Anatomy of a Technical Trade

By Scott Silva

Editor,  The Gold Speculator

7-27-11

One of the laws of market espoused by those that embrace the efficient-market hypothesis states

“Stock market prices are unpredictable.”  Technical analysis, however, has proved effective at predicting future price direction through the study of past market information, primarily price and volume. To be sure, predicting future prices of a stock or commodity can be challenging, and not always successful, but the speculator can profit from correct technical analysis of a traded good. The price movement of silver over the last eleven months provides a good example. So let’s examine the anatomy of a technical trade in silver.

One of the most liquid markets for silver is the market for silver futures, traded on the COMEX.

Other markets for silver include exchange traded funds, or ETFs, which trade similar to stocks. Price and volume history for each type security are readily available, which allows the technician to work.

The technical analyst searches for chart patterns that develop with price action over time. Volume associated with price action is an important factor in evaluating the validity of a particular chart pattern. Independent indicators can also help confirm the validity of the primary pattern. Back in September 2010, we identified a breakout pattern in COMEX silver that predicted a bullish move up. We saw this play out in higher silver prices since that prediction. 

Here is what we observed on September 3, 2010:

BREAKOUT

                As we survey the various elements of the precious metals group in the run-up to Labor Day, it becomes very clear that something big is brewing.  As we see, the chart of silver has formed an ascending triangle going back to Dec. ’09.  This triangle has broken out today, and it presages breakouts throughout the precious metals group. Using the semi-log continuation chart (www.timingcharts.com) we can predict the price objective for silver at about $60 using the present data.

Technical analysts know the ascending triangle pattern is a bullish formation that usually forms during an uptrend as a continuation pattern. Although there are instances when ascending triangles form as reversal patterns at the end of a downtrend, they are typically continuation patterns. Regardless of where they form, ascending triangles are bullish patterns that indicate accumulation. The length of the pattern can range from a few weeks to many months with the average pattern lasting from 1-3 months. As the pattern develops, volume usually contracts. When the upside breakout occurs, there should be an expansion of volume to confirm the breakout.

We use the ascending triangle pattern to calculate the price target by projecting a line parallel to the ascending trend line (bottom trend line) starting at beginning of the horizontal resistance line, and extend it to intersect the price scale. This can be seen as a mirror of the ascending triangle with a common horizontal base. Care must be taken to account for semi-logarithmic price scale. For COMEX silver, the September 3, 2010 breakout from the ascending triangle pattern produced a target price of $60/oz.

We recommended subscribers buy COMEX Silver at $20.78 on September 17, 2010.

Price action in November and December produced bullish pennant patterns that confirmed the continued move up for silver. The chart below was explained to subscribers on December 10, 2010.

       The key technical formation of the moment is the pennant which formed in silver over the month of November.  Silver did move into new high ground early in December.  But it fell back and appears to have met support at the $28-$29 level. The November pennant gives a point count to $40.  There was a 61% move in silver from late August to early Nov., and the pennant predicted an equal (percentage) move.  A 61% rise from $25 gives us a target price a touch over $40.  Our objective for silver at $40 is mid February (on the argument that the second leg out of the pennant will be equal to the first leg in time).

We know that commodities, including silver correspond to movements in the Dollar. This makes sense since silver is usually purchased in Dollars. So when the Dollar weakens, the same ounce of silver commands more Dollars in exchange. Likewise, the strong Dollar buys more Troy ounces (31.1034768 grams) of silver. Hence, silver usually has an inverse relation to the Dollar. It is important to recognize that the price movement of one does not cause the price movement of the other. Prices rise when there are more buyers than sellers for a particular good. The value of the Dollar decreases with increases in the money supply.  The technical analyst can use these facts to his advantage in predicting future price movements.

We can see the inverse relationship between the Dollar and silver in the chart below.

We saw the Dollar drop steeply in September-October 2010. This corresponded to the first large leg up for silver over the same period.  In December we recognized a bearish pattern (head-and-shoulders top) on the Dollar index that broke to the downside for the next five months. This corresponded to the second large leg up for silver over the same period.

Here is what we told clients about the Dollar on December 15, 2010:

Here is the weekly basis chart of the US Dollar.  Notice that the chart gives the clear head-and-shoulders top. This formation has to dominate our thinking on the intermediate term.  A breakdown from the neckline predicts a drop to 74 or lower.  We can expect commodities to benefit on the Dollar decline.

We saw silver continue on a parabolic rise on its way to $60/oz. At $50/oz, the CME slammed the door on buyers by raising margin requirements to 50% of position value. Retail buyers who got in late bailed out, or were called out on margin. Since then, silver has made a return to over $40/oz as investors return to silver and gold as the debt crises in the EMU and the US unfold.

Today, silver and gold have reclaimed milestones. Gold is trading over $1600/oz and silver is trading over $40/oz. The Dollar is selling off, just a point away from its May low of 72.86.

Resolution of the US debt issue is likely to reverse the Dollar’s slide, and pressure gold and silver. But the US debt issue has devolved into a day-to-day melee; Congress and the White House may not be able to control the situation before the credit agencies take action. One thing is certain- downgrade of the US sovereign debt would be catastrophic for the markets here and around the globe.

So, how should the prudent investor be positioned today? Technical analysis helps show the way.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Safe Haven Trade

By Scott Silva

Editor,  The Gold Speculator

7-18-11

Gold is showing its true colors as the ultimate safe haven asset. Gold has been trading at all-time highs as national economies in the European Monetary Union teeter on bankruptcy, threatening the legitimacy of the Euro as a legitimate currency. Adding to global economic uncertainty is the US debt crisis, which has forced the major credit rating agencies to place US sovereign debt on negative credit watch for potential downgrade.

It seems inconceivable that the US would lose its AAA credit rating. US Treasurys have been considered the riskless asset compared to all others. That is, the probability that the United States would default on its debt has been considered zero, up until now. Moody’s has stated that the chances of US default in the next 90 days are 50-50. That’s a long way down from “riskless”.

The US Dollar and US Treasurys have been traditional safe-haven assets. US Dollar denominated assets surge in price when investors sell risky assets such as stocks and high-yield bonds in the so called “risk-off” trade. We saw the Dollar climb at the height of the global financial crisis, right after Lehman Brother’s bankruptcy in September 2008.  US Treasurys also surged. In January 2011, the Arab Spring followed by the Libyan oil shock in February put pressure on the Dollar as commodity prices, led by oil, spiked. Also in January, fears of a Euro-zone debt crisis began to take hold. Investors piled into gold, in a flight to safety, driving the price above $1400/oz.

Traditionally, the Dollar and gold are negatively correlated, which is to say gold prices tend to rise as the Dollar declines, and vice versa. We have seen gold prices, measured in Dollars, rise steadily since 2009. Over the same period, the US Dollar has seen an overall decline. This is not to say that one caused the other. Contrary to popular belief, correlation is not causation. The US Dollar has declined in value primarily due to Fed increases in the money supply. Gold prices have increased because there are more buyers than sellers. The price of gold is a good measure of economic uncertainty.

Another measure of investor sentiment (fear or uncertainty) is the CBOE Volatility Index, or VIX. It measures market expectations of near-term market volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be a reliable barometer of investor sentiment and stock market volatility.

We can see in the chart above that the VIX and the S&P 500 are negatively correlated. Stocks tend to fall when the VIX rises. This makes sense. When investors expect the markets to be volatile, fear of losses drives them to sell. Of course, for most investors, selling begets more selling. Many flee to US Treasurys, considered the safe trade.

But that relationship is now breaking down. Today, stocks are selling off; the Dow is down more than 150 points and S&P500 is down 1.3% to below 1300. Price action in the VIX predicted the sell-off by moving up from 16 on July 11 to 21.78 today. The Dollar index, however, is trading slightly lower than the last week’s levels (75.85 vs 76.31) and, the 10-Year Treasury is trading at the same level as nearly a month ago. So proceeds from the stock sell-off are not flooding into US Dollar denominated assets.

Instead, funds are flooding into gold and gold stocks. COMEX gold has broken through $1600/oz, and the gold mining stocks are breaking higher. The NYSE Arca gold BUGS index (HUI) is up 17% over the last 30 days.  The Philadelphia Gold/Silver index is up 11% for the same period.

Clearly the ‘safe-haven’ asset is gold. Right now the flight to safety is away from stocks and away from the Dollar and Treasurys and into gold and gold stocks.

Subscribers to The Gold Speculator have owned gold and silver (metals and mining stocks) since early in 2010. Specific portfolio recommendations produced 66% profit in 2010 and gains of 40.5% year-to-date for 2011. In comparison, the Dow is up 7.10% year-to date, and the S&P 500 is up 4.09% year-to-date.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Too Big to Fail

By Scott Silva

Editor,  The Gold Speculator

7-12-11

The United States is too big to fail. The largest economy in the world is too strong and too influential to fail. The United States economy leads all other economies as it has for the last 100 years; it has extensive ties to the global economic community. What’s good for the US is good for the world. And what’s good for the US government is good for its citizens.

These are the arguments we hear as the US debt issue approaches a full-blown debt crisis, similar to the near bankruptcy in Greece that continues to plague the EMU.  Today Italy and Spain appear to have caught the Greece contagion.

Could the US actually default on its obligations?  Would default be catastrophic? Is the United States, in fact, too big to fail?

There is no doubt that the United States is coming very close to actual default, just as Greece did earlier this month. The US Treasury must pay interest on outstanding national debt by August 2, 2011. It pays interest from monthly federal income (taxes, fees and interest earned) and from borrowing. The Federal government borrows 40 cents of every dollar it spends. And there’s the rub. Federal borrowing is limited by law, and Congress has already spent up to (and a bit beyond) the legal debt limit of $14.3 Trillion. So if Congress does not raise the debt limit by $2.5 Trillion by August 2^nd, the Treasury will be forced to pay debt interest and not pay out some domestic obligations. If it defaults on its debt payments, the credit rating of its sovereign debt will be downgraded, and the Dollar will decline. Secretary Geithner called the potential result “catastrophic.”

Unlike Greece, the US has no higher collective available with bail-out funds at the ready. Neither the ECB nor the IMF can help the US. Not even the Bank of China could rescue the US today. It already owns over a $1Trillion is US Treasurys.

The current Keynesian solution is to raise taxes by $1Trillion or more over the next ten years, and maintain the current growth rate for federal spending.  Maintaining the growth rate of federal spending implies cuts in federal programs because national demographics portend rapid cost growth in entitlement programs such as Medicare and Social Security. The tax hikes, now called “revenue increases” would come in the form of “closing tax loopholes” on corporations and setting higher tax rates for “millionaires and billionaires.” Taxing the rich, it is thought, will help close future budget deficits and therefore reduce the federal debt. Budget cuts would maintain the current spending growth rate (rather than reverse the slope of the spending curve), and be limited to discretionary programs, including defense, but would not include Medicare and Social Security.

Those opposed to raising taxes cite the nation’s anemic GDP growth rate, which has slowed to just 1.8%, and persistent high unemployment, which ticked up to 9.2% in June. Raising taxes, the opponents claim, might push the economy into a double-dip recession, or worse.

The president agrees that raising taxes in a recession is a bad idea. That’s why he said in his press conference on Sunday that no new taxes will take effect until 2013. The president has stated this position before. In August 2009, on a visit to Elkhart, Indiana to tout his stimulus plan, Obama sat down for an interview with NBC’s Chuck Todd, who passed on a question from Elkhart resident Scott Ferguson: “Explain how raising taxes on anyone during a deep recession is going to help with the economy.” The president responded, “First of all, he’s right. Normally, you don’t raise taxes in a recession, which is why we haven’t and why we’ve instead cut taxes. So I guess what I’d say to Scott is – his economics are right. You don’t raise taxes in a recession. We haven’t raised taxes in a recession.”

But delaying tax hikes to 2013 will not change the need to pay debt obligations on August 2, 2011. And not fixing Medicare and Social Security is no solution to the controlling the largest consumers of the federal budget.

Opponents say it is time to re-prioritize the federal budget, and slash programs that are not essential to operating the federal government, while lowering taxes across the board.  In Greece, the parliament agreed to deep cuts and a wide-ranging austerity program, required by its bail-out creditors.

The bail-out creditors in our case are the US citizens and businesses that pay federal taxes, purchase goods and services with US Dollars. Without substantial budget cuts and entitlement reform, taxpayers will pay more for spiraling federal costs directly by taxes, or indirectly through the inflation that follows the creation of money (and US Treasurys) out of thin air.

So it is the US taxpayer that will bear the brunt of a decision that does not cut federal spending by 3 times or more than the debt ceiling credit raise.

The US debt negotiations are being held in secret, away from the well of the Congress, away from debate, and away from the American people. The people are left with one-way press conference quips and few facts on which to judge, much less to act. And the story keeps changing.  It’s a wonder that the rating agencies have not come down with a verdict already. But the day ain’t over yet.

The markets are reacting. Monday, the Dow dropped 150 points. The NASDAQ shed 2%. The sell-off may have come in part from new fears of debt crisis contagion in Italy and Spain. But there is no good news coming out of the secret US debt crisis negotiations. To the contrary, the US Treasury Secretary took to the Sunday talk shows with a message of impending doom.

Gold is reacting also. Gold continues to move up in price as investors seek the safe-haven trade.

Gold open interest has swelled by 12,000 overnight contracts. Large Speculators have increased their long positions substantially, according to the CFTC.

What is more significant is the fact that since the negotiations began, Gold and the Dollar are moving in positive rather than traditional negative correlation.

It’s time to start thinking about real solutions to our spending problems. As usual, Europe is light years ahead of the United States. The EMU addressed the debt crisis in Greece by enforcing strict austerity by the Greek parliament. We should learn from this example before, by accident or by treachery, the US debt negotiation catapults into a full-fledged debt crisis.

Part of the solution should be a return to sound money-- Bretton Woods II, with some refinements based on experience. One cannot build a sound monetary system based on money backed by thin air. Gold-backed US currency would bring fiscal discipline to the government and help grow the economy.

With a gold standard, commerce would flourish and citizens would prosper.  The Federal government would be smaller and maybe more efficient. The United States economy would grow and become once again, a shining example for the world to see, a tower of financial and economic strength-- too strong to fail.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and growing inflation?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055