Gold Trade for September 2016 (maybe longer)

As another proxy for financial market participants' expectation of general price inflation, gold as of recent has been expressing signs of weakness and downward pressure. In the longer term, gold has resisted the market forces that have been pushing crude oil lower, but trading opportunities still present themselves ever so often.

The preceding chart outlines the last three months of Gold prices. The timeframe for the trade is one month. Sell gold at its current levels ($1310) down to $1245, represented by the green line.

Happy trading.

Gold, Crude, and other Inflation Gauges

Long-term gold prices appear to be in a consolidation range, with the $1,000 price acting as a support level, and by my approximation the $1,500 price acting as a potential resistance level. Industrial supply and demand for gold has always seemed in line with each other, while investment supply and demand, on the other hand, are subject to mismatching. This is usually the source of price shocks in the precious metal. The consolidation range that the price of gold is currently in, represents an equilibrium without any short-term inflation in general price levels. This means that investors are less likely to increase their inflation insurance. In cyclical terms, gold prices will consolidate around industrial fundamentals until investors have cause to increase their hedge against general price inflation.

The 10-year Treasury note price is exhibiting signs of strength, and a buildup of long momentum with both short-and long-term regressions trending higher. Strength in 10-year Treasury prices can signify investor belief that interest rates will not be increasing any time soon in any meaningful way. The S&P500, which has been the driver of financial asset price inflation, no longer has monetary policy as a tail-wind. The overall effect should be the S&P500 switching from a clearly defined upward trend, to a sideways trend. This is the type of environment where the ability to select stocks should yield higher returns compared to passive or index investing.

The dollar index appears to be finding long-term support above the 96.00 level. Overall strength in the dollar index provides little support to short-term price inflation, and consequently depresses commodity and import prices. Without increases in the price of goods and services, there is no justifiable reason for raising wages, and the resulting spillover.

Long-term oil prices are exhibiting signs of weakness, and a buildup of short momentum. The regression trends on one-year, five-year, and ten-year prices all have negative slopes. Longer-term trends in the crude oil market suggest that prices are consolidating around an equilibrium level that represents the matching of global supply and global demand for oil. When there is finally a mismatch of more demand than immediate supply of oil, we will see increases in headline and then eventually core inflation. Until then, we can expect more sideways movement in oil prices with a downward bias, and the same can be expected for general price levels.

When the time comes, and crude oil prices increase and push up the cost of everything that uses it as an input for creating a good or providing a service, investors will sell gold and government debt. As would be expected, any signs of inflation would be met with more monetary policy normalization through interest rate increases. Gold being an inflation hedge, will experience weakened investment demand, and government bond prices would respond to any monetary policy adjustments.

Crude Oil Trade for August 2016 (maybe longer)

I've been looking at Crude Oil in longer-term time frames in relation to its impact on general price inflation, and inflation expectations. The trends are clear in the intermediate-term, but within the intermediate-term there are also short-term trades.

The preceding chart outlines the last three months of Crude Oil prices. The timeframe of the trade I have in mind is approximately one month, with the first leg being long from current levels to within the $45 range, followed by a second leg short to within the $30 range. The trade fits within the overall intermediate- and long-term trends that Crude Oil prices are exhibiting. Over time, the price may extend lower past the target of the trade but, I expect there to be sideways consolidation in the price action before another clear trade makes itself apparent.

Happy trading.

Summer 2016 Part Two: Short S&P500

Last summer, the S&P500 ended a six year bull-run which started in early 2009 and entered into a defined trading range, which we'll call a lower-bound of 1,800 and an upper-bound of 2,500. Historically, equity prices have exhibited an upward bias, so it's easy to guess which direction the S&P500 will be heading in over the next three years. The direction over the next three months however, is not so easily deciphered. The bull-run that ended coincided with the burst of global economic activity concentrated in the emerging and developing markets. The S&P500, which earns a large percentage of its revenues from outside the United States benefitted from the international growth, as well as universally accommodative monetary policy, and multiple rounds of quantitative easing by the Fed.

Fast-forward to summer 2016, and the S&P500 no longer stands to benefit from further systemic increases in financial market liquidity, and the current environment of global economic uncertainty will shift safe haven positioning by international investors out of equities and into government debt. This appears to be the underlying trend playing out in most developed non-commodity exporting economies, where mid to long-term interest rates are considerably low, with no signs of support from inflation. The overall effect will be upward pressure on the US dollar, filtering through to upward pressure on long-term bond prices keeping interest rates low. The shift in investor sentiment will also exhort downward pressure on US equities, and to an extent global equities.

Furthermore, with it's first (albeit arbitrary) interest rate increase, the Federal Reserve is attempting to communicate that financial market stability does not dictate the course of monetary policy. That first step has effectively removed the implicit guarantee to support equity markets in the short-term. Without the artificial supports of Large Scale Asset Purchases as they were by the Fed, the US equity market now has to realign with the underlying macroeconomic reality. A reality where long-term inflation expectations may be beginning to shift lower than the long-held central bank targets, and both financial and real asset prices over time must reflect their underlying fundamentals.

Summer 2015 Part One: Long Dollar

I’m sitting in a long US dollar currency play against the New Zealand dollar that I must admit has been very good to me of recent. The position is one that I’ve been leaning against whenever I saw any short-term (intraday) inclinations of the dollar appreciating. Well more and more, over the past few weeks, I’ve been finding less and less short US dollar trades in my usual hunting grounds against the Australian dollar, the Euro, and the Pound Sterling. It was to the point that I had to start re-evaluating my short- bias stance on the US dollar. I started my search for fractal patterns that clearly repeated themselves in my shorter-timed charts, and the corresponding nascent stages of those same patterns in my longer-timed charts. At the same time I start parsing through the news headlines as the data statistics roll out for signs of an overall change in the sentiment of the numbers. As of now, (backward looking) economic statistics are still showing ‘slow and steady’ progress with US economic growth, and by extent, the rest of the world. 

The dollar has had a fairly extended period of steady gains against most major trade partners. This has been supported by the air of uncertainty that has lingered over the global economy since the recovery began back in late 2009. Most recently, I have stepped forward and called for a reversal of the dollar’s upward trend. This idea was being supported by the relative improvement in US economic data versus that of most trade counterparts, and the implications the Federal Reserve were telegraphing for monetary policy. The most recent development in the narrative is the perceived influence that financial market risk, global economic sentiment ex-US, and international institutions like the International Monetary Fund have over US monetary policy. This latest layer of complexity suggests that there are more elements of uncertainty in global financial considerations, and so more reason for investors to proceed with caution.

The investment portfolio implication is renewed support for a long US dollar bias. Not necessarily because of American economic outperformance, but because the US dollar is a relatively safe asset to hold over time. The same can be said for most other safe haven assets like the Japanese Yen and the Swiss Franc. The exception being gold; as inflation expectations remain well anchored in the US and across most of the developed world, and because it behaves more like a commodity rather than a hedge for financial uncertainty at this juncture. Equities should benefit in the medium term as easy monetary policy at most major central banks continue to depress interest rates, and by virtue the rates at which future cash flows of companies are discounted by to generate current stock prices.

I was right (this time)

If  you went short dollar when I said to go short dollar, then you would have made money. If not you didn't. Keep reading, keep trading, keep making money.

The Tale of the Output Gap

The output gap, is a seldom mentioned economic statistic compared to some more readily recognizable ones like Gross Domestic Product (GDP) or Consumer Price Index (CPI), yet its implications have just as much sway over monetary policy as its better-known cohorts.

The output gap is defined as the difference between the actual output measured in GDP, and the potential output of the economy at full employment without evidence of inflationary pressure. A positive output gap refers to a period where the economy is producing above its long-term potential, and positive inflationary pressure is evident in the economy. A negative output gap refers to a period in which the economy is producing below its long-term potential, and negative inflationary pressure is evident in the economy. The Great Recession, was not the first period in American economic history where the output gap was negative, though it does stand out for its duration compared to other recessions. When it’s all said and done, the US output gap is likely to drift back into positive territory to offset the current period of a negative gap. I am interested more specifically in the overall trend unfolding in the time series of the output gap statistic.

 

After a short glance at the time series going back to 1949 of Output Gap data, a downward trend becomes apparent. My intuitive conclusion is that the American economy has been progressively falling behind its long-term potential for output, over the past 65+ years. This timeline coincides with the lifecycle of the Baby Boomer generation. In other words, the Industrial Revolution that occurred in the US economy leading up to the Great Depression, set the bar so high for relative expansion of production potential, that the following generation spent the sum of its working years perniciously falling short on the whole. Not to be understated, this is the generation that built on decades of industrialization to create what we now consider the difference between developed and developing economies. As a final act, the Baby Boomer generation facilitated the transition from the manufacturing centric economies of their boom years, to the service centric economies the developed world enjoys today.

The next Act is set to be as spectacular as, if not more so than, the previous Acts of the Industrial Revolution and the post World War 2 manufacturing boom seen in the developed world. The next Act is the story of the Millenials and a service driven economy that does not place a premium on labor. The x-factor in this part of the narrative is how integrated and extensive the role of technology will be in the resounding success, or epic failure of the next generation to ‘have a turn’. To the credit of the Millenials, technology is an incumbent part of their everyday existence, and integration of ideas both abstract and mundane, is second nature. The frontier of human-technology interfacing may prove to be ground upon which this next generation of entrepreneurs and problem solvers cultivates the next burst of economic expansion.