Friday, October 17, 2014

Casual Friday

Everyone RELAX!!  The market is up 250 points, it has regained 300 of the 1,000 points it lost in the last 6 trading sessions.  Everything is fine, breathe easy this weekend.  This wasn't too hard to see coming.  After the rejection of the lows on Wed, and a not negative day yesterday, anyone who has been short this market has made a lot of money in a short period of time and is running for the door before the session ends for the week.  This happens literally ALL the time.  Try it.  Next time you see any market down or up 4 days of the week, you can be sure it will move the opposite direction on Fri because this market is made up completely of traders who never hold positions over the weekend.  What if the Ebola outbreak gets worse?  What if there's important news out of Europe? Nobody wants to deal with that on a Sun afternoon and be completely helpless till Mon morning.

Anyway, onto the chart.  I often quote the Dow saying "The market is up 200"  because that's what people relate to.  The average Joe is not saying the markets up 12 and referring to the S&P.  But as a general rule of thumb I follow the SPX more as it is a broader base of stocks.  So, it appears like that low on Wed at 1825 is gonna hold.  I heard a few people call that as it was happening, so congrats on that.  I remained skeptical for the same reason I thought an extremely oversold market would drop down another 20 points on Wed, right to that 1825 level.

And the reason is simply this; we have seen this all before.  The market soars higher and poor old "average Joe" gets sucked in by the cheer leading media, and all the money his friends say they're making.  He looks at the SPX at 2,000 which is 30% higher than its all time high in 2007 before the financial crisis.  Joe knows the market is just "too high", he's smart enough to realize that, but compulsive enough to buy in anyway with the meager savings he does have.  He just can't help himself.  He buys himself some SPX for his little account he opened with his bank.  What he doesnt know is that his bank is the ones who just sold him that SPX that THEY bought from him in 2009 when he panicked and sold everything at 800.  He coughs up a couple thousand to make an offer for the stock, and the bank offers up a couple million shares for sale.  And so does every other bank and major institution.  All at the same time.  Joe's order gets filled first, but then the shear supply completely overwhelms the bids and the market plummets.  At first Joe is certain things will come back, because CNBC keeps telling him how good the economy is. Despite the fact that Joe works twice as hard for less money than he made 5 years ago, he believes them.  Then it goes down further and Joe realizes he made a foolish mistake, but he's not gonna freak out like an amateur, when the market bounces back to the price he bought it at, he will sell. Down, down, more and more until Joe can't take it anymore and offers it up for sale at whatever price he can get for it.  And who steps up to the plate?  The very institution that sold it to him to begin with will be happy to buy it back at half the original price.  And Joe is happy to give it to them.  And then the market rallies and then the process repeats.

The majority of stock held in this market is banks and institutions.  And when it's time to get out, they all trigger the same signals at the same time and the offers by the few Mom and Pop retail investors left in this market will always be overwhelmed by both the supply for sale, and the speed in which the computers try to execute it.  Any corrections or collapses in the market will happen faster and harsher from now on.  If you think 2008 was bad, consider how much faster the computer your on is now then the one you had then, and then realize Wall St computer systems can eat your laptop alive.  If a 2008 situation were to repeat itself, it would happen in about half the time.  Now how scary would it be to see the market drop 50% in about 4 months?  We wanted the computers for the liquidity and efficiency!  ...Be careful what you wish for...

Markets do the opposite of what you would expect.  A market trending higher typically crawls and inches up over a period of months and then smacks down hard in the corrections shaking out any weak hands.  A market going lower will typically crawl lower and have sharp moves higher suckering people to buy in, only to have them sell out in later weeks as things resume chugging lower.  We are screaming up off that low now which makes me think this rally will exhaust itself soon and a resuming of the overall trend (Which I believe now is DOWN) will continue.  Resistance comes into play first at 1900 then again at 1920.  Actually it moves up in 20 point increments all the way up to the high.  That is the first level to watch, these two resistance points are also right where the 10 and 20 day moving avgs are as well.  I highly doubt this market will go on to recover and make a new high beyond 2000 so I will be looking for it to fail somewhere before then.  We are currently up 30 points on the SPX at 1895 and I think that will be the extent of it today.  (But who knows what fun 3:30 will bring!)

Ok, enough on the SPX.  A wanted to take a moment and look at AAPL as just about every seems to own some of this stock.  It has held in ok during this blood bath the last couple of weeks but the momentum on this is dying out.  Moving avgs are rolling over as it is bouncing meekly off the 95 level.  If that level gives way, support is 5 point increments all the way down.  90, 85, 80,75 etc... So this could lose a good 20% which no one wants.  So watch it closely.  However, take a look at the weekly chart...

On the weekly, if things did pull back a bit into that major support zone, we would be looking at a pretty nice cup and handle formation that if it were to break the old highs, would likely target close to 150, so I would recommend buying AAPL after a decline when (if) you get the indication the trend has changed higher again.

Ok, next onto gold and then we will close with some subjects people have brought up.  As usual, we will be looking at the GDXJ.  First, we obviously had that reversal a few days ago and have been holding higher since then.  That is definitely a positive development.  GDXJ got down to about 30.50 then rocketed up to just shy of 35 and since then, the market has felt no need to retest that 30 print, but has also not been able to get above 34.  Look first at the difference between the low the GDXJ put in and the low here on the SPX.  The GDXJ has stopped going down after rejecting a low, and is calmly consolidating, exhausting the bears who have not been profitable the last few days on that trade and getting some longs to jump in here.  This is the type of action that makes me think a rally off of these levels would be sustainable, unlike the action in the SPX.  If the recent trend continues and the market fails and heads lower, we have been seeing gold and gold stocks act strongly in that situation so it could happen.  I would be watching the 40 level with extreme caution because I think we will likely have trouble there, but we could easily get a nice rally in the mean time.  We must still wait to be sure.

Now onto some requested topics, first regarding mining costs as we are on the subject of gold.  The current cost of mining an ounce of gold on average is about $1200.  Which is right where the price of gold currently sits. So essentially, the average gold miner is not making any money in this business.  Now this in itself we know can not be a sustainable thing, because gold mining companies dont spend hundreds of millions over decades of time to develop a mine just out of the goodness of their hearts so you can have a gold locket this Christmas.  They want to make money, or they're not going to mine gold.  And some have already stopped operations at their higher cost mines. A lot of miners I am sure are mining their higher grade deposits now with prices low and won't go back to developing the lower grade mines until price not only makes it worth it, but sustains such a level for a period of time.  Somebody asked, "Will mining costs vs the metals price cause a shortage?"  I will say this, already miners are producing less gold for the reasons I said above, not to mention that there is simply a finite amount of gold on earth to begin with.  So let me rephrase the question to come up with the answer; Mining costs plus the metals prices AND the Asian demand at these prices will likely cause a shortage on some level.  Will it be the shortage that breaks the COMEX?  I doubt it, but I would expect it could make price move higher quickly, and from an individual physical investors standpoint, you might have trouble finding coins at your local dealer.

A side note on that thought... I grew up in a very wealthy suburban area of NJ.  We had NY Jets and Giants you would run into at the bank.  Howard Stern was buying a property about 15 min away in the mountains.  We had maybe 2 or 3 gold coin dealers within a half hour drive.  Now consider that the entire inventory of Krugerrands and American Eagles that these dealers had could be bought up by Howard Stern in 1 afternoon and that would only mean him converting 1/10 of his wealth into physical gold.  When the masses decide they need gold even half as bad as they needed yahoo stock in 1999 or to flip a house in 2006, there will be shortages, that is certain.

Now, lets look at another aspect of mining costs, oil.  The 2 biggest factors in mining costs are the cost of oil and labor.  Labor, hasn't really gone up much if at all in the last 5 years as anyone with a middle class job is all too aware of.  But the cost of 1200/oz to mine is based on the oil prices we have been seeing for the last few years ranging in the 90-100 even up to 110/barrel area.  Oil has now fallen to $80/barrel meaning if it holds in the lower area for an extended period, the gold miners can start showing meager profits here even without a move higher in the metal.  Just another reason why they are likely at an all time low.  So chew on that concept for a bit.

Now the debate of Deflation/Inflation has been brought up again so I will throw my hat into the ring on this again.  Will it be inflation or deflation?  The age old question.  Inflation is INFLATING or increasing the money supply.  And by that definition, inflation has already been happening for years. What people are really wanting to know is when we will see the effects of inflation translate to higher prices.  And that has happened too.  The SPX hit over 2000 last month at the same time when Ben Bernanke, was denied a refi on his mortgage.  Ironic, as he was the man who put the plan of action into play that made banks utilize low borrowing rates to buy stocks as opposed to giving loans.  Because Exxon won't default, but you probably will.  (And with such a twisted view on economics, likely so will Bernanke)  As we sit now, commodities are collapsing and so are stocks, right at a time when both the Fed is suppose to totally end QE and also during the most popular month for the stock market to crash.  Well thought out.  We know that with the keys to the printing press its impossible not to be compelled to use it.  And they will and have, every time, without fail.  Guess what?  They will again.  Be certain, if the market slide continues and gets as bad as I think it could, (1500.  I think the market has at least a few hundred points of fluff it can shed.  I think it is possible to drop all the way to 1500 and quickly, which is why I think this is such a serious situation.) they will counter it with printing.  

So inflation wins right?  Not at all.  It's deflation.  It was ALWAYS deflation.  Look through out history, hyperinflation is a fleeting event.  It never lasts long and on average only lasts a few weeks.  The fallout from all faith being lost in a currency will translate to deflation on an economic level every single time.  The question is what will the price of gold and the market be when we get there?  $5,000 gold and $20,000 Dow are more likely than seeing an $800 gold price and the Dow back at 6,000.

Finally, someone mentioned the GLD and SLV etfs.  I am not sure what it was they wanted to know exactly but I will post the charts with my analysis.  

GLD had a good bounce off strong support and has had some positive developments, but is getting pushed back at the 120 level.  It's a little early to tell now which way this will go but it will have to resolve soon.

The picture in the SLV is similar to the GLD but the SLV broke to a new low, which the GLD didnt, and the SLV's rally off that low is a lot more lack luster than the one in the GLD.  So it's a little hard at this stage to see whether the GLDs strength will prevail sending SLV higher with it, or if the SLV will drag down the GLD with all the other commodities, but as I said, this is a tight range here and it will have to resolve soon, so stay tuned.

A friend of mine asked about buying the "dip" in NFLX this morning so I thought I'd add this one too.  Note, it is very similar to the AAPL chart, which appropriately has been the other traders favorite for the last 5 years.  First of all, lets address WHY there was a dip to begin with, if you can call dropping 100 points or 20% in 3 days a "dip".  It's because the market was expecting NFLX to earn about $1 a share this quarter.  (which do the math, means if they do that every quarter, $4 in earnings a year, means the stock is selling for more that 100x earnings.  Seems legit...)  But they couldn't do that, they earned half of what was expected, 52 cents a share.  (Which again if you do the math means avg of $2 in earnings a year which puts the price tag at about 175x earning now.)  This chart needs to hold that $300 level or it runs the same risks AAPL does.  Actually worse, because there is a hell of a lot more substance to APPL's business than to NFLX's.  This could drop nearly 50%, so be careful on this.


I wanted to add something to the inflation/deflation debate.  Lets assume a scenario.  QE does indeed end this month and the market which looks to have topped has no where to go but down.  Well, suddenly buying stocks with all the QE money isn't the profitable thing to do anymore.  This COULD mean the money banks have been sitting on begins getting pushed out into the economy in the form of more loans, as that is now the profitable trade for them.  Now THAT is where you could get your inflation right in the midst of all this.  The big issue people have been stating is that the money is being sat on and not flowing into the economy, which is why we haven't seen inflation.  This could change all that, and the Fed very well might already know this which would explain why they might not deviate from their expected course and fire up the printing press as quickly as Wall St might like (or scream for).

I think thats all for now (gee it only took all morning to write this,..)  Till next time friends, keep these words in your head as you navigate these markets.  "I'm more concerned about the return OF my money than the return ON it." - Mark Twain

-Jonathan M Mergott


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  2. Really enjoyed your analysis on the market turnaround, even though everyone attributes it to the Bullard Put and QE-4. You and I agree that they will counter any serious correction with more printing.

    I wonder however about the long-term backlash against the dollar? If de-dollarization intesifies due to more printing, then we might get hyperinflation and not deflation, which is a different scenario than you presented. Just a thought.

  3. I agree, we will get more printing and most likely get hyperinflation. What I mean, is that hyperinflation is not the economic scenario we will be facing for any extended period of time. A currency spiraling into oblivion will not continue forever, they will act. The typical first step as they did in Argentina is to announce a new currency that is convertible with the old currency 10:1 or so. So 10 old dollars is now worth 1 new dollar. Essentially just cutting off the zeros, but you have done nothing to make it more valuable. Eventually they will have to face the inevitable thing they really don't want to admit, that the only solution is a gold standard. And that will be the end of hyperinflation. Now, the damage it caused to business and personal savings will leave the economy utterly destroyed. No one will have money, so there will be no commerce, no money flowing through the economy, and that is deflation ultimately. Point is, hyperinflation may very well be on the horizon, but it's not something we will have to face for the next several decades. It will likely only last a few months. What is left behind in its wake however, will be decades of deflation.

  4. Yes, your scenario perfectly makes sense. Before the last financial crisis however Steven Lachance wrote a very prophetic piece: "How Debt Mooney Goes Broke." (

    While many think deflation will never happen due to a rise in interest rates (thus limiting credit and liquidity), the death of the dollar could certainly crush bonds as foreigners dump US debt. With our industry having been hollowed out, we will have no choice but to raise interest rates to defend the currency otherwise we can't import anything as foreigners demand a different form of payment. This is could be an alternative scenario as to how it will end for the market.

    How does it end?
    A debt-based monetary system has a lifespan-limiting Achilles heel: as debt is created through loan origination, an obligation above and beyond this sum is also created in the form of interest. As a result, there can never be enough money to repay principal and pay interest unless debt is continually expanded. Debt-based monetary systems do not work in reverse, nor can they stand still without a liquidity buffer in the form of savings or a current account surplus.

    When debt grows faster than the economy, the burden of interest is bearable only so long as the rate of interest is falling. When the rate of interest reverses course, interest charges start rising faster than debt growth.