with our work in the precious metals sector which pointed towards significant weakness on the horizon through the first half of the year, our comparative profile of the dollar's previous breakout and the saturation of euro bulls through January - we strongly felt the USDX was becoming primed for a reversal. 

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Fast forward to today, our concerns with the possible exhaustion in the US dollar index appears to be well founded. While we have incorporated the previous secular pivot of the USDX in our weekly notes, over the past several weeks we highlighted the diverging momentum signatures of the pattern with audible caution towards exhaustion. The bottom line - we felt that the dollar should have gained more cumulative momentum during the upside pivot and build in expectations that led to its false breakout. At this point it's early to speculate how significant the downside reversal in the USDX will be and its kinetic impacts on sectors such as precious metals and commodities in general. Having said that, it had a clear opportunity to extend itself away from the technical break - but failed quite dramatically. In our opinion, and now coupled with our work in the precious metals sector which point towards an upside reversal, positive divergences in momentum in the euro, and the record net USD long commitments - we like the flip side of the coin. 

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*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology

GDX Analog Update

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*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology

Still Golden

We remain cautiously optimistic that the needle continues to move in the right direction in the precious metals sector. Despite a stumbled start in spot prices, the miners relative to gold have found traction and are now outperforming since the May 20th low and reversal higher. In terms of the tea leaves brewing bullish, its a good one. You'll notice that the GDX:GLD ratio has led the move and is the first to break through its 50 day SMA - which since last fall has been a rising ceiling.

*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology

Creative Seasonings

Picking up where we left off last week, our focus remains where the US dollar is headed next and the interesting and somewhat peculiar economic and monetary backdrops it will undoubtedly be motivated by. With a seasoning of flavors that has recently confused many participants palates; namely, a gathering disinflationary trend, slouching commodity prices, a mixed bag of economic data - and a Fed compelled to tinker with a taper, we wonder how in control of this fusion menu they really are. With that said and perhaps with a pinch of hyperbole, we remind ourselves there is a fine line between creativity and chaos, genius and insanity and for this instance - deflation or inflation. Our suspicions remain - they (the Fed) are limited by their picked pantry of monetary measures that needs to be sparingly and creatively sprinkled, to inspire a lasting experience with just a hint of inflation that neither scolds the taste buds or is missed entirely. To put it mildly, they need to retain their three stars from the Michelin Guide for monetary cuisine on a shoe-string budget and with one hand tied behind their back. 

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As we recently have focused on, the rally in the US dollar index appears to be in jeopardy of running out of upside momentum. And while that possibility seems logically unlikely if the domestic economic data firms around the idea of a taper, the parallels to 1994 - that of a rising rate expectations environment that fails to inspire the dollar may hold some clues. 1994 was also the first time the Fed began to materially raise interest rate expectations following the Savings and Loan and banking crises that culminated in the fall of 1990. Here's a snippet from Floyd Norris back in 94' framing the unusual asset dynamics following the pivot in interest rate policy and posturing in February of that year.
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Perversely, Higher Rates Hurt The Dollar - Floyd Norris NYTimes - May 08, 1994    

"....The bad medicine in this case was the Fed's decision to raise interest rates. In normal times that ought to help the dollar by attracting foreign funds. 

That perverse reaction is another indication of the truly massive speculation that had been going on regarding American interest rates. No one knows just how large, or how leveraged, were all the bets on the bond bull market. In some cases, like Procter & Gamble's misadventure with interest rate swaps, it appears that even the gamblers did not understand how big their bet was. 

Those bets are now being unwound. Rising interest rates are a reason to get out of the bond market, and, with American short-term rates still under European ones, there is a temptation for those abandoning Treasury bonds to get out of dollars as well. 

The unwinding of that speculation helps to explain why everything can fall at the same time, as happened Friday when a surprisingly strong employment report sent bonds plunging -- pushing the yield on 30-year Treasury bonds above 7.5 percent for the first time in the Clinton Administration -- while both stocks and the dollar suffered along with it.  

None of that has much to do with economic fundamentals, which is one reason why intervention in foreign exchange markets is easier to justify now than at other times. But simply because there was so much speculation on ever-declining interest rates, it is hard to tell how long the perverse effects of unwinding that speculation will last."

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Although we still expect 10 year yields to eventually roll over again and tag the bottom rail of their long-term trend, there's symmetry in considering the shift in the current rate expectations environment with what transpired in 1994. Moreover - and as we alluded to last week, there's a strange elegance in transmission when considering one of the prime benefactors of a declining dollar here would be a rejuvenation of inflation expectations just as they flirt with historic lows - and the commodity sector which has provided a tailwind to such trend. A "perversion" of a different kind,  but one Bernanke could wear discretely by ultimately tapering much later down the road. In essence, all bark and no bite. Be that as it may, we believe its reasonable to expect that like 1994 - the equity markets correct swiftly while participants expectations shift.          

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Of course there are some glaring motivational and structural differences - from Greenspan's primary concerns in 94' with rising commodity prices and Volcker's historic battle with inflation; to Bernanke's kitchen, where we would argue there presents the more difficult - yet appropriate assessment of qualifying recent economic growth and knowing the dismantling sides of deflation or inflation is only a few accidents and missteps away. 

We feel a good presentation of this challenging environment is our long-term chart of the silver:gold ratio we publish from time to time that expresses these "funneling" inflation expectations with a rising degree of difficulty for the Fed. 

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We've come a long way since 1994 and the Fed's pantry is down to just a few essentials. Creative seasoning has kept our appetites interested over the past five years, but eventually we need a healthy meal. 

*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology

Connecting the Dots - 6/3/13

*  All stock chart data originally sourced and courtesy of www.stockcharts.com 

*  Subsequent overlays and renderings completed by Market Anthropology