Yesterday (red line above) played out exactly as predicted. After opening up $0.30 (1.5%) on the New York open, silver was worked lower the rest of the day back to essentially unchanged (just like the day before that, blue line, as well). Today silver opened up a modest $0.08 and now, as of 11:00am EDT, it's beginning to roll over. Where will we end the day? Based on the established trading pattern, my guess is $19.50/oz give or take a few pennies.
The Junior Minors 3X Bullish ETF is really setting up a nice consolidation pattern here. We have seen a drift lower for the past 7 weeks with diminishing volume. The RSI and MACD are very close to turning positive. Look to buy on any break above $26 but be sure to use tight stop. This is a highly leveraged ETF so it's not unusual to see 10-15% moves in a single trading day. Regardless of the volatility, the bullish setup is certainly appealing.
See a pattern here? Each day for the past three days, silver has rallied into COMEX open (noted by the vertical yellow line) only to be immediately capped and sold for the remainder of the day. These three days are by no means the only three days where this has happened. This is a constant, repeating pattern that has been playing out for months and years. With the Shanghai Metals Exchange going fully live in late September, will this change? Remember, Shanghai silver stock have nearly been depleted.
What we've seen in the S&P 500 these last five years is nothing short of sad. After the financial meltdown in 2007-2008, investors headed for the exits as evidenced by the graph above. The rally from the early 2000s to the market top in 2007 saw steadily increasing volume. Logically, this makes sense for a couple reasons. First, as the population grows, more and more people enter the stock market representing incrementally more volume. Second, momentum begets momentum. The higher the market goes, the more investors will chase equity prices higher leading to expanded margin balances. Those margin dollars equate to more liquidity and high volumes.
Since 2009, S&P 500 trading volumes have seen steady, year-over-year declines putting us back to where we were in 2005. This should be deeply concerning for informed investors. Trading volume provides liquidity, or depth. When volume is high, then there is a large pool of buyers and sellers and block trades are readily absorbed into the market. Low volume, however, means that the market lacks depth. There are fewer buyers for every seller and fewer sellers for every buyer.
This matters. Why? Because a stock market without volume is like a crowded football stadium with a single exit. If there is a crisis or a sudden rush to the exits, who is going to buy when everyone is selling? Normal stock market corrections can be swift, yet orderly. The "orderliness" comes from market depth. The low volume phenomenon we're seeing shouldn't be seen as a potential cause of a market decline, but rather the potential cause of a disorderly market decline.
An extreme example of a disorderly decline is, of course, the flash crash from May 2010 where the Dow plunged 1,000 points (9%) in an instant, only to fully recover minutes later. According to a report by the SEC and CFTC, the market was so fragmented and fragile that a single large trade could send stocks into a sudden spiral. It then detailed how a large mutual fund firm selling an unusually large number of E-Mini S&P 500 contracts first exhausted available buyers, and then how high-frequency traders (HFT) started aggressively selling, accelerating the effect of the mutual fund's selling and contributing to the sharp price declines that day.
It's no wonder, then, why the Federal Reserve is considering placing redemption gates on certain investments which would prevent security holders from selling when they wanted to. The Fed sees the lack of liquidity in the markets and they fear a sudden rush to the exits. This potential policy has been heavily criticized (and rightly so in my opinion) by a number of analysts, such as here and here. If, as an investor, you know that you may not be able to access your money if you invest in certain assets, would you still invest? Of course not. So basically the Fed is stuck between a rock and hard place. If they impose redemption gates, then many investors will start yanking money out in anticipation of those gates. If the Fed doesn't impose the gates, then they run the risk of a disorderly market crash.
Remember, the first ones out the door are the ones that survive.
Today I'm going to explore the relationship between NYSE margin debt and the S&P 500. Margin data for the month of July was just released a few days ago. July's read was $460.2 billion, just shy of the all-time high of $465.7 billion from February 2014. While absolute margin levels are interesting to track, they don't really tell you a whole lot. As the population grows and as the economy expands, it makes sense that margin debt grows as well. So the fact that we're at or near all-time highs isn't all that meaningful. When you measure margin debt relatively, however, a very interesting picture emerges.
Here we have a graph of NYSE margin debt as a percentage of GDP sitting on top of a graph of the S&P 500 - both going back to January 1990. Notice a pattern here? In the last 25 years, NYSE Margin Debt as a % of GDP peaked just prior to major market tops in the S&P 500. If margin is increasing, then the S&P will likely be rising as that new margin money is being invested in the stock market. On the flip side, declining margin debt reflects investors closing out levered equity positions thereby reducing balances of borrowed money. This can be self-perpetuating - the more investors sell, the lower prices go. The lower prices go, the more margin calls will be made thus forcing more selling...and the cycle repeats. That's why it's so important to equity markets that margin debt keeps growing. It's a constant influx of new money that pushes up prices.
Margin debt as a percentage of GDP hit a record level of 2.93% in February 2014. From there, it dipped for a few months and then tagged 2.93% once again in June. With our new data point from July, margin debt to GDP now sits at 2.88%. This marks five consecutive months where the margin debt to GDP ratio has failed to make a new high. Keep your eye on this metric because the stalling pattern we're seeing might be the start of a new downtrend. We'll need a couple more months of data to really determine if a top is in or not, but, if it is, there will be serious implications for the broader stock market.
The DBC is a PowerShares ETF that seeks to capture the return of a basket of different commodities including Light Sweet Crude Oil (WTI), Heating Oil, RBOB Gasoline, Natural Gas, Brent Crude, Gold, Silver, Aluminum, Zinc, Copper Grade A, Corn, Wheat, Soybeans, and Sugar. I'm taking a look at this today to see what commodities look like relative to the economy as a whole.
Here we have a 5-year weekly chart showing DBC to be in three year downtrend - much like gold and silver. After topping in mid-2011, it has obeyed the declining line of resistance shown above. After tagging the line just a couple months ago, it has fallen, on heavy volume no less, back down to intermediate support (shown by the solid green horizontal line). Short term indicators (not shown here) are suggesting a short-term bounce, but if you look at the weekly MACD, RSI, and moving averages, it appears that further downside is in the making. Look for the 50 dma to provide resistance if we do get a brief rally.
Longer-term, you can see the falling wedge pattern continuing to play out. The dashed horizontal line, marking the low from 2012, will be the next area of support. If this fails, expect a swift drop back to the low 20s where you can see the congestion from 2010.
The action in the DBC should be a bit surprising if you subscribe to the notion that we are in a booming economy as evidenced by yet another all-time high in the S&P today. If a strong stock market reflects a strong economy, then one would think commodities, and industrial commodities in particular (silver, aluminum, copper, oil, etc) would be in high demand and therefore rising in price assuming no readily available supply glut. Since the DBC is falling, it suggests either falling demand or increased supply (all else being equal) for the underlying commodities.
Based on the factors noted above, my bet is that the DBC will break down from here, falling 20% or so back to 2010 levels. In my opinion, this runs contrary to a strengthening economy, which should require more of these commodities to support increased industrial activity. So what's going on? As I've stated in previous posts (such as here and here), this bull market is getting very long in the tooth. We're starting to see evidence that a longer term trend change is starting to take place. While it hasn't happened yet, there are numerous indicators out there starting to flash cautionary warnings. In addition, it seems undeniable that the Fed, through unnatural market policies such as QE, has entirely decoupled the stock market from economic activity. Take a look at the graph below which shows Federal Reserve's total assets overlaid with the S&P 500 (from the Fed's own website). The green circle denotes when the first QE program went into effect.
What do you think? Does the S&P 500 reflect economic activity or does it reflect the Fed's balance sheet? That looks like an almost perfect correlation. As the balance sheet grows, so does the S&P. This would explain why the DBC shown above can fall for years while the stock market continues to make new highs. There is no longer any correlation between economic output and the broader stock indices. What happens when the Fed ends QE in October and starts reducing its balance sheet?
For today's post, I'm going to look at a few credit market charts and try to explain what they're telling us. Credit markets more often than not are leading indicators for the equity markets. In 2007, for example, credit markets peaked and rolled over in early June while the S&P continued to rally for another four months - and we all know what happened after that.
There are two ends of the credit market worth watching: the high yield (junk) market and the "risk free" market (US treasuries). Junk bonds have poor credit ratings and therefore pay out a higher rate of interest to compensate buyers for the increased likelihood of default. US treasuries are often considered risk free because, as the theory goes, the government can simply print more money to cover its interest and principal payments. As a result, treasuries offer lower rates of interest to the investor.
In today's macro environment, where the FED has artificially crammed down interest rates through quantitative easing and other unnatural market policies, yield has become very difficult to come by. Savers and fixed income pensioners have been killed as yields on savings accounts and bond funds are at historically low levels, offering negative real rates of return (depending on who's definition of inflation you subscribe to). As a result, these conservative investors have been forced to "hunt for yield," meaning they must invest in higher-risk debt (ie. junk bonds) just to get a positive return on investment. This hunt for yield has driven the price of junk bond funds to all-time highs.
Zerohedge.com has been ringing the alarm bell for the past two months (most recently here, here, here, and here) on a phenomenon that I'd like to address now. Below is a two-year graph of Barclays High Yield Bond ETF (ticker: JNK). It has been on a relentless 45-degree ascent since bottoming in 2009 as investors bid up high-risk assets in search of any type of yield they can find. In July, this fund saw a fairly dramatic high-volume drop in price, the first of its kind in over 12 months. After a month of declines, price has rallied back just shy of its all-time high, but volume and MACD have been weak - critical non-confirmation indicators that are worth watching.
So why should we care? As Zerohedge stated on August 7:
High-Yield bonds funds saw record outflows of $7.1 billion this week - the fourth week running - as the slow-motion train crash in credit starts to accelerate.
Junk bond funds could very well keep rallying from here, just like they did after the sell-off in May 2013. However, it's the record outflow from these high-yield funds that might make this time different. Remember, credit markets lead the equity markets.
Now I'd like to turn to the other end of the credit market mentioned above: US treasuries. US government debt has always been a safe-haven investment in times of economic duress. Typically during a bull market, you would see investors rotate out of low-yielding treasuries and into equities as stocks would offer higher rates of return through price appreciation and dividend yields. What we've seen these last few years, however, has been an anomaly - thanks entirely to the Fed's quantitative easing program in which it has been buying US debt and mortgage backed debt by the billions each month. So, in addition to seeing continued all-time highs in the broader stock indices, we're also seeing record prices paid for treasury debt. High priced debt means a lower rate of return (as bond yields are inversely related to price). If treasuries are commanding record prices and therefore ultra-low yields, you can see why investors have chased junk bonds higher. They're just looking anywhere and everywhere for some kind of return as anything is better than the negative real interest rates offered by "risk free" debt.
Below is a two year weekly chart of the 10-year treasury note yield (TNX). After bottoming in 2012, yields saw a brief rally into the high 20s (a reading of 25, for example, equates to a 2.5% yield) before moving sideways. Upon closer examination, I would argue that over the past 15 months, we've seen a very nice head-and-shoulders topping pattern as denoted below. Two weeks ago, we saw the neckline violated to the downside with the break of 24. After briefly touching 23, yield rose once again and is now sitting right on top of its 200 dma. RSI and MACD are signaling continued weakness so if yield closes below 23 on a weekly basis, I would expect a swift drop to 18 - the approximate measured move from the head-and-shoulders topping pattern.
Zooming out to a 15-year monthly chart of TNX, you can see that the rally over the past year was nothing more than a dead cat bounce within a much large downtrend. Again, just four months prior to the 2007-2008 meltdown, TNX peaked at around 53, or 5.3% yield. Since that time, it has moved steadily lower, every so often bouncing back up to tag that descending green line of resistance. The peak, or "head" in the topping formation shown above from December 2013, can be seen below as the last time TNX touched the longer term line of resistance. The RSI has now slid back to the midline and the MACD has just made a very long-term bearish cross. These indicators are signaling lower prices (yields) ahead.
One last chart I'd like to show is the TED Spread. The TED spread is calculated as the difference between the three-month LIBOR and the three-month T-bill interest rate. LIBOR (London Interbank Offered Rate) is a benchmark rate that some of the world’s leading banks charge each other for short-term loans and serves as the first step to calculating interest rates on various loans throughout the world.
The TED spread is an indicator of perceived credit risk in the general economy, since T-bills are considered risk-free while LIBOR reflects the credit risk of lending to commercial banks. The higher the TED Spread goes, the more perceived risk there is in the economy. Said differently, a rising TED spread often presages a downturn in the U.S. stock market.
The chart below is a five year weekly chart of the TED Spread with the S&P 500 in the lower panel. While not shown here, the spread peaked back in 2008 during the height of the financial crisis at over 4.00. For comparison, you can see that today the spread is all the way down to 0.22 which more or less has been the low over the past 5 years.
Looking at the graph, you can see two spikes in the last five years. Each spike accompanied a sharp decline in the S&P 500 as shown with the green arrows. Even the though the TED Spread measures credit yields, it has a direct correlation with the broader stock indices. For the last two years, the spread has been working its way into a tight wedge with rising support and declining resistance. From a charting perspective, this is a great tradeable consolidation pattern. While you can't necessarily predict the direction of the breakout, you know that when it breaks out (up or down), it will be powerful and likely prolonged.
So, putting everything together, we have the following data points
My takeaway from all of the above is that credit markets are beginning to flash warning signs. We haven't seen complete breakdowns in junk bond prices or treasury yields yet, but the dominoes are set up and the first one is starting to wobble. So, if we see a decisive break below 23 on the TNX accompanied by lower junk bond prices and a TED Spread above 25, then it's time to get out of the stock market. Remember, credit markets lead equity markets so it pays (literally) to keep an eye on things.
So tonight I'm going to make some quick observations and leave you with a handful of charts that support my assertions. Generally speaking, you will see mining stocks make meaningful moves up or down prior to similar moves in gold and silver. In other words, miners are good "tells" of future price movements for the precious metals. So, when determining the future direction of gold and silver, it pays to keep an eye on mining stocks - individual stocks, ETFs, and indices - to see what they're telling us.
And here's what the weekly charts are telling me today:
Check out the recurring patterns in each of these charts...
HUI (Gold Bugs Index). By the way, that's 9 consecutive weekly closes in a 5% range
XAU (Philadelphia Gold & Silver Index)
DJGSP (Dow Jones Precious Metals Index)
GDX (Gold Miners ETF). Note the volume just drying up on these next two charts. The sellers just can't get anything going.
GDXJ (Junior Gold Miners ETF)
As noted in this Bloomberg article from today, Palladium posted a significant breakout on Friday rallying to 13-year highs. While Palladium certainly has unique supply and demand factors, it tends to move in sympathy with other precious metals. Let's quickly analyze the breakout and see what it means for gold and silver.
After a strong rally in late June, palladium corrected in late July and early August - the same as gold and silver. A few days into August, however, Palladium diverged from the other PMs and started rallying as can be seen by the 9 consecutive white candlesticks on the chart. This past Friday, Palladium blasted through overhead resistance on significant volume on its way to a 13-year high. (As a side note, its all-time high was established in early 2001 and lasted only a couple months before crashing down in the dot-com bubble burst) Its MACD just made a bullish cross and its RSI remains solidly above the center line - two positive indicators confirming the breakout. Also, note the bullish hammer formation on the Friday candlestick. This means that after an early drop, price recovered and closed in the upper half of the day's trading range.
So why is this significant?
If palladium trades in concert with gold and silver, then we have a major divergence that needs to be resolved. As I showed a couple days ago, gold and silver have really languished since they started correcting in mid-July. If PMs move together, then one of two things needs to happen. Either 1) Palladium needs to be sold down or 2) gold and silver need to rise to close the performance gap. Given all of the bullish chart setups and breakouts in the miners, my money is on gold and silver will rally from here.
Gold and and Silver have both struggled for the past month so I wanted to take a look at the daily charts and see what, if anything, we can glean. After a nice breakout on big volume in late June, gold rallied to about $1350/oz but was promptly smacked right back down, effectively reversing the short-term trend (see the MACD cross). Since that time, gold has moved sideways bound by a fairly neat triangle boundary (green lines). The Relative Strength Index (RSI) hasn't done much of late as it continues to hug the midpoint line. Same can be said for the MACD as it has been just moving sideways for the month of August. Although gold has been range bound for the last five weeks, I'd like to point out two potentially bullish indicators. First, the 50 day moving average (dma) continues to rise while staying above the 200 dma. This should act as continued support going forward. Second, the price action from Friday (yesterday), shows nice underlying strength. The price dropped hard to start the day but found support at the lower end of its range. It then reversed hard to the upside on significant volume and closed in its upper range of the day above the 50 dma.
Silver has experienced much more technical damage than gold over the past couple of months. After the big breakout in June, it rallied to about $21.60/oz before being smacked down along with gold shortly thereafter. Since the smack down, silver has marched steadily lower in a tidy channel denoted by the green lines. It's now below the 50 and 200 dma, certainly a sign of short term weakness. MACD and RSI are confirming that as well with readings below the center lines. Volume has been mediocre during the correction when compared to the volume from the June breakout. This means there hasn't been too much selling conviction to the downside. I would guess that silver should start seeing some support in the mid-$19s as there was a lot of congestion in this area from earlier in the year. The bottom line for silver, in the short-term (1-2 months), is wait and see.