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Speculative Exhaustion?

The following is part of Pivotal Events that was published for our subscribers April 17, 2014.


Signs Of The Times

"A Major Demographic Tailwind Is Coming That Could Make The U.S. Boom For Years"

- Business Insider, April 8

"The conditions for a bad market just don't exist. You can throw a dart at the market and about anything you hit is gonna go up the next six months."

- Bill Miller, former Chairman, Legg Mason, CNBC, April 9

"Chronic Deflation Delayed"

- Gary Shilling, March 2014

"Russian capital outflows in the first quarter were the largest since the last three months of 2008."

- Bloomberg, April 9

"March saw the highest sales of collateralized loan obligations since May 2007."

- Financial Times, April 10


Some may conclude that weakening financial markets is due to political strains in Ukraine.

A great euphoria had bid prices to the moon, which condition is always vulnerable to its own excesses. Ukraine is just a catalyst.

Since January the action in credit spreads has been giving a warning on a possible cyclical change. So is the action in the gold/silver ratio.

This week, both were close to the tipping point.

The great global financial bubble that completed in 1873 was underway and withstood two disasters. In Europe it was the Franco-Prussian War (1870 to 1871) when Paris was

besieged. In America it was the Chicago Fire of October 1871 with property losses amounting to $200 million.

In Europe that bubble peaked in May-June, 1873 which was the usual window for the European peak. In New York it peaked in that fateful September, which month became the peak for the 1929 Bubble and the 2007 example concluded in that fateful October.

The course and timing of a great financial bubble could not be interrupted by war or natural disaster. Then when it had run its course the consequent contraction could not be prevented by the senior central bank (Bank of England) or the US Treasury System. The latter, which in not constrained by gold was considered superior to a central bank. That would be in keeping a boom going.

The contraction ran from 1873 to 1895 and senior economists began describing it as the "Great Depression" in 1884.

The contraction that followed the 2007 bubble was appropriately called the "Great Recession". The first business and credit cycle out of the crash has run for five years and has become precarious and vulnerable to any catalyst.

Not to overlook speculative exhaustion.

Stock Markets

Near-term and long-term forces should be reviewed. On the near-term, leadership is provided by the Biotechs. The IBB had plunged from 275 in February to 207 Tuesday morning. This took out the 40-Week ma, which provided key support in November 2013.

This was enough of a plunge to register a "Springboard Buy".

A rebound to around 245 seems possible, which will relieve near-term pressures.

On the longer-term, April was likely to be a "sweet spot" on the election-cycle model. So let's consider this as an uplifting force and when it expires the model calls for a low in late September.

Also we are in the season when an exuberant credit markets can reverse.

On sector stuff, base metals and mining stocks were likely to rally from the oversold in December to a possible overbought at around March. As we have been noting, the zoom made it into late January when the sector was hit by Chinese liquidation of copper.

Mining stocks (SPTMN) rallied from 703 in December to 868 and declined to 758. The rebound made it to 864 in March and the slip was to 757, which set a lower high and a lower low.

The latest rally made it to 842 on Monday. There is resistance at the 865 level and the action is not as overbought as at the January high.

Over in the oil patch, the XOI was part of the "rotation' expected in December. This sector became quite oversold on the Daily in early February. The index declined to 1370 and rallied to 1565 a couple of weeks ago.

However, the swing from oversold to overbought was outstanding which suggests a pause in the action, and this week's rebound is testing the high.

This prompts a look at the bigger picture.

A bull market ran from the end of the financial crash at 406 in early 2003 to 1665 in May 2008. Crude oil registered a rare Monthly Upside Exhaustion that we took as indicating a secular bear market. Our point now is that that bull market ran for a little over five years.

The current bull market for the XOI has prevailed from the crash low of 744 in late 2008 to 1564. The run amounts to some five and half years.

Our special study on "Peak Oil" was published in late February and looked for an important top in a couple of months.

Are we there yet? It could take a while yet.

What we have been impressed with is that during the bear market for the CRB that started in 2011 crude oil was at 114. Now it is at 104.

On the same move, base metal miners were at a cyclical peak of 1600 and now they are at 822.

On the same move, the XOI was at 1409 in 2011 and recently the index was as high as 1565.

Crude suffered only a minor price decline while oil stock prices, net, did rather well. When other resource sectors such as base and precious metals did very poorly.

This shows up in charting the XOI relative to the HUI. When the gold sector peaked in 2011, the ratio had plunged to 1.69. The out-performance of the oils since has moved the ratio to 7.77 at the end of 2013. The move was strong enough to drive the Monthly RSI to 83, which compares to 80 with the peak in 2000.

The XOI/HUI ratio corrected to 5.67 in March and has recovered to 6.94, which seems like a big test of the high.

Since 2011, the oils have outperformed base metal miners. The ratio has gone from .789 in 2011 to 2.04 at the end of December, when it became relatively overbought on the Daily.

Another "rotation" seems to be building, which would be from the oil patch to the gold patch.

On the general stock markets, once past the April "sweet spot" for the S&P and credit spreads forces of levitation will take the summer off.

The "lines in the sand" would be credit spreads breaking down, the gold/silver ratio breaking out and the S&P taking out the February low of 1737.

For the NDX the February low was 3419 and Tuesday's intraday low was 3414.

Then did "Big Foot" come in with the endless bid?

Maybe something else. As noted above the drop in the Biotechs was severe enough to register a "Springboard Buy". This does not include the S&P, which registered the signal in October and represented the broad stock market.

At the risk of a play on words, the plusses for this month seem to be adding up.

There is the "sweet spot" for the stock market, there is a seasonal low for the DX, a rush of enthusiasm for credit spreads, a seasonal high for crude and a seasonal low for gold. All likely to be realized, along with the key reversals over the next four weeks.

Credit Markets

First the price or yield action:

On this move JNK reached 80 on the Daily RSI in early March as it reached a price of 41.62. The correction was to 40.79 and it made it to a fresh high at 41.33 last week. It is now at 41.30.

Yields for European bonds continue to decline, providing global leadership on lower-grade securities. The yield on the Spanish Ten-Year reached 7.5% in the summer of 2012 and 3.06% was clocked yesterday; a new low for the move. It has registered a Downside Capitulation for two consecutive weeks, which means the action is impetuous.

In price, this is an Upside Exhaustion.

This sector does not have a long history so we looked for an equivalent example in longdated treasuries. The bond future rallied from 66.46 in September 1990 to 100.85 in September 1993. That run was accompanied by a long decline in commodity prices and reached a huge excess. This registered on the ADX. On the top week, Ross had a target of a 17-point decline. The full decline was to 75.21 in late 1994. Essentially, the bear was accompanied by rising commodities.

In back-testing, the 1993 action registered a Weekly Upside Exhaustion.

Over in spreads, narrowing can often run into May. If the play becomes very popular a reversal can follow. Some have set up significant reversals such as the one in 1998 that collapsed the huge hedge fund--Long Term Capital Management.

That one was particularly embarrassing to the central banking cartel. It had Nobel economists on the board and the fund management was so compelling that a number of central banks loaned it money, directly. What's more, the Bank of Italy did that and even took an equity position.

That was indirect speculation in lower-grade bonds.

The failure amounted to $4.6 billion suffered in less than four months; from July into October.

This time around, central bankers have been directly speculating in lower-grade bonds. The Fed's shopping list includes a lot of the dreadful sub-prime mortgage bonds.

A representative issue the AAA.07-2 crashed from 99.33 to 23.10 in 2009. In the five-year bull market the price has soared to 63.5 last week. As seen in the chart the last week of the rise was straight up. Compulsive buying, by whom?

At the last high in May 2012, the Fed was reported as a big buyer.

State-sponsored inflation in lower-grade bonds has created a huge bubble and eventually every kind of bubble collapses.

Sub-Prime Mortgage Bonds

Sub-Prime Mortgage Bonds

  • The rally from the low of 54 in October to almost 64 has been outstanding.
  • The recent spike up shows impetuous buying.
  • Last year's drop in the AAA.6-2 was from 76.2 in early May to 67.8 in early July.

Consumer Credit Binge

Consumer Credit Binge
Larger Image - with permission of Ron Griess at www.thechartstore.com

  • Ron included this chart in his Week-End Blog.
  • It is interesting that with the worst financial collapse since the 1930s, addiction to credit retreated from 24.5% to only 22.8%.
  • It has since jumped to 24.6%.
  • Although absurd, this confirms that the Fed's attempts to get as many as possible over extended has been successful - again.
  • Margin exposure on the NYSE is also at record highs.
  • The job description of a margin clerk is vastly different to that of your basic central banker.
  • It is to get the accounts "in line".


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