INTER-MARKET RELATIONSHIPS THAT ARE DRIVING THE STOCK MARKET AND COMMODITIES

This will be a quick post today illustrating what I expect over the next 2 years, and the inter-market relationship between the currency markets, CRB and stocks.

Pay particular attention to the inverse relationship between the dollar index and the CRB; notice how the CRB almost immediately began moving down into its three year cycle low once the dollar formed it's three year cycle bottom in May 2011.

Stocks are driven by not only the dollar but to some extent by commodity prices. When commodities start to surge too high they act as a drag on the economy and consequently the stock market begins to stagnate. When commodities are falling, as they have been for the last year, it tends to act as a mild tailwind for the stock market and this explains why stocks have continued to rise for most of this year despite the dollar moving generally upwards since February.

I think I have mentioned before that virtually every recession since World War II has been preceded by a spike in oil prices of 80% - 100% over a short period of time (usually a year or less).

The surge from $50 a barrel to $100 in 2007 was the straw that broke the camel's back and tipped the economy over into recession, which began in November '07. A further spike to $147 a barrel the next summer guaranteed that the recession would be the worst since the Great Depression, especially considering that the real estate market and debt bubble was imploding at the same time.

Now that the CRB has formed its three year cycle low the dollar index should be at or pretty close to a final top, which should then be followed by a move down into its next three year cycle low sometime in 2014.

If the inter-market relationships continue to hold up, and I don't see why they wouldn't, then we should see commodity prices moving generally north for the next couple of years until the dollar forms its 3 year cycle low in mid-to-late 2014. At some point along the way rising commodity prices are going to begin pressuring the economy, just as they did in 2007 and 2008, and also in 2011 as the CRB surged up into its final three year cycle top.

My current guess is that we will see the stock market start to stagnate in 2013 forming a much extended rounded topping pattern. By late 2013 the stock market should be clearly in a new bear market that will begin to accelerate to the downside as commodities spike into their final top as the dollar bottoms in 2014.

At that point I expect to see a severe deflationary event as the stock market and commodities collapse similar to what happened in the fall of 2008 and early 2009. This collapse and deflationary event should be accompanied by the dollar rallying out of its next three year cycle low in 2014 .

Most bear markets tend to last between 1 1/2 to 2 1/2 years so we can probably expect a final bottom in early to mid 2015.

CONGRESS ARE YOU LISTENING?

Well, it's that time again. Every two years our senses are assaulted as politicians spew an endless stream of nonsense in the attempt to garner votes from a mostly unsophisticated American population. This year the major topic, not surprisingly, is jobs. Each and every politician would like you to believe that he or she has the cure for the persistent unemployment problem.

Of course it's all completely ridiculous. You would think these people could read a history book. Never in history has government been able to legislate productivity. Governments just misallocate capital. They tax one group of people and give the money to another group of people to dig holes. Of course, once the hole is dug or the road built, that job expires. It's not a sustainable productive use of capital.

Real productivity is entrepreneurs creating sustainable companies that satisfy a human need. AAPL is a sustainable business satisfying a human need. GOOG is a sustainable productive business. XOM is a productive business. None of these companies were legislated into being by government.

Almost without exception, real progress involves industry destruction due to mankind’s creativity. For example, when oil was discovered the whaling industry collapsed. When the automobile was invented it destroyed equine powered transportation, and so on. The emergence of each new major technological advance, throughout the history of mankind, has caused employment opportunities in some industries to utterly vanish. The industry that once provided employment becomes obsolete.

This is part of the normal and healthy sequence of human progress. Progress is a result of replacing inefficient technologies with ones that are not only new, but more efficient.

Likewise, nations that refuse to allow this process of creatively inspired ‘destruction’ are found to have economies that stagnate and ultimately fail.

There is one way, and one way only, to cure our employment problem (and debt problem). It is the same cure that ultimately ended the Great Depression and serviced the gigantic debts that were incurred during World War II. That cure was the advent of two brand-new industries: plastics and electronics. These two industries created millions of jobs worldwide and spawned an economic boom from 1945 until 1966.

Now the world is back in the same position it was in 1930, and where Japan found themselves in the early 1990s. The world has created another debt bubble and we've chosen to kick the can down the road just like Roosevelt did in the ‘30s, and Japan has been doing for the last 20 years. And just like in the ‘30s, we are going to get the same result which is persistently high unemployment and generally declining global economic conditions.

What we need to do is allow human ingenuity and creative destruction to actually cure our problems. The biggest problem the US faces today is the triple threat of Social Security, Medicare, and Medicaid. These three entitlement programs have bankrupted the country, and let's be honest, there is no way any politician can possibly reform these programs, or even attempt to do so, and have a prayer of getting elected.

The cure to our problem is staring us right in the face. We don't need to reform Social Security, or government health programs. We need to make them obsolete.

Rather than plowing taxpayer dollars into an insolvent banking system (as the Japanese have been doing for 20 years), we need to allow capitalism to work and insolvent companies to go bankrupt. The taxpayer dollars that are now flowing into an endless black hole which are the financial system and government stimulus programs need to be funneled into the biotech industry. Rather than fund expensive surgeries or endless treatments that only manage symptoms, we need to discover real cures for disease, injuries and aging.

Imagine if a person with an arthritic knee, instead of a $20,000 knee replacement surgery, could simply walk into the doctor's office and receive a stem cell shot that would repair and permanently cure the disease. Or, how about a permanent cure for diabetes, heart disease, and obesity?

Yes, what I'm talking about is a complete overhaul of the global healthcare system. Yes, this is going to be creative destruction on a massive scale. Many many doctors that studied for years and years are going to be put out of business. Health insurance will become mostly a thing of the past as the modern healthcare of the future will become easily affordable by all. No different than buying an iPhone today.

Yes, some industries are going to suffer and go bankrupt, like health insurance, many doctors, and a big part of the pharmaceutical industry.

But millions and millions of jobs will be created and when we reach the stage when we actually cure diseases, especially as related to aging, we will eliminate the gigantic burden the three big government entitlement programs. If people can remain healthy and active for their entire life there will be no need for Social Security benefits and Medicare and Medicaid. These programs will become a thing of the past, as most diseases, and injuries will be quickly and easily reversed or permanently repaired.

So instead of the same old nonsense drivel we get during every election, it would be refreshing if politicians understood the real problems, and the real cures, and put in place policies that would actually have long-term benefits and accelerate the transition through these dark times and into the next Golden age.

Congress, are you listening?

BULLS STILL IN CONTROL, BUT TIME IS RUNNING OUT

In last week's article "Three Weeks Left" I outlined a brief synopsis of what I was expecting based on how the daily cycles were unfolding. So far markets are playing out pretty much as anticipated.

This week I'm going to go a bit more in depth and tie cycle's analysis with the upcoming fundamental calendar, namely the next two FOMC and Jackson Hole meetings.

As you may recall from the last article, the dollar index is in the process of moving down into an intermediate degree bottom, which in turn is triggering a rally in virtually all risk assets, most noticeable in the energy and grain sectors as the CRB exploded out of its three year cycle low.

I think we will probably see the dollar continue to drift generally lower for most of the remainder of this month, possibly even into the Jackson Hole meeting (August 25 – 27) as traders continue to hope for the next round of QE.

When the Fed fails to deliver, which they almost certainly will, we should see the market start to move down into its daily cycle low, which coincidentally is due almost exactly on the September 12 – 13^th FOMC meeting. 

   

The September FOMC meeting will be the opportunity for the Fed to shorten the stock market intermediate cycle and possibly abort most of the move down into the yearly cycle low due in October. However, I think the Fed is probably going to balk at the September meeting also, and when they do it will initiate the real move down into the normal timing band for an intermediate and yearly cycle low in late October, or early November.

I suspect that the Fed will finally cave at the October meeting and begin an open ended QE with the misguided goal of achieving a nominal GDP target and lowering the unemployment rate. The one caveat would be that the Fed meeting in October would call for a slightly short stock market daily cycle, which is not unusual if the market is experiencing a hard decline.

Another possibility, although one with lesser odds in my opinion, would be a final intermediate and yearly cycle low on the November employment report, or the presidential election results, which would stretch out the daily cycle to its normal duration of 35-40 days.

Based on the current cycle count, and taking into account the timing band for the next two FOMC meetings along with the dollar's current intermediate cycle, we should trigger a top in the stock market sometime around the end of August. However, let me warn bears that the move down into the intermediate bottom is not going to be an easy short. I expect we will see most of September chopping back-and-forth with several retests of the highs before finally rolling over. Most of the losses will probably coming in the final 5-10 days before the bottom. As I have said previously, this will not be an easy market for bulls or bears - either one.

Gold is a bit of a different animal than the stock market and its intermediate cycle has a different duration. But gold is still tethered to the dollar index as it continues working through the consolidation phase of this new C wave. Here is a chart I posted back in February depicting the extended consolidation that I was anticipating this year.

Considering that gold is still in this consolidation phase I think we are probably going to see a test, and more likely a break of the D-Wave trendline as the dollar completes its move down into its intermediate cycle low later this month. That should be followed by an intermediate decline that should bottom ahead of the stock market in mid to late September.

At that point I suspect gold will start to sniff out the next round of QE and will begin to resist the remainder of the dollar rally, very similar to what happened between May-July.

Open ended QE, which I expect to begin at the October FOMC meeting (there is a small chance that the Fed will act early in September), is going to be the driver of what should be an inflationary spiral, culminating with a parabolic move in the CRB index and the next leg up in the secular gold bull (probably to $3500-$4000) as the dollar drops down into its next three year cycle low in mid-2014.

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BULLS HAVE 3 WEEKS LEFT

3 weeks, that's how long the bulls have left before stocks roll over and begin the next intermediate degree decline. That being said, the next 2-3 weeks should yield some very healthy gains in virtually all asset classes. Why is that you wonder? Well, it's because the dollar has begun moving down into an intermediate degree correction which will, in the next few weeks, fuel the 'risk-on' trade.

As of Friday the dollar was on the 11th day of its current daily cycle. The normal duration of a the dollar index daily cycle is 18 to 28 days, with the average being about 23 or 24 days. This suggests that the dollar should bottom somewhere around August 21st or 22nd. As you can see in the chart below whenever the dollar moves down into an intermediate degree trough it generates strong gains in asset prices.

What follows, once the dollar bottoms and its next intermediate degree rally begins,  is not going to be pretty. Stocks are going to start to struggle and ultimately move down hard in September and probably October if the Fed doesn't unleash QE3 at the September FOMC meeting.  

By the end of August and certainly by the time we get into September the markets are going to call the central bankers bluff, and it is going to take more than words and the threat of quantitative easing to keep asset prices propped up.

I have covered the rest of the forecast in depth in the weekend report available to premium subscribers.

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TOO CLOSE TO CALL

Is it a bear market, or is it a bull market, that is the question.

On one hand Europe is obviously in a recession. China is slowing dramatically, and the US economy is clearly in 'stall mode' at best, and slowing rapidly at worst. That alone would suggest that a bear market has begun.

On top of that, the S&P broke through its daily cycle trend line today (although it did manage to rally back before the close).

A break of the trend line usually indicates that the daily cycle has started its decline into a cycle low. If this turns out to be the case, then this cycle would have topped on day 21 which gives it quite a few days to move down into the cycle bottom. (Average daily cycle length trough to trough is about 35 to 40 days). If it does turn out that the cycle topped on the 21st day then there is a strong chance of testing the June lows at the next daily cycle bottom.

As a matter of fact I think if we break below the June 25th half cycle low it will indicate that the intermediate cycle has topped and we should break below the June bottom if not during this daily cycle then probably a sharp break below that level during the next daily cycle.

On the other hand, there are quite a few bullish signs that are popping up.

For starters, this is an election year. Does anyone really think that the politicians won't pull out all the stops to try and keep the economy and markets inflated up until the election?

Next, the advance-decline line managed to make a new high even though the S&P was still 3% below its 52-week high. As Jason Goephert at sentiment trader.com has pointed out, this has almost always lead to new highs. As a matter of fact, Jason noted that since 1940 there have been 13 similar occurrences and all but one led to the market making new highs within 3 months, on average within 18 days of the advance-decline line breakout.

Another positive is that the CRB's rally out of its three year cycle low appears to be consolidating in a bull flag in preparation for another leg up. If stocks are caught in a bear market then the CRB should be rolling over rather quickly.

Oil is also resisting the short-term weakness in the stock market and appears to be consolidating the initial $10 thrust off its intermediate bottom, and preparing for another leg up.

A different but related vein of thought is the US dollar index. Today was the 16th day of the dollar's daily cycle (average duration 18 to 28 days). This being the case, it's getting late enough in the cycle that the dollar should start to move down again any time now. A major concern for bears would be any move lower by the dollar as risk assets tend to trade inversely.

An even bigger concern is dollar sentiment. It is currently at levels that have generated intermediate tops almost without fail in the past.

Chart courtesy of sentiment trader.com

The fact that we still haven't seen a left translated daily cycle out of the dollar makes me think that the dollar still has an intermediate decline ahead of it. This week will be the 17th week in an intermediate cycle that usually runs 18 to 25 weeks and there's a good chance this sentiment extreme is going to force an intermediate top as soon as this daily cycle runs out of steam.

A possible negative is the fact that gold seems unable to gain any upside traction in this new intermediate cycle. If the CRB has formed a three year cycle low why isn't gold generating any upside momentum?

If gold were to drop below $1547 it would indicate that a left translated daily cycle is in progress and as many of you know a left translated daily cycle often indicates that the intermediate cycle has topped as well.

Another negative is the fact that mining stocks as represented by the GDX ETF did move below their prior daily cycle bottom. The one small sign of hope is the reversal Thursday, which if it holds above the May lows could indicate that miners are just moving through a 1-2-3 reversal, and this was the #2 test of the lows.

Of course we won't know whether this is in fact what is happening until miners either break below the May bottom or move back above the June high. 


For the bulls the S&P needs to move above $1375, the CRB must generate another leg up, and gold must make a higher high by reclaiming the $1622 level. These are the bullish lines in the sand.

The bears they need to see the stock market drop below the half cycle low of $1310, the CRB must break downwards out of its consolidation, and gold has to drop below $1547.

I think the appropriate position for traders at the moment is to stay in cash until we see which one of these lines are going to be crossed first.

THE CRB JUST FORMED A FINAL THREE YEAR CYCLE LOW

I think it's clear by the action in the dollar index this morning and the response by risk assets in general, that the bottom I have been looking for is here. 

Today will be the first day in a commodity rally that should last roughly 2 years topping in mid-to-late 2014 when the dollar puts in its next three year cycle low.

The next two or three weeks should produce an exceptionally violent rally from extreme oversold conditions followed by a consolidation period as the dollar bounces weakly out of its intermediate bottom and rolls over quickly signaling that the three year cycle has topped.

The last two three year cycle lows in 2006 and 2009 generated a 20% and 32% rally during the initial move out of the final low.

This is day one of what should be roughly a two year rally into a massive parabolic spike sometime in 2014.

Let me reiterate that the initial rally out of one of these major cycle lows is always extremely aggressive. Today you have a chance to get in on the first day of this initial move. Those that wait will end up chasing into overbought conditions very quickly.

As is often the case, gold sniffed out this bottom early in May. The rally today confirms that we have a daily cycle bottom in place and a new cycle beginning that should last 15-20 days before the next short-term correction.

Miners confirmed this major bottom with a 24% initial rally on huge volume. This should be a multi-year low that will not be violated until the secular bull comes to an end.

To find out how cycles analysis enabled me to predict this major bottom I have reactivated the one week trial subscription to the premium newsletter.

OIL AND THE CRB APPROACHING A FINAL BOTTOM

June has been the month of major bottoms. Stocks and gold have already formed major yearly cycle lows. Now it's the CRB's turn to put in a major three year cycle bottom. This bottom will almost certainly form well above the 2009 low, establishing a pattern of higher lows and setting up for what I believe will be an extreme inflationary scenario over the next two years, culminating in a parabolic spike much higher than the one in 2008.

Sentiment has reached levels similar to the last three year cycle low in 2009.

Chart courtesy of sentimentrader.com

At this point we are just waiting for the oil cycle to bottom. Today is the 51st day of oils intermediate cycle, which generally runs 50-70 days on average. I think oil is going to bottom in the next 3 to 5 days. The reason being; oil is in a waterfall decline that has just formed a midpoint consolidation. Once the midpoint consolidation gives way the final plunge usually lasts 3-5 days. This should correspond with a dead cat bounce in the dollar index before it rolls over and heads down into an intermediate bottom sometime in the next 4-8 weeks.

During this final plunge it appears gold will move down into a daily cycle low. That low should hold above $1526 as I think gold has already formed its yearly cycle low back in May, slightly ahead of the stock market and the CRB.

Sometime in the next few days investors will get the single best buying opportunity to position in commodity markets for the coming inflationary period. I prefer the precious metals (more specifically mining stocks) as they have already indicated they are going to lead this next leg in the commodity bull, but I think investors will generate tremendous returns in almost any area of the commodity sector. 


One to watch is natural gas. It might be the largest percentage gainer during the next two years as it has gotten beaten up more severely than almost any other commodity.