Inflation Hedge Assets Continue to Break to the Downside

• Outside day hints that the short-term downtrend for bonds may be over.
• Dollar Index may be completing an inverse head and shoulders.
• Stronger dollar forces gold to test its lows.
• Stronger dollar causes gold to break down from a 2-year trading range.

Here is a link to the video version of this article

Equities

Despite the sharp advance of the last two weeks Chart 1 shows that  the daily KST for the S&P ETF, the SPY, remains slightly oversold. That suggests that more upside potential lies down the road. However, the chart also shows that the S&P is running  into resistance at the recent highs, which may mean that a pause is necessary.

Chart 1

Other positive signs include the fact that the high low percentage for the S&P 1500 ($SUPHLP) in Chart 2 has managed to reach a post September high unlike the S&P 1500 ($EIS) itself. That shows that many stocks are breaking to new highs, enough in fact, for the cumulative version of this data to rally back above its 10-day EMA. Notice that it had remained above this average for all of 2014 until mid-September. As long as the indicator continues to trade above its average it suggests that the rally dating from mid-October is intact.

Chart 2

The S&P 600 (small caps) (IJR) and its A/D Line ($SMLADP) have moved back above the extended neckline of a head and shoulders pattern. The Index itself has also moved above the down trendline joining the head with the right shoulder. As long as it can remain above the line the probability of the head and shoulders failing will be better than 50/50. However, if the upside breakout fails and the Index drops back below the neckline the situation would be more problematic. We may see a pause in order to digest recent gains, but the rising KST suggests that a test of the previous high may well be in order.

Chart 3

One thing that the recent rally has put to rest is a possible Dow Theory sell signal. That would have happened had both the Industrials($INDU) and Transports ($TRAN) begun a period of declining intermediate peaks and troughs. As you can see from Chart 4 both series reached new highs in mid-September and fell below their  August bottoms. That set the scene for a possible failed rally attempt with a subsequent decline below the October lows. However, this week’s action by the Transports took them to a new highs. It requires both series to trace out declining intermediate tops  and bottoms for a sell signal   Consequently, even if the Industrial rally fails to take out its mid-September high and subsequently drops below its October low that would only qualify for half a signal. There is also the question of whether the recent rally would qualify for intermediate  status, but that’s a debate for another day!

Chart 4

The near-term technical outlook may look constructive, but Chart 5 shows several important longer-term technical aspects. First, the  bull market trendline dating from 2012 has been decisively ruptured. That either means a trend reversal or a  slowing down in upside momentum sufficient to result in a trading range. Either way, the implication is that the name of the game has changed somewhat. Second, the recent rally has run into resistance in the form of the extended dashed trendline. Third, during the 2012-14 rally the Global A//D Line (!PRGLAD) was in gear with  the ACWI itself, but the breadth recovery rally has been far less robust this time around. Finally, there is the possibility that the trading action since late 2013 represents a head and shoulders top.  That scenario is quite speculative at this point, but if, after the current rally has run its course, the price does slip below October's low, say to $55 that would signal a primary bear market for global equities.

Chart 5

One of the reasons we cannot rule out this possibility lies in the fact that the Special K for many averages has moved into a bearish mode. One of the more egregious is the technical position for the Value Line Arithmetic ($VLE) . In this respect Chart 6 demonstrates the fact that joint trendline breaks for the price and SPK are usually followed by a major trend reversal. We see that both series have already violated trendlines and that the SPK has started tracing out a series of declining peaks and troughs at A,B,C and D. That suggests, but does not prove, that the Index will eventually break below the October low and complete a 1-year head and shoulders top.

Chart 6

Finally, the ratio between stocks and bonds (SPY:TLT) has already broken down. Currently this relationship is in a retracement rally mode. If it could move above the dashed green trendline at 1.73 that would negate the distribution pattern. However, with all three KSTs being in a bearish mode that seems unlikely. The moral of the story seems to be stay with bonds rather than stocks until the ratio breaks above 1.73!

Chart 7

US Credit Markets

The Barclays 20-year Trust, the TLT, experienced an exhaustion blow-off a couple of weeks ago. I still think a move of that magnitude requires additional corrective activity before the bull market can extend. However, Tuesday saw an outside day develop and that suggests that the down part of the correction may be over and that a sideways to small up move is in order. I would be more confident of this had the momentum indicators reversed to the upside, but as you can see the MACD is still declining. Having said that, you can see that the outside day experienced a quick false move below the green support trendline and that’s a definite plus for bonds.

Chart 8

Dollar Index

The Dollar Index tracking ETF (UUP)  is in a confirmed primary bull market and has been correcting in the last few weeks. It now looks as though that correction is over because the Index, in the form of its ETF, has tentatively completed and broken out from a consolidation reverse head and shoulders. Note the strong outside bar and heavy volume during Wednesday’s session, which adds credibility to the breakout scenario. Normally I would want to see the KST reverse to the upside from a lower level but it’s important to remember that this is a young and very strong bull market, where counter-cyclical (bearish in this case) indicators trigger a lot of false negatives.

Chart 9

Some credibility to the breakout comes from the fact that it has been confirmed by the inversely plotted Gold Mining ETF, the GDX, which has broken sharply and convincingly to the upside. The dollar and gold related assets do not always move in the same direction, but it’s not usually a good idea to bet against this relationship.

Chart 10

Precious Metals

Occasionally the gold shares (GDX)  lead the price of the metal (GLD) as we see in Chart 11.  That does not guarantee that gold, which after all, is at support, will extend its decline. However, we would be much more confident that prices were headed higher were the shares experiencing some kind of positive divergence with the metal instead of experiencing decisive new lows. The breakdown point for a decisive new closing low would be $114.

Chart 11

Commodity Indexes

Charts 11 and 12  show why the precious metals, which discount inflation, are under pressure. First we see  the completion of a head and shoulder top in the CRB Composite and my Inflation Index. It is possible to point to the positive stochastic for the Inflation Index  in the bottom panel but in my book trend trumps everything, so until these two series can rally above their respective resistance trendlines I am treating the breakdown as a valid one.

Chart 12

Oil ($WTIC) is offering us a far more decisive signal with a 5-year top completion and a negative long-term KST sell signal.

Chart 13

Good luck and good charting,
Martin Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.