Market Comments

Bonds

We will start with the bond market this week, as we believe the action taking place is just a warm-up for the main event. The Fed is walking a tight rope over a minefield, and the wind is blowing from all directions. Off in the distance storm clouds are gathering on the horizon.

Two-year US Treasury yields jumped up 4 bps to 4.72%. The five-year yields were up twice as much as the 2-yr. popping up 8 bps to 4.63%. 10-year Treasury yields inched up 3 bps to 4.57%. The long-bond yield rose 2 bps to 4.52%.

The yield curve has become more inverted. The spread between new 2-year and 10-year yields widened and ended the week at negative 15 bps. We have stated for a while now that the Fed wanted an inverted yield curve. Now we see they are getting what they want. We think they want more, and that they will get more. The spread between the 2-yr. and 30-yr. is 20 bps.

Although the Fed is raising short term rates note that the 30 year rose only 2 bps. 30-year mortgages are tied to the long bond, which means real estate has a strong connection with the long end of the market.

The Fed doesn’t want to break the back of the long bond or the real estate market. It wants to let them down – ever so slowly and softly, as if floating on a cloud. We wish them the best of luck – they are going to need it.

M3 money supply increased $1.5 billion to a record $10.281 Trillion. During the past year, M3 has expanded 8.4%. As we have repeatedly said: they are inching up short term rates hoping to create an inverted yield curve, without pulling the rug out from under the long bond and the real estate market.

At the same time they continue to inflate: in the money market and in the credit markets. In other words the Fed is doing what the Fed does best: inflate, but now it costs a little more.

We note that the Bank of Japan is reportedly easing off on its zero bound interest rate policy. The Japanese 10-year JGB yields popped 7.5 bps to 1.585%

Could this mean that Japan’s deflation and zero interest rate strategy may be over? The Nikkei apparently thinks so, as it bounced off of its 50 dma and rose 2.47% for the week – suggesting the worst may be over

Stocks

As we stated last week the Nikkei has been a good performer the past year, and further to the above we mentioned that if the up trend was to continue that the Nikkei would have to find support at its 50 dma, which it did this past week. Below is the Nikkei daily continuous chart.

Nikkei Average Daily

Chart Courtesy of StockCharts.com

As chart illustrates the Nikkei isn’t completely out of the woods yet, but it is starting to look a bit promising. It fell through its 50 dma but has since recovered and is now sitting right on top of it. It now either time to put out or time to get out. Time will tell. For those inclined to start accumulating a new position we offer the following chart of the Japan ETF:

 

Japan iShares (EWJ) Daily

Chart Courtesy of StockCharts.com

 

The US stock markets were fairly quite this past week, content to just hang out and tread water. There wasn’t much action either way: up or down. The one exception was the gold stocks that put in a good week. The HUI was up 7.35 points to 320.64 for a weekly gain of +2.34%

Physical gold was up $2.65 to 559.15 for a gain of 0.479% for the week. The gold stocks outperformed the physical by over 4 to 1 – a good showing. We mentioned last week that we would be watching this ratio closely – we did and it has performed admirably. As of now the charts hint at further upside action towards the old high from January.

We do expect a test of the old highs. But a knew high at this time is not needed, nor do we expect one. If we get one we will be glad to take what the market offers, and we will oblige it. However, we believe that an intermediate term correction has more odds of occurring than does an intermediate advance from these levels.

A solid short term rally is most likely to unfold. Those that want to play it will need to be quick and nimble on their feet. The physical is the safest. The stocks more leveraged. NEM and GFI are the go to players. Personally, we favor silver right now.

As stated above, it appears that the short term direction of gold and the shares will be up. But we offer two caveats of concern: There are less than a few geo-political events taking place in the world right now that are pulling upwards on the price of gold: Iran, Iraq, Nigeria, and the supply and hence the price of oil. These issues will be more fully discussed in the geo-political section below.

If these events are resolved it would put downward pressure on the price of gold. If these events intensify it will place upward pressure on the price of gold. For the first time in some time now, gold is being used as the safe haven it always has been, and will be, in times of uncertainty and danger.

The second caveat is that gold has not undergone an intermediate term correction in many moons (literally). We are closer to an intermediate term correction than an intermediate term advance – unless the above listed geo-political events erupt, then all bets are off. We now live in a world where the 10 sigma event could come at any time – from any source. Below we see the chart of the HUI Index.

 

HUI Gold Index Daily

Chart Courtesy of StockCharts.com

 

The following weekly chart shows just how long its been since a serious intermediate term correction took place – back in May of 2005. That’s 10 months ago – a bit long in the tooth.

 

HUI Gold Index Weekly

Chart Courtesy of StockCharts.com

As the above chart clearly shows, it has been since last April and May (very center low point of the chart) since the HUI had a severe intermediate term correction. This doesn’t mean that one has to happen, or that it is going to happen tomorrow – we simply are noting what we have noticed.

Next we look at the daily continuous chart for gold. The recent correction can be seen going down and finding support at the 50 dma. It has since rallied back up to 559.15 which is 18.14 above the 50 day (541.01).

 

Gold Continuous Daily

Chart Courtesy of StockCharts.com

 

The next chart is the weekly continuous for gold. It illustrates the nice long term trend the gold has and is within. It also has more information imbedded within. But the chart first.

 

Gold Continuous Weekly

Chart Courtesy of StockCharts.com

 

The above weekly chart of gold shows a very nice long term advance. Higher highs and higher lows. The price pattern goes from the bottom left corner of the chart to the top right hand corner – just the way you want them to go and look.

Notice the incline of the last move up. It is getting a bit steep. The 40 dma is at 447.67 and gold closed at 559.15 which is 111.48 point difference or 24.90% above.

This bears watching closely. The move is becoming extended, which bull markets often do, and can and do for very long periods of time. Next up we are going to look at a longer view of gold to see what it might be hinting at.

 

Comex Gold

Chart Courtesy of the CBOT

 

Please note – the above chart is a very long term chart going back 30 years in prices. Although some of the price action on this chart occurred decades ago, it will and can still play into today’s gold market.

The above chart shows a high of 873 back in 1980 – 26 years ago. Gold then declined to 252.50 in August of 1999: 19 years after the high and 6 years ago since the low.

If we take the high of 873 and subtract the low of 252.50 we get a total decline of 620.50. A 50% retracement gives 620.50 divided by 2 = 310.25.

Take the low of 252.50 and add the 50 percent retracement (310.25 + 252.50) = 562.75. The market is just below this area of long term resistance.

This is evidence that an intermediate term correction from these levels would not be a major surprise, nor from keeping with ordinary market action. A watchful eye is warranted.

 

CRB Index Daily

Chart Courtesy of StockCharts.com

 

Commodities

Commodities is one of our three long term paradigm bull markets, the other two being precious metals and energy. All three markets have been in up trends for the last few years.

Of the three we are most bullish on the precious metals. Presently they are in the best technical shape: holding above their 50 dma and a good distance from their 200 day.

As the charts of the CRB Index below show, a critical juncture is pending. The CRB has had a pretty steep downward correction. It sliced through its 50 (334.74) day and bounced off of its 200 (320.36) day, and now sits at 328.90

 

CRB Index Weekly

Chart Courtesy of StockCharts.com

 

The above weekly chart of the CRB shows that it is just holding above its trend line that goes back over 2 years of price action. For the bull market in commodities to carry on the 320 level is important to hold as support.

The move through its 50 day was a short term correction. A further move down to its 200 day was an intermediate term correction.

A move that violates the bottom of its upward channel and stays below the 200 day will strongly question the long term bull market in commodities. This level warrants watching.

 

Oil Light Crude Continuous Daily

Chart Courtesy of StockCharts.com

 

Notice how similar the above chart of light crude looks to the CRB Index. Oil has

pierced through its 50 dma at 63.06 and through its 200 dma at 60.93, closing the week out at 62.93 Friday’s strong move up propelled oil back over its 200 dma.

If this level holds it would be in probability the beginning of a new move upwards. First major resistance is the 50 day. If the 200 day is violated again and becomes resistance, the long term trend will come into question.

As we mentioned earlier in the report: there are three major geo-political events occurring that are directly weighing in on the markets.

 

Geo-political

Presently there are three “hotspots” occurring: Iran, Iraq, Nigeria. Iraq is self-explanatory. We attacked the country to supposedly bring peace and democracy to the people. Apparently no one bothered to ask them if they wanted to be democratic. Small oversight.

One of the first rules of true democracy is that you don’t go around the world force feeding your way onto other nations. They should be free to choose what they want.

This is very similar to the situation many slaves faced who were owned by any of our founding fathers. They should have been freed both during and according to the writing of the Constitution.

The Constitution was all for freedom and liberty – at least for those writing it. But those doing the writing didn’t seem too concerned about the freedom of the many slaves they owned that were back home on the plantation doing their master’s work.

Now we are finding out that war is the easy part – its the peace that is to come after which can be most daunting. Iraq is coming closer and closer to civil war. None of which goes unnoticed by gold or oil.

Iran appears to be a serious potential problem, as they are talking about nuclear energy and the possibility for nuclear bombs. Iran is not, however, capable of producing a nuclear bomb at the present time. They do not have the facilities to cool down the hot uranium needed. Russia does. Russia has offered to take the hot uranium to its facilities for cooling down. It is a long process in time and complexity.

We look for Russia to make the deal and diffuse the situation. Both Russia and China hold veto powers in the United Nations Security Council. Obviously the tension is affecting the price of oil, and if things go bad it could disrupt the supplies of oil.

We do not believe such will happen. But one never knows. We do expect problems in this area, but most likely not over this particular series of present day events. Stay tuned.

Nigeria appears a bit harder to discern the outcome of. They are fighting a guerrilla type war that is hard to defend or fight against. They want the oil companies out. Even if the oil companies do not leave, the working conditions must be very stressful and less productive.

Besides the attacks on the oil companies, various sects are fighting between themselves. Look for things to get a bit worse before they get better. Once again, oil and gold are watching carefully.

 

Geo-economical

Russia’s current account surplus widened to $86.6 billion in 2005 in a preliminary report. That is an annual expansion rate of 48%. Obviously the Russians are enjoying the benefits of higher oil and gas prices.

None of which went unnoticed by foreign investors, who injected $53.7 billion of loans into the economy last year. That’s a 32 percent increase from 2004.

Germany’s gross domestic product did not grow at all during the fourth quarter. Europe’s Household spending declined the most in four years for Europe’s largest economy.

Producer price inflation in Germany is rising to levels not seen in almost 24 years. Unlike Russia, Germany has to input its oil and energy supplies. Prices for oil and other forms of energy are up and put pressure on other prices across the spectrum of industries they are used in.

But the Germans remain upbeat as business confidence rose to the highest in more than 14 years. We wonder if this portends for that which is to come – or for that which has been?