A 3-dimensional approach to technical analysis
Cycles - Structure - Price projections
"By the Law of Periodical Repetition, everything which has happened once must happen again, and again, and again -- and not capriciously, but at regular periods, and each thing in its own period, not another's, and each obeying its own law ... The same Nature which delights in periodical repetition in the sky is the Nature which orders the affairs of the earth. Let us not underrate the value of that hint." -- Mark Twain
A Review of the Past Week
The markets took a little breather this week. Most of the major indexes reached their high point a week ago Friday, and began a slight correction into mid-week before rebounding and paring their losses.
This was undoubtedly the action of the 6-week cycle -- the half-span of the more dominant 12-week --which conformed to the expectations outlined earlier of making its high during the fifth or sixth week after its October low, and sending the SPX into the stated projection zone.
The McClellan oscillator gave ample warning that a top was in the making. It began diverging negatively from price action two weeks ago, indicating that a loss of breadth support for the rally was taking place and that a correction was imminent. This action is now confirmed by the new highs/new lows, and the combined reading of these two important indicators suggests that the correction has longer to go before we can resume the up trend.
This week's action is not expected to be the reversal of the intermediate trend, but only of a correction in the short term up trend which began in October.
Oil made a new correction low this past week, almost reaching $40 on Friday and closing not much higher, and this, in spite of an announced cut in production by OPEC.
The behavior of oil prices over the past 6 weeks is an interesting one. In November, as oil was rising to$55 a barrel, the financial media clamored that peak oil had arrived, that there was a dearth of supply, and some of the "experts" -- very serious and intelligent people -- predicted that the price of oil would most likely continue to rise to $60 or even $100 a barrel. Then, just six weeks later, OPEC is so concerned about a developing oil glut that it decides to cut production? What's going on here? Can investors be that much out of touch with reality and be entirely caught up in emotional rather than rational thinking? Or was there gross manipulation of the gullible public which is always ready to accept the worst case scenario? This is a pattern of behavior which repeats itself over and over in the equity and commodities markets and perhaps psychologists will some day give us an adequate explanation for it. Right now, it is called the "herd instinct", whereby investors jump on the bandwagon of the prevailing trend without concern for its rationale, and suffer the consequences.
To some extent, the same thing may be happening to gold and the dollar, where recently there was no high in sight for gold and no bottom to the dollar. In the meantime, the commercial traders, the only people who seem impervious to temporary insanity, were continually increasing their short positions, and once again proved to be correct as the dollar has began to rally and gold has already backed off substantially. While this may prove to be only a blip, it is important to note that the well-defined 8/9-year cycle in gold which made its low in 2001 may have peaked and could be instrumental in taking gold prices lower for several more years. Of course, there are longer cycles at play as well. Other dominant gold cycles include the 5/6 year cycle which was to make its low either this year or next, the 15/16 year cycle whose low is due in 2006, and the 18 year cycle scheduled to bottom in 2008. If these cycles continue to prevail, the odds of gold making new highs in the near future are not as good as its going significantly lower over the next few months.
This is supported by the behavior of the XAU (gold and silver index) which has been a very accurate diverging indicator to bullion price and which has recently refused to confirm the new highs in gold.
And since the dollar moves in exactly the opposite direction to gold, we can suppose that the above cycles have precisely the reverse effect on the dollar which is likely to rise substantially from this level. But, of course, this is not the prevailing view. Everyone just KNOWS that the end of the decline in the dollar is nowhere in sight. Just as they KNEW that oil was going to go to $100! This may still happen, but I would not bet on it.
In the chart section you will see some long term charts for gold, the dollar, and the CRB index. They make a very interesting pattern of mutual confirmation and I will analyze them in detail.
Current Position of the Market
SPX: Long Term Trend - The long term trend turned up in October 2002 in conjunction with the 12-year cycle. It is now reinforced by the 10-year cycle. A top is likely in mid-2005.
SPX: Intermediate Trend - A strong intermediate up trend is in progress.
SPX: The Short-term trend has now entered a corrective phase.
Because of market volatility, the short term trend is better analyzed on a daily basis with the help of hourly charts. This is done in our daily market updates and Closing Comments.
Daily market analysis: If you would like to receive an explanation of how I arrive at buy and sell signals and be notified on the day that they occur, please let me know at ajg@cybertrails.com.
Also, please read the important notice at the end of this letter.
What's next?
Now that the 6-week cycle has brought about the anticipated short-term top, how much or a price correction can we expect, and for how long?
A minimum of 2 more weeks of correction into the week just before Christmas is likely. Based on seasonality, there is a tendency for a "Santa Claus" rally to occur in the last days of December and lasting into the first few days of January or longer. There are variations to this year-end scenario and it is very much dependent on the prevailing cyclic configuration at the time. In 2002, the rally started after Christmas and lasted only a week, while in 2003 the rally started in November and continued into March 2004.
The controlling factor this year should be the 9-month cycle, whose low I still expect to be ahead of us. Based on its historical range, the low could come as early as 2 weeks from now and as late as the end of January. Since this cycle normally ends in a selling climax immediately followed by a sharp rebound of prices, it should be fairly easy to determine when the low is made.
Charts
The three monthly charts which appear below are that of gold bullion, the CRB commodity index which is used as an inflation gauge, and the US dollar. They have many features in common.
The first thing to notice is that bullion and the CRB have been in a prolonged up trend while the dollar has been in a prolonged down trend.
Next, we notice that the moves began and ended at about the same time.
Structurally, we can count five major waves in all the charts. They have been labeled 1 through 5, and it would appear that a sharp reversal of the trend has taken place and that wave 5 is complete in all 3 charts.
A channel has been drawn on all charts using a technique called Andrews pitchfork, which consists of creating a median line (solid) according to very specific criteria and drawing parallel lines (dashed) which mark the outside boundaries of the trend on either side of that median. Note how perfectly prices were contained within the channels created by that method. The dollar found its final support on the extension of the median and has reversed course. Gold is finding temporary support in its median line, which is not uncommon, but the CRB is the first one to challenge the lower confines of the up channel.
In the case of gold and the CRB, the 5th wave failed to reach the top channel line before reversing, and the dollar failed to reach the bottom of its channel . This is a sure sign of long term deceleration and the very likely completion of the entire move. Since this is a monthly chart, the last bar on the chart will not be complete until the very end of December, but based on what has already taken place, it would be surprising if gold and the CRB do not end up lower and the dollar higher by the end of December.
And now, let's put this price action into context with what we have talked about before: When will the long term economic cycle known as the Kondratieff wave make its final low? Judging by the behavior of the CRB, it looks very much as if deflation concerns are going to surface once again. In its final phase, the Kondratieff wave characteristically brings about deflation as economies around the world go into a slump. Are we getting a glimpse here of the beginning of the Grand Finale? It will be interesting to follow the progress of commodities over the next few months and years.
Finally, a kind word about Fed chairman Alan Greenspan. He has been much maligned by a number of critics, but it is just possible that his perspective is just a little broader than most people give him credit for.
Greenspan is very much aware of the potential ravages associated with the deflationary phase of the Kondratieff Wave. He has stated this clearly and repeatedly in the past, beginning many years ago before he became chairman of the Federal Reserve. Hence, his decision to re-flate the economy after 9/11 by bringing interest rates down to a 40-year low and by dramatically increasing the money supply. So far, he has succeeded, but only because long term cycles have been in his favor and still are. But in a year or two, and going into 2014, it will be a different story, and "pushing on a string" is just about all he will be able to accomplish.
Already European economies are beginning to slow, and the latest economic news from Japan is not encouraging. If in fact, economic growth is beginning to weaken world-wide, the U.S. economy cannot be too far behind. However, there is still some time before it starts decelerating significantly , and "behind" is the key word here, because if the European and Japanese economies are going to take the lead downward, would it not make sense for their currencies to begin to weaken vis-à-vis the dollar? Another reason for the dollar to potentially have made a major low.
There are other factors to consider, of course, and things may not move quickly, but if deflation really takes hold, it will affect all commodities, including gold and silver, and interest rates will start to drop again. This is why it is so important to continue to closely monitor the 3 charts displayed above.
SUMMARY:
The move which began in October has entered its first real corrective phase. This was forecast by pronounced deceleration in the McClellan oscillator. The correction is expected to last at least a couple more weeks, but it could be longer depending on when the 9-month cycle decides to bottom out. The span of time when this could happen ranges from the 4th week in December to the end of January.
However long this correction takes, it is only considered to be a short term correction and not a reversal of the intermediate term market trend.
Gold and the CRB index may be making a major top, while the US dollar may be making a major bottom
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