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December 30, 2010

Dollar Crisis 2011

Apologies for the dearth of December posts. As you all know, the holidays can be quite hectic with all the requisite activities, and in these times, I have no choice but to give priority to the Member letter. However, the markets have recently been throwing curve balls, and I wanted to sneak in a final blog entry for 2010. So, let's begin with the stock market, which has been the beneficiary of the usual holiday-time, anti-gravity machine (I think it might even be the same device Santa uses).

Equities seem to be setting themselves up for another January correction. An incessant, 14% rally out of the July low has spiked confidence levels to the nosebleed level of 79% according to Combined with several ominously-poised indicators and the fact that stocks are now due for an intermediate cycle decline, the prospects don't seem too positive for stocks once the Street gets back to work.

NYSE New Highs vs New Lows

S&P 500 bullish percent

CBOE total put/call ratio

There is no telling what will transpire on the first couple trading days of a new year, but my expectation is to see the stock market get down to the business of correcting no later than the second week of January. The bigger puzzle pertains to what happens to precious metals in such a scenario. As with the beginning of 2010, gold sits late within its usual time frame for a correctional low. In January, the stock market correction dragged precious metals down into an extended decline. However, 2010 also kicked off with a large rally in the dollar. Going into 2011, the DX is weakening and is expected to dive into a 3-year cycle low by late spring.

dollar index weekly chart

I have little doubt such a dive would fuel a monster run in precious metals. I also suspect the sense of panic surrounding the problems with our currency will subdue stock prices rather than send them shooting higher. But the question concerning us most is whether an equity correction will also drag on the precious metals arena or whether PMs will simply diverge from equities and shoot higher as a safety play. We have a few clues... one suggesting a correction is needed, and two leaving the door open for continued strength.

Gold miners bullish percent

Weekly gold chart

Weekly gold chart

As you can see, there is a precedent for only a brief pause during a parabolic run, and it occurred during the dollar's previous descent into a 3-year cycle low. Unfortunately, gold miners bullish percent data is not available for that period, so we don't know if the dollar's 3-year cycle decline provided an exception to the 80% rule.

However, the 80-week moving average for gold tells a powerful tale. Even if one were to buy into precious metals today and suffer a drawdown, the eventual completion of the parabolic move should more than cover the timing mistake. Consider that the 80WMA is rising at about $35 per month. Four months from now... roughly the time frame the dollar should be finding its low... the moving average would be around $1300. If gold manages to rally 45% above that average... commensurate with previous parabolic rallies... we will see a gold price of $1885!

At this point, it is clear that holding onto a core position is prudent. One could even reasonably augment a core position and then swing for a home run if gold does, in fact, find its way through a correction.

I promise to be back within a week or so with an Outlook 2011 write-up. Happy New Year, everyone.


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