TREASURY RALLY HINTS AT STOCK PULLBACK -- SO DOES 20% AUGUST DROP IN SHANGHAI INDEX -- GOLD IS CONSOLIDATING IN BULLISH SYMMETRICAL PATTERN -- GOLD SHARES ALSO LOOK PROMISING
STOCKS AND BOND YIELDS MOVE TOGETHER... Last week (August 18) I wrote about one of the side-effects of a deflationary environment being the positive correlation between stock prices and Treasury bond yields. In other words, Treasury yields and stock prices trend in the same direction. Chart 1, for example, shows the yield on the 10-Year Treasury Note (green line) and the S&P 500 (black bars) peaking together during 2007 and falling together until the end of 2008. Both have risen during 2009. Notice also in Chart 1 that bond yields turned down before stocks in 2007 and bottomed before stocks at the start of 2009. That suggests that the direction of bond yields hints at the possible direction of stocks. Which brings us to Chart 2 which compares the same two lines during 2009. The two up arrows show bond yields turning up three months before stocks in 2009. Both rose together into June when bond yields peaked. The August move to new 2009 highs by stocks, however, hasn't been confirmed by a similar move in bond yields (see falling green line). When two markets are positively correlated, and one of them starts dropping (bond yields), that's usually an early sign that the other one (stocks) may start to drop as well. When bond yields drop, Treasury prices rise. As a result, rising Treasury Bond prices hint at lower stocks.
Chart 1
Chart 2
TREASURY PRICES TURN UP ... Chart 3 shows daily price bars for the Barclays 7-10 Year Bond Fund (IEF) since last December. Bond prices peaked last December which was three months before stocks bottomed. Stock and T-Note prices have trended in opposite directions since March (bonds down and stocks up). Chart 3 shows T-Note prices bottoming during June and forming a "higher low" during August. The IEF has also broken a five-month down trendline. A close above the July high at 92.35 would turn its short-term trend higher. Since rising Treasury prices usually coincide with falling stock prices, you can draw your own conclusions. Bond prices usually rise for one of two reasons -- a weaker economy and/or lowered inflation expectations. Hence, my view that rising Treasury prices suggest that stocks and commodities are due for some type of downside correction.
Chart 3
CHINA SHOWS SIGNS OF WEAKNESS ... I also wrote on August 18 that Chinese shares had risen too far and were due for a setback. I showed China iShares having retraced nearly half of its 2007/2008 bear market after doubling in price since last October. Chart 4 shows the Shanghai Composite Index (SSEC) having retraced 38% of its bear market after more than doubling since last October (which is in itself a sign of an over-extended market). Of more concern is the 20% drop in the SSEC since the start of August and the drop below its blue 50-day moving average line (Chart 5). Since China has led global stocks and commodities higher all year, any signs of weakness there could cause profit-taking in those markets. Another side-effect of a deflationary environment is that stocks and commodities rise and fall together. A correction in one implies a correction in the other. One possible exception is gold which hasn't participated in the commodity rally.
Chart 4
Chart 5
WATCHING GOLD TRIANGULATE... In the same August 18 message, I wrote some positive words on gold. I did so for at least two reasons. One is the "symmetrical triangle" that's identified by two converging trendlines since February in Chart 6. Since that's usually a "continuation" pattern, it favors an eventual resolution to the upside. A decisive close over the upper resistance line would signal higher gold prices. Another reason for optimism is shown in Chart 7. That pattern (which Arthur Hill has written about) shows a potential "inverse head and shoulders" pattern forming since spring 2008. The two circles show a potential "left shoulder" and "head". The 2009 triangle (converging lines) represents a potential "right shoulder" in that bullish formation. A close over the "neckline" near $100 ($1000 in the price of bullion) would signal substantially higher gold prices. Little attention has been paid to gold this year. It may be time to start paying more attention to it. Gold shares too.
Chart 6
Chart 7
GOLD STOCKS SHOW STRONG CHART ACTION... Gold stocks are also showing pretty decent chart action -- both on an absolute and a relative basis. Chart 8 shows the Market Vectors Gold Miners ETF (GDX) consolidating above a broken resistance line extending back to March 2008. It's one of the few ETFs to have done that. Chart 9 shows the GDX/SPX ratio doing even better. That ratio measures the performance of the GDX relative to the overall market. After surging to a new high this spring, the ratio has been consolidating (while stocks have been rising). The ratio has now declined to a support line drawn under its spring low and is showing some bounce. Needless to say, any upturn in gold prices would have a positive influence on gold shares as well. And, as I have pointed out before, gold can thrive in both a deflationary and an inflationary environment.
Chart 8
Chart 9
