The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, May 14th, 2013.
You unlock this door with the key of imagination. Beyond it is another dimension - a dimension of sound, a dimension of sight, a dimension of mind. You're moving into a land of both shadow and substance, of things and ideas. You've just crossed over into the Twilight Zone.
No words can better describe present circumstances in the financial markets today than the timeless opener to the TV series The Twilight Zone, from the sixties. Many of you who are too young to remember hearing these penetrating words coming over your televisions way back when have still heard these words, or reference to them, due to the imagery they create with an almost harmonic transcendental quality, something that's bigger than all of us. And that's the way markets should be right - bigger than all of us - free and unfettered. Of course such thinking is pure folly in the increasingly interventionist world we live in today, where central planners and totalitarians increasingly distort reality in order to maintain the status quo, at least for now.
But it's getting a bit tired, this episode, where even the bulls don't know why they are buying anymore other than prices keep going up relentlessly. In fact, it should be no surprise to those still living in the 'real world' that dangerous divergences and disconnects between the economy and markets have become truly profound (like never before), so much so that if the stock and / or bond markets were to undergo even 'normal' corrections, there's a risk that recovery could be a non-starter (putting it mildly), just like Japan. Because again, just like Japan, people on this side of the world, and pond (think Europe) are getting older, and as this process continues to unfold they will keep deleveraging, which will keep pressure on the macro, and is a force (Mother Nature) that will need to be properly reflected in the markets at some point.
For now however, it's 'comply or die' in the financial markets, or you will be punished as Max Keiser points out, with financial repression and outright manipulation of the markets never greater - taking us well into The Twilight Zone. Although money supply measures are growing slow compared to the crisis years (2008 / 2009), still, liquidity is plentiful enough to maintain the 'illusion of normalcy', which aides in conditioning of the collective mind, just as Orwell envisioned it. Stocks are squeezed higher on a continuous basis, with macro-conditions now stretched to the limit due to demographics, peak consumption, and the depressing effect of QE. This condition set is flashing a profound warning for those willing to listen - those not influenced by the 'comply or die' policies put upon us by unscrupulous central planners.
These are quite possibly the most treacherous market conditions ever, completely based on money printing, leaving the realm of risks (mistakes) that are possible well within jurisdiction(s) of central banks. Any slip ups here, like letting the rate of change in money creation slip to far down (see Figure 1), could cause another episode like that witnessed in 2008 at any time. As you know from our discussions a few weeks back (see attached directly above), we are in that position right now, with European banks are ripe for a meltdown; so again, right now the bulls are playing chicken with destiny in my opinion. The problem with fiat currency monetary systems is they are like junkies; they need increasing doses of the addiction in order to postpone the inevitable - drying out and / or death.
This is of course why present central bank policies (think currency wars) are so dangerous, because the addict is so depended on getting a daily fix, that without it, death would be the more likely result. And this may be why central authorities are attempting to manufacture a recovery (despite crashing macro measures) using bogus statistics like this, so that they can attempt to allow for bonds (and stocks) to correct because things are getting a little frothy to say the least. Margin debt levels are also back to pre-recession levels, (along with complacency) meaning peak levels last witnessed in 2008, which in turn means 'yes Virginia (CNBC), we are in bubble conditions again.' What's more, if this what the Fed is doing, it only needs to follow its own surveys in order to quickly realize such an endeavor would like be an error (from their perspective), possibly causing an unplanned event in the market(s) (these trades are very crowded). But hey, you can't tell these guys anything (especially the Bernank) because they are geniuses - right?
Today, both central planners and the public largely believe a 7 - sigma event (like what just happened in the gold market) is not possible in the stock market due to the controls in place, which is a very dangerous sentiment backdrop. And while it's true that speculator betting practices in the options market still shows a healthy degree of anxiety regarding stocks, still, the fact most investors / speculators chose to hedge in options as insurance rather than sell is proof complacency reins supreme, and that at some point hedging will no longer make sense, potentially bringing in some real selling. With margin debt back at record levels (see above), this thinking is not a stretch, which again, as suggested above, is why the Fed is attempting to slow stocks down a little, now talking about tapering back on QE.
And that's all one should expect for now, a little correction this week met by big put buying created by anxiety associated with QE tapering. Bank run prop desks must be salivating over prospects to selling the dupes a bunch more insurance that will never be paid off. Because once stocks swoon a bit you can expect POMO injections to be increased, which will keep the perpetual short squeeze alive and well considering the Fed is timing this tapering to coincide with favorable (bond) market conditions. Later this year things won't be so sanguine in bonds when increasing funding needs are met (think ballooning deficits and no debt ceiling), but of course Bernanke will be gone by then, so no bad from his perspective. The rest of us will be suffering, but Bennie will off selling his book and making paid public appearances, like Mr. Magoo did right after he finished up at the Fed.
Why will the rest of us be suffering? Well, for one thing, and as alluded to above, much to the surprise of one of the most complacent markets in history, we will likely be suffering from post bubble withdrawal symptoms again (which will be worse the longer addiction denial runs on) once stocks top out on a lasting basis, which could be closer than many think. Be that as it may, stocks, as represented by the Dow, could also hang in their until late summer / fall as well if speculators / hedgers keep buying puts in droves and not selling, perhaps based on the belief any talk of tapering is a ruse, and that it's QE to infinity like originally promised last year. At a minimum most market participants today believe they have the Fed at their backs, and that if stocks began falling they would change their tune quickly. (i.e. this is why they don't sell and hedge with puts instead.). But this is a dangerous circumstance because the Fed is not infallible, and at some point the bond and / or currency markets will not be able to maintain the policy demanded by present day believers. This is why if not now, once the Dow reaches the broadening top target depicted in Figure 1 below (~ 16,800 plus), one would be foolish to remain sanguine on the stock market indefinitely. (See Figure 1)
Along this line of thinking it would be wise to take a good look at the Dow / Gold Ratio to see what it's telling us, because as alluded to last week it's likely retracing the move down all the way from 1999 highs at 44.48. But before we do this, let's see what the gold charts have to say specifically, because the picture is blurred with the random volatility to be expected in such fluid trading conditions. In looking at a daily plot, attached here, we can see that gold has risen about $100 off of last month's lows in what looks to be an aggressive a - b - c correction, where the b-wave may have been completed Friday with a reversal doji, meaning prices should now vex the $1500 area before turning lower again if the Dow / Gold Ratio is to keep correcting higher. Is this possible with gold oversold on so many measures? To answer this question we will review the weekly plot from the Chart Room, which does show that there is in fact room for more selling in the RSI, other indicators, and stochastics. What's more, one should notice the massive ROC diamond broke to the downside with the plunge last month, suggestive further weakness should be expected. (See Figure 2)
The open interest put / call ratio on GDX has risen to .62, which could support precious metals shares (because GDX is the largest ETF) with some slight squeezing into options expiry Friday, in turn supporting bullion prices, accounting for a move in gold to $1500ish; but, don't expect much more until ratios get back above unity on both this contract(s) and on NUGT as well, still at approximately .25. (i.e. meaning aggressive speculators are still wildly bullish holding 4 calls for every put.) This means the prevailing risk remains to the downside with paper pricing mechanisms (COMEX, etc.) still in charge, so taking outsized risk on bullish bets should be considered irrational acts and avoided. Referencing last week's commentary on where the Dow / Gold Ratio should be heading then, we said:
"The fact the Dow / Gold Ratio has not even retraced 23.6% (a minimal target even in wildly bullish markets) of the move from 2000 remains a concern from an inter-market / technical perspective, however when one considers the fundamentals (supply constraints given all the fiat currency chasing increasingly scarce physical), because precious metals have and are such a heavily managed market, where prices should be far higher at present, perhaps such a concern is not pertinent. In order to clear the market in this regard, gold would need to plunge towards $1,000 and stocks remain stable, if not rise. Can this happen? Only the shadow knows for sure, but such an outcome would take the markets into places they have never been before. From the perspective we are seeing all sorts of things never witnessed before (market intervention, record complacency, and unparalleled complicity given the size of the bureaucracy), no potential outcomes can be completely discarded."
Thus, from a technical (inter-market) perspective there is good reason to believe the Dow will extend its gains to 16,800 plus and gold will fall further, possibly all the way down to 1100 (channel support), as we push further into the year; again, possibly extending present moves through summer on light volumes. Such a move would bring the Dow / Gold Ratio to the 15 area (44.48 - 5.80 [2011 lows] = 38.68 x 23.6% + 5.80 = 14.92), which is the 23.6% retrace off the 1999 highs. At a minimum one should expect the retrace to touch the 233-monthly exponential moving average, which is in the proximity of 15, denoted on the plot from the Chart Room displayed directly below. (See Figure 3)
Now there is always the possibility the retrace ends closer to present levels with significant time line turns for both gold and the Dow / Gold Ratio due anytime now, however stocks are still rising in parabolic fashion, so as soon as gold finishes correcting higher, if that's what it's doing, then another plunge is possible, taking us into this timing window. The point I am attempting to make here is anything is possible, so please do not discard such an outcome, especially with all of the significant signals thrown off recently supporting such an occurrence. (i.e. think deflation scare, etc.)
What could cause gold to plunge further? While I have no idea what would be the exact cause of such an outcome at this time, how about hedging announcements, as a guess. Nothing these producers do should surprise you considering their histories. (i.e. heaven forbid they cut back production or hold back product.) Or how about the future is just so bright traders become more convinced they don't need gold anymore. Or how about a good old fashion deflation scare once the broads roll over, with HFT, algos, and margin clerks taking credit for a real plunge. Because when the stock market does turn lower, the decline should be fast and furious due to such factors, along with unprecedented complacency. Again, nothing should surprise you considering the increasing desperation being felt in the markets these days; so make preparations now before its too late. The SPX / VIX Ratio is only one good days trade from the target matching the 2008 highs at 138 now, meaning although stocks could still go much higher (see below), one's tolerance for risk should be re-examined.
Of course the good news associated with a move in the Dow / Gold Ratio back up to one of the loftier retracements is that the move from the 1999 highs was all one wave, implying gold, and the entire precious metals sector, is going much higher one day. Once the masses in North America finally get a good taste of the anarchy that is building behind the scenes every day now, from asset confiscations to martial law, increasing numbers will eventually lose all trust for big brother, which will change everything. The emperor will be revealed to have no clothes. High-level bankers revealed to be nothing more than marauding thieves (cracks are already showing in this regard), like their brethren, politicians and elitist business interests - speculating fools that are allowed to bail themselves out with your money, and a new twist, bail-ins, which is bureaucratic theft.
So, on the one hand you have stock market technicals that are truly scary, where profit margins are not there, but on the other hand you have a growing surplus of money in the system because of a rapidly shrinking budget deficit suggestive the bubbles are going to get even bigger. What's more, the bulls (think Tepper) are saying the Fed must cut back on QE or we will see bubble conditions like the second half of 1999. And while in many respects the bubbles are already bigger than the tech wreck, taking this into consideration, visualizing the Dow / Gold Ratio running up to 15 does not seem so unlikely, which is why it will probably happen, with stocks moving materially higher and gold lower. (i.e. a rising dollar[$] and real rates would cause further losses in gold.) The ride will get more volatile with bond yields likely to break higher, which will be the market's undoing in the end (think later this year or next), but that's down the road - right?
This will be the biggest bubble condition the world will ever witness - The Twilight Zone - believe it or not.