Challenging Conventional Assumptions

There are many old adages in the market that are like stereotypes: they may work more often than not, but there are enough exceptions to make them dangerous when applied blindly. I have been reading commentators talking about the US Dollar and how the Commitment of Traders is extremely bearish because the "commercials" are bearish on the US Dollar and they are the "smart" money. But are these insiders the smart money for all of the different futures contracts and are they usually right? Of course not.

When it comes to the US Dollar (and, by implication, the Euro), the commercials have a terrible history when it comes to predicting the intermediate-term trend and have more often than not been dead wrong over the past 5 years or so!

Let me show you a chart stolen from finviz.com to show you what I mean. This is a weekly chart of the US Dollar over the past 5 years or so thru part of today's action with my comments:




So, is the US Dollar about to collapse against other paper currencies or will recent history repeat and the US Dollar move higher from here? I think the latter.

This doesn't mean Gold (and silver) can't rise, as all paper currencies are sinking relative to Gold and will continue to do so until the Dow to Gold ratio hits 2 (and we may go below 1 this cycle). However, this may have implications for favoring Gold stocks over Gold once we hit bottom.

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A New, Simple Way to Play the Dow to Gold Ratio

Since I haven't noticed anyone else out there commenting on it, I thought I would offer my kudos and thanks to the folks over at Factor Shares for launching a new series of spread ETFs for traders. The product that has my attention and interest is a double leveraged spread of the Gold to S&P 500 ratio. This is a simple way to play the Gold versus paper theme that is near and dear to my blog. Though the Dow to Gold ratio is better known, an S&P 500 to Gold ratio is really no different.

The new ETF I am referring to has ticker FSG and you need to do do your own due diligence if this is something that interests you. Please understand that I had never heard of the Factor Shares company before they released this product, I am not versed in the counterparty risk this product may carry, and I have no relationship with the company behind this new ETF. Like all leveraged ETFs, there is slippage that will plague this product and thus FSG is better used for trading rather than as a "buy and hold" vehicle. However, we are fast approaching a "buy" point for this ETF due to the oversold nature of the Gold to S&P 500 ratio right now.

Here is a 5 year daily log scale chart of the Gold ($GOLD) to S&P 500 ($SPX) ratio (i.e. $GOLD:$SPX) through Friday's close with my thoughts:





The FSG ETF has been trading now for about 8 months and it looks like its volume is starting to pick up, which is a good thing:





Meanwhile, the bearish sentiment on precious metal stocks and precious metals is starting to get to a point where it is time to start thinking about going long. I think we may need one more plunge, but that should just about do it. If we get a "falling knife" in the Gold stock indices and precious metals over the next few weeks, I will be looking to catch it.

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Exciting Times

The big picture is shaping up quite nicely now that we have ended another quarter. A nasty cyclical global equity bear market has begun, the third of the ongoing secular bear market for "advanced" Western economies that began in 2000. As an advanced economy, Japan is the odd man out, as they have been mired in a secular equity bear market for almost 22 years now. There are some interesting "big picture" nuances to this cyclical bear as they relate to precious metals that should provide phenomenal profit opportunities for those with cash on hand.

First up, the rally I have been expecting in the US Dollar Index ($USD) has begun. Unlike many Gold bulls, I don't subscribe at all to the "dollar to zero next year" theory. I think cash is a great position right now and I was the opposite of bullish on Gold when Gold hit $1900/ounce recently. I was also bearish on Gold stocks at that time and told my subscribers to avoid them completely, though I wasn't brave enough to short them. For now, when looking at the "big picture," the US Dollar Index rally is absolutely set to continue. Here's a 6.5 year monthly chart of $USD thru Friday's close with my thoughts:





I am not saying the US Dollar (or any fiat currency) is a good long-term investment. Far from it. But the US Dollar is rising based on the same thing that happened in 2008. Many continue to deny that we are going through another 2008 episode and yet it is starting to happen right in front of our eyes. No, it's not exactly the same, but the same principle applies: forced de-leveraging due to a liquidity crisis. This is US Dollar positive and equity and commodity negative. People scream that Bernanke and his interventionalist compatriots around the world would never let it happen, but this is naive at best. Not only are they not as smart as the markets, but they are often far behind the curve when the crunch hits. Additionally, a cynic (realist?) would point out that another crisis would give central bankstaz and governments cover to do what they love to do: print more money, bailout banks and other corporations that contribute the most money to political campaigns, and enact ridiculous new rules and regulations that only benefit their friends.

In the meantime, the S&P 500 US stock market has all the classic markings of a new bear market. And this is one of the healthiest advanced economy stock market charts out there! Stocks are dangerous here and should be avoided in my opinion. Here's a 12.5 year monthly chart of the S&P 500 ($SPX) thru Friday's close:





During this emerging period of turmoil, however, the fundamental fuel to fire the next leg higher in Gold stocks is evolving right on cue. I believe that physical Gold held outside the banking system is a safer and better long term buy and hold opportunity compared with Gold stocks. However, I like to trade the miners when I think they are going to provide leverage to the Gold price (note to Gold stock bulls: they often don't). We are fast approaching one of those good times to be long Gold stocks. The Gold to commodities ratio (or Gold to oil ratio if you wish) gives us an idea of whether the operating margins for producing Gold stocks are expanding or contracting, all other things being equal (and all other things are never equal, but this is a "macro" sector analysis data point). If the Gold price is rising faster than the variable costs of getting Gold out of the ground (e.g., energy), this is good for profit margins. When profit margins are expanding, it is rare that stock prices don't eventually follow suit, although the timing is the tricky part for traders.

In any case, here is a 6.5 month chart of the Gold ($GOLD) to commodities (using $CCI as a proxy) ratio using a monthly plot of $GOLD:$CCI:





The future's so bright for Gold miners that they've gotta wear shades according to this chart. And I don't think the move higher in this ratio is done yet. I see an explosive move off the bottom once it comes for Gold stocks, but I don't think we're there yet. However, soon we should see yet another epic buying opportunity (a la 2008) in the Gold mining sector. We may have already seen the bottom in the Gold price, but we will likely need to re-test it, whether the re-test ends up being slightly lower or higher than the recent low near $1550. The speculative fever in Gold has been broken for the short to intermediate term, a healthy thing. Trust me when I tell you that this fever will come back into the Gold market soon and eventually rage out of control. Are you buying Gold now while prices are low or will you wait until prices are higher again and then kick yourself for not buying while there was a sale?

The Dow to Gold ratio will hit 2 before this secular cycle ends, and we may well go below 1 before this mess is over. Specific trading recommendations reserved for subscribers.