Weekly Market Wrap: 25 March 2013 – The party on Wall Street continues & may do for quite some time

This regular column reviews the condition of several different markets including: stocks, commodities, currencies and precious metals. This week focuses on the Dow Jones Industrial Average, copper, the US dollar, and gold.

Stocks

Dow Jones Industrial Average

Having broken above its previous all-time high on 5 March the Dow Jones Industrial Average continued to rally until 14 March where upon it ran into overhead resistance at the top of its price channel (green line). Since then, however the index has entered a trading range and is currently bouncing around between 14,546 and 14,383.

A 40 day (60 min) chart of the Dow Jones Industrial Average (Click on the chart for a larger version)

A 40 day (60 min) chart of the Dow Jones Industrial Average (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

During the past few trading sessions the index seems to have run out of steam, however the stochastic oscillator (circled) shows that momentum is still to the upside and therefore the index could still retest the top of the range.

In a recent article in the Huffington Post, Michael Pento, President of Pento Portfolio Strategies, explained the recent highs in the stock market, saying:

When central bankers dedicate their existence to re-inflating asset bubbles, it shouldn’t at all be a surprise to investors that they eventually achieve success. Ben Bernanke has aggressively attempted to prop up the real estate and equity markets since 2008. His efforts to increase the broader money supply and create inflation have finally supported home prices, sent the Dow Jones Industrial average to a record nominal high and propelled the bond bubble to dizzying heights.

Mr. Bernanke has already increased the monetary base by over $2 trillion since the Great Recession began in late 2007, which has helped cause the M2 money supply to grow by $3 trillion–an increase of 40%! Therefore, it isn’t such a mystery as to why there are now partying down on Wall Street like it is 1999.”

There can be little doubt that politicians and central bankers are inflating another massive asset bubble – this time centred around sovereign debt – and sooner or later this bubble will burst with devastating consequences for those caught up in it.

As Mr Pento concludes, “The bursting of the bond bubble will be exponentially worse than the deflation brought on by the NASDAQ and real estate debacles. It is sad to conclude that the middle class is set up to get slaughtered even worse than they did when the previous two bubbles burst.”

Although he is bearish on the US economy and is dead against the Fed’s neo-Keynesian monetary policy, Mr Pento manages money and is long US equities because he believes that the Fed will keep the party going for a great deal longer than anyone expects.

Commodities

Copper

Global inventories of copper have now increased to the highest level in nine years, with stockpiles reaching around  870,000 metric tons – equivalent to almost five months of North American demand.

As a result, hedge funds are making the biggest bet against copper on record. According to the Commodity Futures Trading Commission (CFTC), in the week ended 19 March, hedge funds raised their net-short positions in US copper futures by 53% to 25,719 contracts the highest level since records began in 2006.

As the chart below shows, copper prices made a new low last week, reaching $3.388 before rallying slightly to close at $3.466.

A 2 year (weekly) chart of Copper (Click on the chart for a larger version)

A 2 year (weekly) chart of Copper (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Copper inventories monitored by the London Metal Exchange (LME) have risen by 76% so far this year to 562,475 tons, the highest level since October 2003.

Jack Ablin, chief investment officer at BMO Private Bank in Chicago, noted recently that “We’re sitting on unprecedented stockpiles of copper and other metals”. He went on to say that “Demand has been pretty tepid for industrial metals. In the global economy, we’re seeing improving growth, but it’s still at a slow rate” something which is confirmed by figures from China which show that imports of refined copper declined in February to the lowest level in 19 months, while exports rose for the sixth month in a row.

The outlook for copper remains negative and due to the metal’s recent bearish breakout from its multi-month triangle consolidation pattern, it is possible that the price will fall to $2.82 per pound in the weeks ahead (purple notation on chart).

Currencies

The US dollar

As the chart below shows, the US dollar began to decline sharply in February 2002. By November 2004 the greenback had fallen by 33% and after a rally in 2005 the decline continued. The dollar eventually bottomed at 71.33 in April 2008 after which it rallied strongly as investors sought refuge from the global financial crisis.

A 12 year (monthly) chart of the US dollar index (Click on the chart for a larger version)

A 12 year (monthly) chart of the US dollar index (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

The chart also shows that for the past few years the US dollar has been bouncing around in what looks to be a triangle continuation pattern. If the dollar were to continue to rally it may well reverse when it reaches 86 and then move back towards the lower end of the range.

It is common for an asset to enter a rest or consolidation phase after such a big move, and these consolidations often form a predictable pattern. If this is in fact a continuation pattern, then the dollar can be expected to breakout to the downside, however the final direction of the move will not be known until it occurs.

Precious metals

Gold

Gold has been in a major bull market for 12 years, and despite numerous predictions from prominent investment banks that the bull market is over, the long-term picture remains positive.

The chart below shows that although gold is still in the consolidation pattern that began after its September 2011 all-time high, it is still well above its long-term trend line.

Another indication that gold remains in a bull market, comes from the 14-period RSI (relative strength index), which recently bounced off the 50 level (circled). Gold has remained above this level since late 2002 apart from for a brief period during the financial crisis.

A 17 year monthly logarithmic chart of gold (Click on the chart for a larger version)

A 17 year monthly logarithmic chart of gold (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Despite gold’s recent bounce, the long-term stochastic oscillator (circled) shows that momentum is still to the downside. It is therefore possible that gold could once again retest the $1,525 area before it finally finds a catalyst that will send it to new highs.

The battle between the forces of inflation and deflation continues to rage, however it seems inevitable that when policymakers efforts to re-inflate the system finally fail, we will experience a period of deflation during which assets will be re-priced according to their true value.

As Marc Faber, author of the renowned Gloom Boom & Doom Report, explains in his March commentary:

“I worry about the time when the current asset inflation will give way to a serious asset deflation, which will inevitably happen sometime in the future. As an observer of markets I am, therefore, concerned that the decline in gold prices could be telling us that we are about to enter a period of asset deflation.

I should like to make two points very clear. I am not sure when the asset deflation will start. Most likely, different asset classes will deflate at different times and with different intensity. The second point I wanted to make is the following. In a deflationary environment (whenever it will happen), financial assets (stocks, government and corporate bonds especially high yield bonds) would likely be the most vulnerable assets. In fact, in a deflationary collapse, I would envision money to flow into a sound currency and move out of “funny” paper monies. Therefore, I continue recommending the gradual accumulation of physical gold.”

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