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The dollar, Stocks, Bonds and Gold

Looking back over 20 years, and forward one, two or more

I’m going to start this study as an absolute beginner.  Beginning strictly from a comparison of four 20 year charts: the dollar index (DX), 30 year treasury bonds (ZB), the SP500 (SPX) and gold (GC).

And then I’ll use this backwards view to make guesses about the next year or two.

I’m leaving a few markups on each of these charts.  Just the roughest, most obvious things I see.  But I would like to see how they’ve played against each other, and against world events over the past 20 years.

I am not reading any expert opinions, but just looking at the data myself.  I can’t help that a few ideas have leaked in to my head.  But the goal is to look at the charts fresh.  And think about how they compare to the broad strokes of what I know happened in the world during those times.

This way, if, for instance, I get an idea that the dollar will get stronger, I could hopefully make some theory about how that would affect other vehicles, and build trading plans accordingly.

Here are the charts

The Dollar

Dollar 20 year spare 7-31-16

SP500

SPX 20 yr spare 7-31-16

30 year Treasury bond

30 bonds 20 year spare 7-31-16

Gold

gold 20 year spare 7-31-16

What is there to see?

30 year bonds

The first thing that leaps out to my eye is the weirdly consistent up channel in 30 year treasury bonds.  I have gone out more than 20 years, and this trend goes way further back in time.  What the heck is so great about US treasury bonds?

When I was a kid, my grandma bought me some.  30 years later, I cashed them in, and they were worth a tiny bit more than she had paid.  If she had bought me some Johnston and Johnston, I would have had a small fortune.

Bonds seemed boring to me when I was a kid and knew nothing.  30 years later, I still knew slightly more than nothing, and they still seemed boring.  Now I’ve been immersed in markets for over a year, with some increment more knowledge than none, and bonds still seem boring to me.

One bit of knowledge, that somehow penetrated my bean, is that the stock market has consistently out-performed bonds (and in fact, any other investment vehicle) over a large time frame, and any large cycle within the absolute time frame.

One thing this tells us is that the bond market is not driven strictly by real investment.  It is a more tangled web.

Today if you bought 30 year bonds, you’d be making a quarter of one percent interest, which is better than any time in the past 8 years.  If you bought bonds in Europe, you’d have to PAY to hold them!  WTF.  It just doesn’t make sense as an investment vehicle to a naïve observer.

Of course, playing futures on bonds can be quite fast paced and exciting, but that’s another story.  My question is, why are bonds acting this way, on a large time frame?

Bonds and how they get that way

Now, let’s admit, we know bonds “should” have an inverse correlation with interest rates.  If rates are raised, bond prices should fall.  Because the new bonds pay more, they are worth more than the older bonds.

But look at the bond chart.  Since 2008, interest rates have been zero, and bonds have been trending up.  Interest rates weren’t going down, they were flat-lined.  Then, interest rates went up a TINY bit early in 2016.  What did bonds do?  Shot to all-time highs.

(Picture greedy investors, rubbing their hands together, cackling, “I gotta get me some of that quarter of a %.  Not!)

At some point, scratching our heads, we might have to venture in to the jungle of “experts,” and seek opinions, amongst the poisonous and predatorial denizens, of hidden interests, biases, regurgitations of degrading signals, and so on.  Seeking knowledge from others is like a whole new set of charts we have to study.

So let’s just look at these charts a bit more.  2014-2016 bonds shot up.  The up move went parabolic in 2015.  That was 6 months after the dollar started its giant run, which went from about Aug 2014-March 2015.  Both had a big orgasmic blow off right at the open of 2015…then stabilized sideways in to big bull flags.

This coincided with the end of the Fed money printing program, that had created $4.5 trillion, and ended in October of 2014,

What happened to stocks at that time?  Their run up plateaued.  And Gold?  It had already fallen, starting at the beginning of 2013.  From mid 2013-the end of 2015, it settled in to a slow downward consolidation (a bullish formation….a bear flag should hit the lowest point first, then slowly grind up.)

What can we glean from all this?

The QE phase from 2008-2014 was huge, historical and unprecedented.  So it’s fair to say, that movements of all these vehicles would be at best analogous to ways they had been powered in the past.

On the charts we can “see” that newly minted QE money flowing in to everything, stocks, gold and bonds.  Even while it only barely supported the dollar (only barely kept the money supply equalized).  We know that some of those bonds were “bought” by the government itself, which could partly account for the general up trend during that phase.

The rest was a transfer of wealth.  Everyone who defaulted on their loans in 2007-08, lost.  Then money was printed, and whoever could get their hands on that money was buying hand over fist, stocks, bonds, gold, etc.

Technical observations

It hurts my head to think so much about “why” things happen.  Let’s retreat for a moment and rest on technical chart patterns, and observe “what” seems to be happening, and about to happen, rather than why.

Technically speaking, bonds appear to be at the top of a channel, and look poised to fall.  This fits with the concept that the Fed actually will raise rates a bit in 2016.  The dollar looks poised to rise out of a bull flag.  That fits too.

If the dollar gets more valuable, gold and commodities “should” be weakened.  Gold is sort of like a giant bull flag, but it is also at down trend line resistance (the trend line: the weakest technical).  It could go sideways in this tightening down trend.  This could be a bull flag that plays out over years.  It’s 3 years old already.  I’ll link this to my 10 year guess on gold.

What about stocks?

The SP500 and Nasdeq are both in very bullish postures.  Everything points up.

The SP500 in July broke out of its 18 month range, and ended the month of July at the very top of the breakout.  And it ended in a giant bull flag, with no excess (tail) on top.  In fact, it made a historical consolidation up here throughout July.

This tiny 20 point range, from about 2150-2170, that lasted for 2 weeks, in the uncharted waters of all-time highs, was historical.  The last time there was this small a range that lasted for that long was in the time of Nixon.  It was a historically boring market!  But it is certainly bullish.

ES 2 pt 2 week range

So, if stocks seem to want to go up, the dollar seems to want up, bonds down, and gold, sideways to up…what would cause this?

My imaginary scenario

The dollar continues to consolidate or drift up through its bull flag through the summer.  The Japanese yen stimulus starts to inflate the yen and drive the dollar slowly higher.  The pound and the euro go sideways or inflate, pressing the dollar slowly up.

Meanwhile, US stocks go up, since that’s what the charts suggest they want to do.  Earnings season has so far been very strong.  The Fed actually does follow through and raise rates sometime in the fall, or by year end.  Around that time, the EU renews QE.  Possibly the Bank of England does something to weaken the pound around the same time.

This is the perfect storm, and the dollar pops to $102 or $104 (which one of those #s has big implications for the future, as I’ve suggested elsewhere.)

The Fed suddenly appears to wake up.  Economic indicators get weak.  A new president comes in.  The Fed not only reverses the rate hikes, but maybe even announces new QE.  The dollar falls.  Commodities pop.

But what about stocks and bonds?

If there really was fresh QE, it should support higher prices in stocks, if 2008-14 is any indicator.

If the Fed reversed interest rate hikes, it would theoretically also support higher bond prices.  Which might also make sense, if bonds had by that time fallen, due to a rate hike in the fall.  They might be, by then, low in the channel, and ready to continue their never ending up channel.

Let’s think this future fantasy through a little further.  What causes the Fed to drop interest rates back to zero, and start printing money again?  And when does this happen?

It’s not just that the dollar hit fresh highs against the Euro, Yen and Pound (and maybe Yuan.)  It’s the fact that dollar strength impacted the economy, and we start getting bad economic #s.

So, let’s say the US economy looks good through much of 2016.  The SP500 goes to $2400 and change.  This is a natural target.  We get it by doubling the range of the past 18 months.

It took us 5 months to climb from $1800 to $2172.  That is almost $400.  We are less than $300 from the target zone.  How long might it take to get there, allowing for some pullback, and consolidation?  It could easily happen in 2016.

ES $2400 target

Supposedly the stock market usually crashes about 6 months before a recession is announced.  Markets fall faster than they rise, usually.  A 20% correction is the technical definition of a bear market.  20% of $2400 is $480.  That takes us roughly back to just sub $2000…which is only back in to the range of this recently familiar territory.

So the stock market corrects sharply from giddy new highs, sometime around late 2016, early 2017, in the time of new president so and so.  The EU is printing money like mad.  The dollar is at 12 year highs.  Oil is still weak.  There are more defaults due to the strong dollar and weak oil.  The Fed “reacts.”

Comparing the current market cycle to others, is the sky about to fall?

One of the bits of news I’ve lately been unable to avoid is, the current economic rally is long in the tooth.  It’s now the fourth longest rally in 100 years, and yet, the economic growth during this phase is some of the weakest ever, with around 2% annual growth.

http://blogs.wsj.com/economics/2016/07/29/seven-years-later-recovery-remains-the-weakest-of-the-post-world-war-ii-era/

And yet, it does not appear to be over.  It’s due to correct.  Not if, but when and how and how much.

It’s novel also in the sense that it has been fueled by this enormous “stimulus” of money printing, and sustained zero % interest rates (as opposed to healthy businesses borrowing to grow, employing people, and that growth paying banks for the borrowing, etc.)

And I can’t shake the thought that, if a recession was severe, and world-wide, and all the central banks have already used all their bullets (they are already at zero interest, or less, and have already printed a bunch of funny money), is that the perfect storm?

It’s easy to be Chicken Little here, and say yes.  It’s too hard for me to say no.  But I’m willing to say, maybe not.  Maybe we can just invent new bullets.  Negative rates.  Who knows how much money can be printed, when it’s the giants of the world doing the printing (the US, EU, China, Japan, GB.)

We can’t compare this scenario to any hyper-inflation problem of the past (Weimar, Zimbabwe, Argentina, Venezuela) since those were much smaller economies.  They were like the ecosystems of Easter Island or the Galapagos compared to major continents.

And it’s not that money creation per se is “bad.”  Good and bad are measures of how it is created.  Ideally it’s created through healthy borrowing of real companies and individuals, driving real productivity.  Governments borrowing it in to existence, to shore up the supply when it disappears because real people and businesses are defaulting is “bad.”

(The governments “spend” it in to the economy by growing programs, paying more of the population to do things in the economically inefficient way governments do things.)

But it’s not black and white.  There is a mix, of good and bad money creation, and constant experimentation.

China has given us lessons in the past 20 years that big countries can seemingly pull off the impossible.  There were predictions of economic implosion in China, way back in the 1990s, when all sorts of debt was going bad.  China simply printed a bunch of money, created shells that bought the bad debt, inflated away its value, and went merrily along its volatile way.

Now Soros and others say it’s going to happen again, and this time China can’t finagle its way out.  But Soros has been predicting a Euro meltdown for years.  He’s a perma-bear.  He famously shorted the Euro zone and the US stock market in the spring of 2016.  Wrong!  He must be down $billions now.

So in terms of trading, even on, or particularly on a macro scale, it’s very hard to say what can or cannot happen.  It could be that the world will become a giant reflection of Japan over the past 20 years.  Maybe it will be a giant stagflation.

Maybe world economies and individual standards of living will be sort of on pause, while we wait to see how robotics and AI will be integrated in to a world economy, driven for 1000s of years by human labor.

How do you trade that?  I wouldn’t want to try.  I’ll stick with shorter time frames for now.  Minutes, hours, days, weeks at the most.  But I certainly find it an interesting time to live, and try to understand.

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