When the New York Times published its apocalyptic interview with Bob Prechter a month ago, it is as though an invisible switch was flipped on. The mainstream media summarily jumped on the deflationary bandwagon and "deflation," once just a word used only in Scrabble, has now become a core part of everyone's vocabulary. I heard that the on the new immigration tests you must spell and define "deflation" in order to get your citizenship. If you think I am exaggerating, "google" deflation over the past month and check out the results. There might be more references to it than to President Obama, or even Lady Gaga.
As I pointed out in my piece on July 5, the day of the Prechter article, "this weekend the Times featured a major bearish article with Bob (never wrong) Prechter and quickly it has become the most emailed article in the paper. When was the last time that Prechter has been quoted in the mainstream media, let alone in my ultimate contrarian media indicator (the Times)? A major bottom in view? With the Times finally figuring out that we have had an ugly stock market, it is very likely. I have maintained that the Times remains the ultimate contrary barometer in financial markets." And once again the Times came through. Of course, it is worth pointing out that since then, the Dow is up over 10% and most commodities over 20% proving that you buy the rumor, sell the news. But then again, that is the cult mystery of Prechter.
I admit that the current environment is depressingly negative and the deflationary argument appears both logical and inevitable. But here is the problem. Markets tend to correlate much closer to what investor sentiment reveal especially when it is extreme, than to what the fundamentals seem to be or what the Elliot Wavers postulate or even more recently, to the certain appearance of the dreaded, deadly (gulp,) "death cross." Of course, none of our readers bought into that expectation, just as you didn't to the Y2K crisis. Like fervent Bible believers, "like a tree planted by the water, we shall not be moved."
And at this point the sentiment polls continue to reveal that investors and advisor services remain extremely cautious, suspicious and even downright fearful. This week, in spite of another up week in stocks, both of the two most cited weekly polls, the AAII and the Institutional Investors, remain at levels that are historically found at stock market bottoms, not at tops. Even this week in the CNBC online poll, 52% of the participants believe that the market will be lower at the end of the year against 24% who believe it will end higher. In spite of a very decent market over the past month or so, that is a lot of unconvinced bears, in my view. Don't take my word. Locate charts on these polls and study the correlations. Why is this important to the gold share holders and buyers? Read on.
GOLD SENTIMENT CONTINUES TO RISE CONTRARILY
Recently I pointed out that there has been a peculiar but very perceptible shift in two key gold sentiment readings. The first is the ratio of the double short-double long ETNs (DZZ-DGP). The other has been a similar dramatic shift in the put-call ratio on GLD. If you look at these two together you will find a strong bullish correlation, that is if you are a contrarian.
THE DZZ-DGP RATIO
I could not find a chart and am too inept to construct one, but I was able to add up the approximate volume figures for two distinctly different recent periods. First, let me preface this by pointing out that the average ratio since these ETNs went public in February 2008 has been about 2:1, long to short. To me, this bias seems reasonable considering gold had been up every year since 2001.
But from May 4-26, 2010, during the Euro-Greece crisis, things changed. As gold shot up to its high at $1265 speculators rushed into the metal. But they also furiously plunged into the double long ETN (DGP) to leverage themselves even further. The ratio during this time was over 4:1, and with an enormous jump in volume. To me that was a huge change, and if you are a contrarian, it should have served as a warning. As an aside, it's instructive to see that when these vehicles first went public, they came at the first top at $1000 gold. A coincidence? Most likely not. So to find the latest readings as significant has some precedent.
As the crisis ebbed so did the frenzy to buy the double longs, and gold returned right back down from whence it came, around $1180. But as the dollar continue to fall back, the DZZ-DGP ratio changed radically. Just as there was that sudden turn to buy double longs now came an equal shift, to place the bet on the other side. From July 9 through August 7, the DZZ-DGP ratio has fallen from that 4:1 ratio to a record low 1:1 ratio, by far the lowest in its short history, and an amazing turnaround in sentiment. I want to point out that this abrupt bearishness towards gold not only coincided with the dramatic shift in the put-call ratio on GLD as I discuss next, but also with the sudden outpouring of deflationary sentiment that struck the stock market, as it fell again under 10,000. My conclusion is that there is an obvious link between the stock market and gold sentiment, and that link is the fear of a deflationary collapse. But if both stocks and gold are going up as I believe, then deflation will begin to fade as a real concern over the foreseeable time.
THE PUT-CALL RATIO FOR GLD
Notice that each time this ratio has risen sharply over the past two years, gold soon hit a bottom and then quickly moved up (chart taken from Schaeffer.com) Recently, right at the top of the Euro-Greece frenzy and as gold made a slightly new high, you will see that at the gold top the ratio sank to about .92. But as the crisis abated, there has been a unusual jump in put buying, which I believe also correlates to the huge change in the DZZ-DGP activity. If you add in the current pessimism towards the stock market with the heavy bearish sentiment towards gold, along with the optimal season for the precious metals, you have an very compelling case to expect something very unusual just ahead. At least, I am.
ANOTHER VERY BULLISH INDICATOR HAS JUST APPEARED-HEAVY LIQUIDATION IN THE RYDEX PRECIOUS METALS FUND
Just over the past week or so, the Rydex Precious Metals Fund registered another gold bull signal. This is different from the other two because this indicator measures the mining shares, not the metals.
As you examine these charts, courtesy of the excellent Decisionpoint.com, note that when each time asset flows dropped sharply, it occurred at a near-term bottom. The last two liquidations came at the end of July 2009 when the HUI fell to 300 and then went up to 500, and again this year in February when the HUI fell to 360, once again up to HUI 500. We are now seeing another large liquidation but it is peculiarly different because the HUI has not dropped nearly as much as it did the previous two times. My guess is that this time is different because the next move will be the definitive breakout in the HUI and its components. The important thing is that this indicator is closely matching the two other ones I just cited.
THE CONCLUSION OF THE MATTER
I have tried to show that we have a very bullish alignment for gold and gold shares right now. First, as I hinted earlier, there is the historical link between stocks and the gold shares. Except for a very brief period at the bottom of the stock market in 2003, this relationship has held up extraordinarily well. Normally they move in a relative tandem, but at one critical time, right before the credit crisis in 2008, the plunge in the HUI served as an alert (in hindsight) to the drama that was to come. You can see that the HUI dropped sharply in July 2008 almost 2 months before the Dow finally caved in. Likewise, the HUI bottomed in November 2008, but the Dow didn't do so until March 2009. But in both instances, they were eventually connected. As the HUI moved up so did the Dow.
Since then, the HUI has consistently outperformed the Dow which I believe is a harbinger of the good things to come. Throw in the 3 separate historical extremes in the gold sentiments and the optimum season for the precious metals and we have very strong reason to believe that something explosive is upon us.
I have likened this impending move to the period, when after 16 years of consolidation, the Dow, as shown above, finally broke out in 1982. Coincidentally, it occurred at almost the exact time in August that we are now in. Look how frustrating it would have been during the previous 3 years as the Dow moved up, only to drop down sharply once again. Sound familiar? But within 2 months, the Dow had risen 40%, and within 5 years was up almost 4 times. Would you take that right now"
Since the precious metals shares are historically much more volatile, I wouldn't be at all surprised to see an almost 50-75% move in the listed shares by the end of October, with the smaller shares going up much more. From there, my guess is that we might have a month to digest the gains, rid the markets of the momentum players and then accelerate into February of 2011. Remember this market has most of us so frustrated and disappointed that most of us would be happy with just the crumbs from under the table. But the evidence of these sentiment barometers as well as the perfect season for a monstrous move shows me that we are now ready for a shocker. For the faint of heart, keep your nitro next to your computer.
FINALLY, A REMINDER
When I got back into gold back in 2001, I was convinced that an historic cycle had come. If you would have told me that gold was going up from $250 to $1200, I would have predicted a massive move in the gold shares (as I did back then.) But in spite of the metal's gains, we all have battled through boredom, frustration, doubt and even fear. These have led many to try to trade the shares and the metals, with very few doing it successfully.
I always quote the wise and tried Richard Russell here. To paraphrase him: "The stock market is a cruel master and will do everything it can to take away your money." It is not a coincidence that he, along with Jim Sinclair, James Turk and Bill Murphy, remind us not to try to trade in and out of this market, not just because it is so difficult to trade profitably, but because there will eventually be the defining launching point. It happened back in 1982 and if I am correct, it is about to do it again.