Thursday, August 25, 2011


Before we get to today's main topic, the $100 spot that was laid on GOLD yesterday, I want to go through a few setups that are at hand. First, Sugar is now once again in play, and aggressive traders could certainly be short coming into today here. What I like about his now is the new high with the huge divergence in the POIV index, right at a time when both a seasonal decline is indicated along with a longer term cycle high is projected. We also had my COT Index spike sharply down right at the right time here. How you find your way into this trade is up to you, but this is one I have been talking about to short for a downward move. It does appear that now we may have started that move. You would have had to have been pretty sure about this to have gotten short already, but are we ever really sure? Trading is about probabilities and making money, not about being right. The older I get and the more trades I make, the more I realize this.

Here is another setup that I think is in play here, Natural Gas. I have been talked about this market for a couple of weeks saying I was looking for a long. We are still a week or two away from what would be the ideal seasonal low point, but we are close enough where in general history has begun upward moves. We have a nice clear trend line we can draw on the price chart. My COT index is not in the buy zone yet, but again we know this thing is far from perfect. There are a few other things I use that are not shown that support this trade if we were to break out from here, so this is one I am looking at.

The coux de gra was laid on the world's favorite market yesterday, following a prior day where it had also moved down heavily. In my never ending diatribe about this market, about which at times I have been admittedly dead wrong, I mentioned that we would see $100 down days once this market topped. Yesterday we saw one of those, at one point down about $110. Is this the all time high? I do not know.

It certainly could be, all of the elements are perfectly lined up for this to fall 50% or more, but they have been for a couple of years now. As I constantly say, bubbles are very difficult to time and this one has been no different. I do recall talking to a friend who is in real estate who reads here occasionally about the bubble in real estate popping, and how I caught it so perfectly. I had mentioned that in my studies I found a few things that were 4 standard deviations above the mean, which is a statistical certainty or close to it, that a big reversion will take place. If we carry that forward to this market, you may recall the comparative analysis I did with the DX in a chart the other day. It showed that at levels of 30 in a particular way of measuring this, that declines typically occurred. We were at close to 200 in that measure on the chart I showed, so more than a multiple of 6! I do not ever recall ever seeing anything anywhere near that extended in price.

The next chart shows 4 Standard Deviations on a 60 day basis and what has happened historically when we have had these levels of extension. If you look at the second chart you will see the former all time high was made at these levels. In each of these cases we had meaningful declines.

The second occurrence on this chart even though it worked, I do not consider to be valid. The reason for this is when you get extraordinarily large moves like this once the trend changes, there is a reset period required before indicators get back into "normal" mode. We had not fully recycled at that point even though had you referenced this it would have advised you correctly.

Now that I have shown just raw statistical reasons as to why a decline should occur here, lets talk about some other things surrounding this market. This is without question anecdotally, the most over hyped trade I have seen in my lifetime. The biggest issue I have with that hype is that it is based on a false premise. There is simply no consistent history of this store of value concept. It makes sense logically when it is argued, but it is not in the data, PERIOD. Times of crisis have resulted in both rallies and declines in GOLD prices over time, about an even bet.

I am sure people will come out of the woodwork with you have to buy now, this is a great buying opportunity. It strikes me as strange that most people will accept an argument based on statistics until it is applied to their favorite field of interest. When that happens they create reasons as to why it is different this time and the reversion will not apply to their market. The real estate bubble and the stock bubble of 2000 are both perfect examples of this. It was going to be a new world revolutionized by the Internet and that was why companies with no revenue should be valued in the billions. They sure aren't making anymore land is what they cried in real estate. Now it is we have this financial crisis, so Gold is a store of value. Even though we are 4 standard deviations above the mean, that means nothing because of their fundamental argument which is based on an idea and not precedent. The long term cycles still call for a January top, so we could move higher again, or that could be a right shoulder type of situation.

Folks just go look at the charts during prior crisis periods, this relationship is just not consistent. We have had a monster bull market here, and with all commodities, there are reversions. There will be one here and it appears to be under way. I am not short this market yet, I don't try to fade moves like what this one has been it is suicide. If we calm down some and get a valid retracment pattern for a short entry I will be a player here but most likely in Silver, since it has long since put it's top in. Sell the weak and buy the strong.

If you are a GOLD bug don't bother with the comments arguing this, it is a waste of time and I know I cannot convince you until the price drops to $600, so let's just move on. These are my thoughts so let's just agree to disagree. You have been right so far, I did not think price would get this far, the question now is whether or not it is has peaked. For the record, I am not sure at this point. This above discussion is based on a reversion being underway, I do not know if this is going to be the all time high or not at this point and neither does anyone else. I could care less if it is or is not the all time high, that is not what will make me money.

Good Trading


Anonymous said...

Is there a reason you never, ever mention T-Bonds or Notes. If there were ever a bubble we are at or very near it in government bonds - much more so than gold in my opinion. They ran 20 full points since the June lows and 15 full points while the Bernanke's were getting crushed. Huge moves and huge profits and nary a word. I know some traders think it is a manipulated/rigged market but no more so than what the FED did to stocks in the last year. Just curious. Don in rocking and rolling Virginia.

Chris Johnston said...

You are not reading very carefully, I just said within the last few days I thought a top was near in bonds. I also called the huge bond breakout that occurred just about a week prior in July, not sure how you missed that I talked about it several days.

There is a difference between a normal market top and a bubble. Bubbles are inflated prices with no fundamental basis, like GOLD. Bonds have rallied but there is a direct fundamental link that has existed forever between crisis and interest rates. There has always been a flight to quality into bonds during times of crisis, there is no such historical relationship with Gold to crisis periods.

As I say, it is in the data, the GOLD relationship that is alleged, is not in the data.

Opinions are one thing, I make my calls from historical cause and effect relationships.

Read back in my old posts, there are many comments about bonds in both directions.