INVESTMENT EDGE
The US stock markets continue to consolidate and digest its huge 2017 year run-up and subsequent double digit correction. The lone exception being small cap stocks as they have moved on to all-time highs. Will the rest of the market follow suit? The benefit of the doubt has to be given to the prior underlying trend but I don't think the answer will be resolved any time soon. Until then, check out this month's Charts on the Move video at the link below ...
For months I have been mentioning seeing signs that inflation is perking up. This is seen directly in the prices of commodities as they are coming back to life after severe multi-year downtrend. Taking a look at wheat as an example, it’s easy to see its price peaked back in 2012 and has fallen almost 60%, bottoming in late 2016. Since then it has been consolidating sideways, eventually breaking above the red long-term trendline mid last year.
The 2-year (so far) sideways consolidation has formed a fairly symmetrical inverse head and shoulders reversal pattern with price now sitting above a rising 200-day moving average and just under the pattern’s neckline. If in the next few weeks/months price were to confirm the pattern by breaking above the neckline on increased volume, its upside target is near the 730 level (indicated T1 above), a 35%+ increase from where it sits today.
In spite of a relatively ideal reversal investment set up that has developed on wheat, I still wonder whether this is the real deal. Even though this provides a remarkable 7:1 reward to risk ratio because so many commodities have provided false breakouts over the past few years I have become somewhat jaded to their signals.
Almost every prior stock market crash was caused, or at least exacerbated, by market illiquidity.
As you can see in the chart below, the FED’s recent activity of unwinding their balance sheet by selling a small fraction of their QE accumulated holdings coincided with the most recent 12% stock market consolidation (not the sole reason for the correction mind you). It is important stock investors understand the correlation between the FED removing liquidity and lower stock prices. When you combine this balance sheet activity with a simultaneous push higher in interest rates we are entering into uncharted territory knowing just how the market will react.
Regardless, the current consolidation in the SP500 has a clearly defined upper and lower boundary, 2670 & 2530 respectively, making it a much easier task to manage whatever happens. Above I add exposure, below I decrease.
Those that follow precious metals know that when the gold to silver ratio reaches 80 that it is a trigger to buy silver instead of gold. Historically, the ratio rarely gets and stays above 80. When it happens, some sell all their gold and convert it to silver, wait for the ratio to crash, then flip their silver back to gold. There are others who make a pairs trade and go long silver and short gold. The point being that historically when the ratio tags that 80 level it sets up a high probability investment opportunity.
Below is a 15-year chart of the ratio of gold to silver (the blue line). What you can see is that if you had purchased silver (price in bottom pane) after the ratio crosses above 80 and then below the (red) 50 day moving average it would have been a very profitable investment. I have marked those cross-overs with a red vertical dashed line. The first instance of the cross-over occurred in 2003 and silver went on to rise more than 300%. The second occurrence in 2008 saw silver rose more than 360%. The third and most recent instance in 2016, silver went on to make a modest 30+% over a short 5 month period.
Fast forward to today and the ratio closed out the week still stuck at 80. The longer the ratio stays above 80 the likely the bigger the reactionary move. The current chart of silver looks horrid as it has gone nowhere for more than a year and a half and can’t get out of its own way. I don’t know when it will happen (its definitely not right now) but it is my belief that when it does, the silver will present one of those rare triple digit profit opportunities that investors should not miss.
The sideways chop continues but for how long? No one knows for sure but i think it will be months before we escape. What about you?
My latest Charts on the Move video which talks about this and a lot more can be viewed here ...
