Weekly Market Wrap: 26 April 2013 – Markets reach major inflection point

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, the S&P 500, sugar, the US dollar, and gold.

Stocks

Dow Jones Industrial Average

Last week’s market wrap showed the Dow testing the lower green uptrend line (circled), however, having tested it twice, the index then began to form another mini uptrend (blue lines).

In both the short and intermediate term the Dow remains in an uptrend. Only a break below the lower green uptrend line would force short-term traders and trend followers to close out their long positions and potentially go short.

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

Sentiment plays an important role in financial markets, however extreme sentiment in either direction is generally not a good sign.

Last weekend’s Barron’s semi-annual Big Money poll revealed that 74% of money managers identify themselves as bullish or very bullish about the prospects for US stocks. The 74% figure is an all-time high, going back more than 20 years, and the magazine cover that accompanied the article read “Dow 16,000!” and claimed that “the Dow could hit that level by the middle of next year”.

Given the backdrop of unprecedented monetary stimulus, the Dow may well reach the 16,000 level. However, it is worth considering previous calls by Barron’s in its Big Money Poll.

On 1 May 2000 for example, the cover story read “Still Bullish! (Dow 13000)”. When the poll was published the Dow was at 10733.91, having already peaked nearly 1,000 points higher in January that year. The index then went on to lose around 40% of its value in the 2000-2002 bear market, with the S&P 500 and Nasdaq faring considerably worse.

On 2 May 2007, when the Dow was trading at 13,264.62, the Barron’s Big Money Poll cover story read “Dow 14000?”. By October the market had advanced around 6% to 14,000, and by November the poll was showing bulls outnumbering bears by 2-to-1. This time the headline read “The Party’s Not Over”, however the market had already peaked, and proceeded to lose over 50% of its value in the 2007-2009 bear market.

S&P 500

A long-term chart of the US equity markets reveals a market that is bumping up against major long-term resistance (blue line). The RSI (relative strength index) also shows that the S&P 500 is overbought, just as it was at the two prior major tops.

A 15 year (monthly) chart of the S&P 500 (Click on the chart for a larger version)

A 15 year (monthly) chart of the S&P 500 (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Although from a long-term perspective the 8 and 21 period EMAs (exponential moving averages) reveal that the trend is still up, the market is likely at an important inflection point. At this stage a 5-10% correction should be welcomed by the bulls.

Commodities

Sugar

Thanks to a couple of years of good harvests which have led to a large surplus, the price of sugar has tumbled. Since reaching a peak in early February 2011 the price has fallen by more than 50%, and more declines look likely since the market is expected to remain in surplus until the end of the growing season in October. Production is then forecast to begin falling during the 2013-14 growing season which should begin to put a floor under sugar.

A 3 year (daily) chart of Sugar (Click on the chart for a larger version)

A 3 year (daily) chart of Sugar (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Currencies

The US Dollar

In periods of deflation cash is king and that cash gravitates to the senior currency, i.e. the US dollar, and the “safest” and most liquid form of debt, i.e. US Treasuries.

The chart below shows that during the past 11 weeks this is exactly what we have seen. Not only has the flight to safety pushed up the value of the dollar (green arrow), it has also brought down the yield on the 10-year Treasury bond (grey arrow). The chart also shows the price of copper (orange arrow) and the price of crude oil (black arrow) – two other indicators of deflation, and both show strong downtrends.

A 6 month (daily) chart of the US Dollar Index, Copper, Crude Oil & US Treasuries (Click on the chart for a larger version)

A 6 month (daily) chart of the US Dollar Index, Copper, Crude Oil & US Treasuries (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Of course, when talking about deflation in this context we are talking about asset price deflation rather than monetary deflation (which is the true definition).

With just about every central bank already pumping liquidity into the global economy there is virtually no chance of seeing a true contraction in the money supply. However, if economic conditions continue to worsen we can expect even greater inflationary countermeasures from policymakers.

One likely next step is for the Fed and other central banks to force banks to loan the new money into the economy. It is also likely that we will see central banks purchase assets other than bonds and mortgaged-backed securities (MBS).

Precious metals

Gold

Thanks to record demand in the physical market gold has managed to rally $128.50 or 9.7% from the $1,321.50 level it reached after its recent two-day crash.

A 1 year (daily) chart of Gold (Click on the chart for a larger version)

A 1 year (daily) chart of Gold (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Momentum in the gold (and silver) market is now to the upside, however, what was support for gold at around $1,525-1,530, now becomes overhead resistance, and it’s likely that the yellow metal will require multiple attempts to punch through this level. It may also encounter selling as it nears both the $1,500 level and the lower blue downtrend line.

With physical demand so strong it seems likely that gold will continue to move higher. Looking out over the remainder of the year however, gold is still in need of a catalyst that will ignite the next leg of the secular bull market. For signs of this we continue to watch the growth in US bank credit as well as the intentions of the next Bank of England governor, Mark Carney.

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