Leaving the Year of GOLD – 2011

As we come to the end of the 2011 roller coaster ride, now is a good time to review strategies and check on the macro perspectives shaping our approach to 2012. One particular change in commodities we have seen recently has been a significant break in technical support in the price for gold accompanied by a fundamental shift in the demand for gold.

In terms of the price for gold the commodity, there has indeed been a significant technical deterioration in recent sessions, and after being bullish on the major trend for gold for some time, we now view the long term outlook as being in no better than a neutral but weakening position. The fact that for the first time in close to 3 years bullion has broken below its 200 day moving average is a clear warning that a potential topping pattern is now starting to form. So, while it’s oversold near term, we would not do buying at this time but instead use rallies in the price for bullion back toward 1615 – 1650 (basis February) to do additional reducing in positions. Thereafter, down the road, a close below 1535 versus February would signal the beginning of a more serious bear market move.

There are also some fundamental changes to the demand for gold.

In the past 10 years, Exchange Traded Funds have entered the markets. Gold ETFs are backed by the physical commodity. With approximately 2,000 tons being used to support gold ETF’s, the demand for the commodity from financial products has grown to multiples of the physical bar and coin commodity. But gold ETF asset growth has been decelerating for months.

In addition, we are beginning to hear major commodity trader financiers pull back from the market, which also would have negative implications for the financial demand for gold among other commodities.

In addition, gold’s behavior relative to other investments has shifted – from negative correlation to equities during some of the scariest economic episodes of recent years, to a positive correlation recently. The inverse correlation has happened in the past with announcements of quantitative easing when equities rallied and demand for protection against inflation was at a premium. Inflation protection is not needed now. Also, Gold has rallied in the past with the rise of sovereign default fears. This role is in part being filled by “haven” currencies such as the U.S. dollar, another factor in making gold move more in line with stock markets.

If the positive correlation to equities continues early next year, recent buyers may lose patience and look elsewhere, to stocks what pay relatively high and reliable dividends given the new correlation, for example.

So as we prepare for the new year, we will continue to monitor the correlation of gold to other assets and the trend in financial demand for gold in particular. In particular, we will watch for the price to climb above gold’s 200 day moving average supported by increasing financial demand for the commodity.

Godot is on the Horizon-Coming out of the Market’s Overbought Condition

The last time we commented on the internal condition of the market, we referred to Godot, Samuel Becket’s legendary character who the others  in Waiting for Godot are waiting for but who, in fact, never arrives.  Since that time, which was back on February 14th, we have not posted as we have continued for the market to indicate its intentions.  Well, as we wait for the U.S. markets to open today, the internal condition of both the New York Stock Exchange and NASDAQ have already exhibited an important change by coming out of their respective overbought conditions.

For those who are interested in how we measure the overbought/oversold condition, we monitor a ten day moving average of the difference in the number of advancing declining stocks and the corresponding volume of trades.

As of last night, the New York Stock Exchange had left its overbought condition and on higher volume.  The number of advancing issues was still slightly above the number of declining issues.  NASDAQ has traveled further toward its oversold condition, with more declining issues than advancing and also on higher volume.  In addition, the number of NASDAQ stocks reaching a 52 week low is more than the number of stocks reaching a 52 week high.

As with overbought being a sign of strength more than an indication of time to sell, so will an oversold condition reflect weakness rather than a time to buy.

What to do now?  Take some chips off the table by selling holdings that are already weak.  The market is now in a weaker condition that will accordingly be more affected by global political events on the negative side than before.  In other words, the market is now more susceptible to a pullback and needs to prove itself on the upside and with greater volume.

In terms of specific levels to watch, we have already broken the first very short term levels:

S & P 500: 1,323   Dow: 12,180   NASDAQ: 2,795   Russell 2000: 818

indicating we are due for more than a one day correction.

The next levels to pay attention to are:

S & P 500: 1,275 Dow: 11,800   NASDAQ: 2,676   Russell 2000: 771

Stay tuned….

Dodge

Waiting For Godot

Few can deny the market has moved significantly to the upside and in is need of a rest.  By almost all technical measurements, the “market” has been overbought and could use a pullback.  There certainly has been multiple occasions recently when political and/or economic news has provided a perfect excuse for a “pause that refreshes”.  As in Samuel Beckett’s play, Waiting For Godot, market participants have been waiting by the side for the market to correct.  And as with Godot, the individual for whom the two main characters are waiting (in vain), the market has failed to pull back.

Unlike Godot who never arrives in Beckett’s play, however, in my opinion the market’s pullback  has already arrived and is hidden in the bushes in the form of internal rotation. Many of the big winners during the September – January rally (such as Amazon) have already suffered significant corrections in the past few weeks.  And even when a more serious correction arrives,  it is likely to remain controlled and rotational.  Accordingly, we need to give the bull the benefit of the doubt, but shorter term, choosing stocks carefully is becoming increasingly important.

The overbought condition of the market remains a condition of strength and should not be contradicted until it comes out of that condition.  If the Dow Transportation Average can break out and close above 5,257, then overbought or not, all the popular market averages will be in gear to drive further to the upside.  There are certain levels to watch on the downside which would indicate a pullback is on its way:

For very tight downside levels of support, watch:

• the S & P 500 to break below 1,310;
• the Dow Jones Industrial Average to break below 12,900;
• the NASDAQ to break below 2,769; and
• and the Russell 2000 to break below 804

For a more serious correction, watch:

• S & P 500 to close below 1,275
• the Dow Jones Industrial Average to close below 11,800
• the NASDAQ to close below 11.800; and
• the Russell 2000 to close below 771

There are confirmed signs now that our economy is shifting into a higher gear and supporting the strength of the market, which acts as a discounting mechanism.  Our GDP is on course to grow 3.4-3.5% this year vs. 2.9% last year.  According to a recent Kiplinger report, business confidence is climbing at both big and small companies.  Nearly 80% of CEO’s at the Business Roundtable expect sales to increase in the first half of 2011, 60% plan to raise company spending, and 45% plan to add to their payrolls.

Consumer confidence is climbing, and the Conference Board Index is over 60 again for only the second time since it fell from over 100 to a recession low of 25.

New hiring does remain sluggish, but layoffs are waning.  At the same time, we are seeing a reduced rate of  productivity gains.  Consequently, we expect to see some hiring momentum through the rest of the first half of this year.

Pressure on home selling prices appears to have halted its downward trend (even though recovery won’t start in earnest until the number of foreclosures retreats).

Interview on BFM Malaysia 2011 Feb 7

Sunday night (EST) I was invited to provide some market commentary for BFM: The Business Radio Station. The interviewer called from Selangor, Malaysia. To hear the interview, go to BFM: The Business Radio Station.

http://www.bfm.my/market-watch-070211-dodge-dorland.html

or listen to the broadcast here:

Sunday night’s questions reverted back to the shorter term implications of this week’s events (earnings, Bernanke’s expected comments before the House Budget Committee).  In addition to developments in Egypt, however, there was a new interest in whether the revamps to the Euro Zone Rescue Fund and increase in Germany’s lending capacity will be sufficient to calm the markets.

Dodge

Interview on BFM Malaysia 2011 Jan 31

Last Sunday (EST) I was invited to provide some market commentary for BFM: The Business Radio Station.  The interviewer called from Selangor, Malaysia. To hear the interview, go to BFM: The Business Radio Station.

http://www.bfm.my/market-watch-310111-dodge-dorland.html

or listen to the broadcast here:

Last Sunday was the first time in a while that I’m found the market needing to answer the question of whether it will undergo a more serious pullback, and I focused on specific levels for the Dow and S&P 500 to determine how it would respond.

Dodge

Inverse Stagflation – the Longer Term Implications of Shorter Term Creeping Inflation

All eyes are centered this weekend on what is going on in Egypt, and the personal involvement in the streets adds to the present, critical nature of the transition taking place within the part of the world that would otherwise be geographically in the far distance.  The intensity of the situation, which we will focus tomorrow in a post here as well as during the Sunday night interview on BFM radio, it is only natural to overlook some of the more ordinary news coming out during this earnings season, news that may have equally important implications for the future.  In particular, we are now seeing the beginnings of inverse stagflation take hold in the form of creeping inflation.  And the ramifications may go well beyond individual companies or industries.

Inflation will not be overwhelming for the United States this year.  We expect our inflation to reach 2 % this year, as compared to (or vs.) the 1.5 % for 2010.  However, individual companies will be more severely affected by inflation experienced be specific commodities.

This past week, we saw the impact across a broad range of individual companies and sectors:

• Coach Inc. (COH) with the rising cost of leather
• Kimberly-Clark (KMB) with the cost of specialty paper
• Sherwin-Williams (SHW) with the cost of paint
• Starbucks (SBUX) with the cost of coffee
• U.S. Steel (X) with the cost of coal and scrap metal

For these companies, future strategy will have to involve hedging their future purchases.  This will differ from a company like VMware (VMW), one of the darlings of cloud computing whose flat margins  may result from a more constructive investment in hiring and building new capabilities across geographic and product lines (as mentioned in Tuesday’s edition 0f Investors Business Daily).

The most interesting impact of this beginning inflationary cycle, however, may not have anything to do with Coach Inc.’s bottom line however. In one of the earliest reactions to this challenge, Coach said it is moving some production from China, where inflation is already hitting the cost of labor, to other countries with less perceived inflationary pressure such as Vietnam and India.

Individual companies’ shorter term strategies to address the inflation side of inverse stagflation may have longer term positive benefits to countries with relatively less inflation that will only become more watched with the passage of time.

Dodge

Interview on BFM Malaysia 2011 Jan 23

Last night (EST) I was invited to provide some market commentary for BFM: The Business Radio Station.  The interviewer called from Selangor, Malaysia. To hear the interview, go to BFM: The Business Radio Station.

http://www.bfm.my/dodge-dorland-landor-fuest-obama-inflation.html

or listen to the broadcast here:

Tonight’s focus was more to longer-term interests such as inflation, Obama’s re-election chances, and what impact the President’s State-of-the-Union speech will have on our economy.  This time, however, is the first time in a while that I’m finding the market undergoing some more serious weakness and am focusing on specific levels for the Dow and S&P 500 to determine if there will be a more serious pullback.