The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, January 18th, 2011.
That's what the stock market is right now more than anything else in terms of importance - it's a culture of complacency and corruption (from last week) that is perilously addicted to the Fed's liquidity. And I am certainly not the only one voicing concern in this regard, where you will find a recent interview with Mark Faber attached here on this subject addressing the root of this problem, which is of course the Fed's increasing inflationary policies. Within this interview, Faber discusses how Bernanke's misplaced policies targeted at lifting real estate prices is failing miserably, and that this inflation is making it's way into other essential commodities having price supportive demand / supply dynamics (think food, fuel, etc.), which is of course lifting prices in these areas just when an ongoing negative wealth effect in the sectors where people have most of their savings continues unabated. As Faber points out in no uncertain terms, and as usual, Fed policy is failing miserably (which is known to other Fed Presidents), and that this failure will have unexpected and profound consequences, not the least of which will undoubtedly include 'general price instability' eventually. (i.e. contrary to the Fed's primary mandate these days.)
As you may know, Bernanke is not one to take failure sitting down however, and has now began to expand the Fed's daily monetization practices (and effectively its mandate) to include not just the bond markets, but stocks now as well. So it's no wonder speculators are becoming dangerously complacent these days, with the Bernanke put in the market every day propping up prices. One does need to wonder just what extent Banana Ben intends to take his monetization practices however, where as you may know, like a junkie, in doing so he has now set US markets on a 'crash course' in one way or another, where he either keeps increasing the dosage (potentially triggering shades of hyperinflation), or the stock market fails too, adding to the list of Fed failures. Unfortunately the junkies don't realize this, and continue to play in the markets assuming the Fed (Banana Ben) will keep feeding their worsening habits. This, is of course a recipe for disaster no matter what happens, where the deciding factor looks like it will be the bond market, with both foreign fringe (to the core) economies and the muni-bond market in the States continuing to unravel at alarming rates.
Why is this observation important? Answer: Because short of what might produce shades of hyperinflation in undesirable sectors (again think food, fuel, etc.), Bernanke will be forced to either ramp up monetization practices further, or risk not just the muni-bond market imploding, but Treasuries as well; which again, as per our opening, will continue to play havoc in real estate, and likely stocks eventually too (think flash crash) when Murphy's Law decides to kick in. So, it's important to realize that because of Banana Ben's increasingly dangerous monetization experiment, which will also be written up in the text books to his dismay and shame, that both the broad bond and stock markets are 'accidents waiting to happen', with all the ingredients (sentiment, technical, contagion risk, etc.) for crashes now in place. That's right, we are just waiting for the trigger(s) to be pulled, and as long-time readers of these pages know (they know the importance of open interest put / call ratios [no other sentiment system predicted this rise in stocks]), that could be as early as this week (a January top) with options expiry removing put related support from the major US indexes.
Yes, but isn't the monetization alone enough to lift stock prices independent of this? Answer: Unless Banana Ben is willing to buy up the whole market once the selling starts, in my estimation the answer to this question is no. That's why you don't start something like this in the first place. More recently (circa 1997) Hong Kong authorities tried this, and when the currency crisis hit in '97, stocks collapsed under adverse conditions. And while this scenario will likely not repeat here, still, something else will happen to trigger the selling (think options expiry), like Steve Jobs medical leave popping the Apple bubble, and then it's all over for the speculation game for some time once again. (i.e. think 2-years plus.)
To cloud the waters however, we have had US price managers come down on precious metals quite hard since the beginning of the year, this while stocks have been squeezed higher making the manipulation obvious. Unintentionally then, US price managers have succeeded in creating a downside buffer for themselves in that precious metals are now short-term oversold on the dailies, and due for a bounce, which should act to support the broads as well because surface dwellers will take this as an inflation signal. So, as suggested above, this confusion could support general price levels in volatile fashion in coming months, where precious metals (the mania de jour?), like tech stocks in the year 2000, may not top for the present sequence until March.
And while I don't for a minute think such a top in precious metals would be the ultimate full blown mania top, because public participation rates are still too low, at the same time some degree of exhaustion at that time (March) would provide an alignment within the larger inflation trade enabling all equity groups to decline in unison, just like they did on the upside via the dollar's ($) depreciation. Furthermore, as you will see below, while the dailies and weeklies might allow for a rally at this time, least we forget this does nothing for the monthlies, which at extremes, and poised to turn lower. And again, with stocks never this overbought previously in history, eventually (by March at the latest), this should be enough to roll over the entire inflation trade.
Until then however, and as the British would say, the bureaucracy's price managers have made a 'right proper mess' out of maintaining synergy within the inflation trade, which is the whole idea in keeping the speculators both confused and taking stupid risks. This morning's trade profile is perfect example of what you can expect over in weeks to come with options / oversold related strength in precious metals being used to lift the entire equity complex after trapping a bunch of unsuspecting speculators in short positions yesterday off the Steve Jobs news. They can do this because don't forget the open interest put / call ratio profile (attached above) for precious metals in the ETF's and indexes is supportive of prices, so the price managers will use this to squeeze prices higher this week, which as postulated above, will be used to support the larger equity complex. (i.e. hence the turn around in stock futures overnight.)
Of course some think that if the bureaucracy's price managers can stick handle gold down into ETF and index options expiry with open interest put / call ratios as high as they are, it's conceivable they might get their negative monthly close as well. Martin Armstrong discusses the various support levels in gold (and more) attached here. According to him, he thinks a negative monthly close below $1372 would pause gold on an intermediate basis, but me, I'm not so sure in this regard. As you know from the above, I'm still looking for one more rally into late winter / early spring before an intermediate degree correction sets in. And if I had to pick a target, Fibonacci resonance related resistance just above $1500 remains the possible goal, with Mother Nature exerting her inexorable draw to this level through time. (See Figure 1)
Figure 1 
You will remember from previous discussions on the subject that Fibonacci resonance related projections is a high confidence targeting methodology, which in gold's case, and as can be seen above, would involve the channel breakout holding support and then surging to the target. Along these lines it should be noted if this occurs, that it's a less frequently successful sequence except in very strong markets. And so from this we can conclude the move(s) in precious metals should remain bullish as long as this channel breakout in gold is maintained. If it fails, which is what I expect to happen as summer approaches, then a trip all the way back to the bottom is possible, putting gold back down into the $1100 area, and possibly lower. The count and sequencing shown below on the monthly plot from the Chart Room support this thinking, where we are in the throws of finishing up 1 of Primary (minimally) C right now with technical indicators now at the tops of their respective ranges. (See Figure 2)
Figure 2
And if you think precious metals shares are not long-term overbought in some measures, just take a look at the MACD of the Amex Gold Bugs Index (HUI) monthly plot pictured below, where again, as you can see it's at the top of it's range and apparently turned lower. This is why monthly closes in the sector could prove important here in January, given because the establishment systematically suppresses precious metals, when viewed in the larger scheme of things, any downside moving forward should be viewed as mild. Moreover, with physical supplies of precious metals so low at present, which is a condition likely to get nothing but worse, this should always be in the back of your mind, that any weakness in gold and silver should prove temporal even if other asset categories begin to implode. (See Figure 3)
Figure 3
At the same time however, one should also notice that while stochastics also appear to be rolling over, other indicators displayed show just how lack-luster this past rally in precious metals has been, and that when the stars become aligned once again, more gains should be expected. Further to this, just look at the weekly HUI / Gold Ratio plot below, where while prices could definitely fall further, RSI for example is already down in the low 40's and vexing support, suggestive that under the right conditions a bounce is in order. So, while prices could remain soft for a period of time while the larger equity complex corrects (whatever you call it), eventually the future for precious metals should appear bright on a sustained basis, not just because they get squeezed into options expiry again. (See Figure 4)
Figure 4
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