Structural Analysis of Gold

Gold has been declining for the past 2 months. Gold spiked after Brexit vote but since then it has gone sideways.

Above chart shows that the Gold bottomed at the end of 2015 and then rallied for more than 6 months. After topping in early July, Gold went sideways for 3 months before undergoing a sharp decline at the beginning of October'16.

However, interestingly, latest decline has just completed a 3-wave corrective structure in Gold. 3-wave corrections represent that the primary trend remains intact and we are just experiencing a minor pull-back in the asset.

A similar pattern is visible in Silver. But Silver is sporting a much more clearer structure. Recent correction was clear 3-waves with a triangle in the middle. 

Furthermore, Silver is sporting a series of 1s and 2s which means that a big rally is coming in the Silver market. And when Silver starts to rally hard, it is a good time for Gold to follow.

Now that the Gold and Silver are showing that they are undergoing correction in broader uptrend, let's look at the Gold stocks. Gold stocks have rallied amazingly since the beginning of this year. Almost 200% rally from January bottom in GDX. Recently, they have also undergone similar correction over the past few months.

Following chart shows the performance of gold stocks:

Gold stocks clearly show a 3-wave decline, which means that this is just a correction and primary trend will resume soon.

Overall, the trend remains up in precious metals as shown by the market structure analysis. Market Classification Model also remains in a bull market for Gold. Therefore, we are very close to a bottom of this correction in Gold and will soon see a resurgence in the yellow metal.

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September Performance Recap

September was a volatile month in the markets.

If you look at the SP500 chart, it has been going sideways and frustrating many market participants.

As we mentioned in the last post, pretty much all the major asset classes have experienced sideways action over past month.

2016 has been a volatile year so far with markets declining sharply in Jan and February, followed by a nice rally. During these volatile times, our proprietary strategy has out-performed the SP500 by 16.3%.

SP500 Performance (Jan - Sept) = 7.8%
Conservative Strategy (Jan - Sept) = 24.1%

Cumulative performance since January in relation with SP500 (total returns) is shown below:

Monthly Performance: 

Following chart shows monthly variation in performance.

Model is agile enough to take advantage of trend changes and re-allocate in strategic positions prior to big market moves.

All of these returns are for a portfolio whose current Beta is 0.32 and whose YTD Beta is -0.57, which means that these returns are totally uncorrelated with the market. Therefore, portfolio has a very high Alpha.

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September 2016 - Market Recap

September was a volatile month for all asset classes, as it started with a sharp decline in Stocks, Bonds and Gold. We will discuss these assets below and will leverage this information for October forecasts.

However, need to highlight that last IPM turn window was scheduled for September 26th. Market has made a bottom on September 26th and it's possible that we will see a sharp rally in the next few weeks. We will share details on the IPM turn window in next couple of posts. We are already positioned in our aggressive IPM based strategy to take advantage of this date.

Bonds

• Since the start of September, Bonds experienced severe decline
• Decline brought out the bears, as expectations of an impending FED rate hike increased
• The decline was so severe that at one point, TLT has decline -4.4% by mid month
• This decline was followed by a sharp rally to near break-even levels for the month
• In summary: A lot of volatility but no real action / direction, which is apparent from following chart

Stocks

• Stocks opened September slow but soon after the long weekend and on the heels of a strong jobs report took a nose dive

• Even though the low that was made in early September still holds as the low for this correction, stocks' sideways gyration pushed many investors out of the market till the end of September.
• Fed did not raise the interest rates and their expectations saw a sharp decline, which suggested that the stocks can rally further
• Decline in optimistic sentiment has allowed us to consider this sideways action as consolidation before next move higher.
• Following blog posts were published in September on stocks:
• Sideways Consolidation nears End on 9/30
• Inverted Head and Shoulders pattern abound on 9/29
• Correction Complete - Approaching Vacuum on 9/22
• Technology getting ready for a Break-Out on 9/20
• Interesting 5 days in Stock Market on 9/15
• IPM Model Review on 9/7
• Overall these posts have been spot on in regards with the overall trend of the market

Gold

• In contrast to Stocks and Bonds, Gold started with a sharp rally. However that rally fizzled out
• Since then, Gold has been going sideways. There are two options for the Gold in the month of October:
1. Gold and precious metal complex has already bottomed and will soon rally to new highs
2. Gold has traced out a triangle and will decline in October, to mark a bottom
• Both of the above scenarios suggest that the metal will be higher in future months. The question is whether it will take a detour to lower prices before rallying

Summary

• Consolidation is the name of the game
• Overall SP500 gained +0.02 %, Bond lost -1.7% and Gold gained 0.7%
• We will soon see a well-defined trend but volatility might continue till Presidential elections in November.

Upcoming Blog posts:

1. Strategy Performance - September recap
2. Forecasts for October
• Stocks - Elliott Wave and IPM Model
• Bonds - Structure and relationship with stocks
• Gold - Long-term targets and patterns
3. Performance of Options strategy based on IPM Model

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Benefits of Model - Part 3

With Federal Reserves not raising the interest rates and Bank of Japan maintaining negative interest rates, the markets are primed for some interesting action. At this point, one must ask:

• Why is the Fed so uncertain? 

• What are they seeing that even with stock market (SP500 and DJIA) near all time highs, they are not willing to increase the rates?

We know that the economy is not very strong. And it is a good decision from the Fed to not raise rates. However, what type of signal will it send to the investors? Is it time to be wary of the stocks as the economy struggles or is it time to get aggressive?

The question then becomes, even though the Fed has maintained the interest rates for now, how long can they maintain this posture? Will they not increase the rates on the first sign of strengthening economy? In that case, if the May jobs report comes in very strong, which is expected based on last week's extra-ordinarily strong weekly claims data, will that push Fed over the edge to raising rates at June's meeting?

In short, there are so many questions on the fundamental side. Similarly, from a technical perspective there are also several questions. At this time, the best strategy for any individual could be to stay out of the market and wait for the market to show its true direction, which could result in a delayed entry into a good long/short position. Or follow a system that takes out emotion from the investments. Since we have been using the Portfolio Enhancement Algorithm since the start of 2016, we decided to analyze the Q1' 2016 performance.

In the last few blog posts, we have discussed the benefits of Portfolio Enhancement Algorithm based in 2016 based on real-time performance with real money (as of April 12th, model was up ~9%, while SP500 total return index was up ~2.5%. 
Following are some additional benefits that we realized by using the model during Q1' 2016.

1. Benefits of the Model - Part 1
2. Benefits of Model - Part 2

5. Trend/Momentum following ability

Model offers the ability to utilize two of the most basic concepts of investments that help investors in the long run. In fact, hedge funds, which made a lot of money in 2015, were momentum following hedge funds. These funds realized that oil price decline had strong momentum and therefore, continued to hold short positions in oil.

As long as one can stay with the trend, investments pay off in the long run. My 8 years of experience in the financial industry has confirmed the adage that "Trend is your Friend." If a person tries to fight the trend, it’s possible that he might make few good trades but in the long-run the investment account will suffer. 

Although there are indicators and analysis techniques that allow a person to identify potential areas of trend changes and market timing, there is no Holy Grail. Therefore, the best option for investors is to stay with the trend. While staying with the trend, it’s imperative to have risk management facets to guide one about potential upcoming changes in the market structure.

This is similar to regular health checks that one undergoes to see how a person is doing internally. If one doesn't do health checks, they won't get a forecast of what is going on inside his/her body. As a result, it can be too late when one reacts to the new developments. In order to mitigate such risks in the investment world, this model has in-built risk management and market health check mechanisms.

6. Positioning for Next Market Move 

Another key aspect related to risk management and market health check is the ability of the model to position for the upcoming move in the appropriate area. It’s always critical to position one's portfolio before a move happens rather than reacting after a move has started. This not only reduces the stress, but allows one to establish a good position

Since majority of portfolio gains occur at the start of a new rally phase, if a person waits for the rally to begin, they might miss on the lion share of the move. On the other hand, if a person enters too early they might sell before the move actually starts. As a result, it’s always critical to correctly position the portfolio for next moves and have confidence in the allocation.

This is another huge benefit of this model that it allows us to position the portfolio for an upcoming move without taking too much risk and ensuring enough diversification with risk management perimeters. As a result of these benefits, this model can be applied in any portfolio and can be used with leverage to compound returns.

As an example, the model allowed us to position in such a way that we benefited from the Jan/Feb 2016 market decline and then allowed us to mitigate losses through accurate positioning in March, followed by sharp gains during the last week of March and first week of April.

• Buy and Hold features
• Quantitative benefits:
• Beta
• Sharpe Ratio
• Alpha

Bonds Bull is Roaring

We have been discussing stock market's #Bear and Bond market's #Bull for a while. Now it seems like Bond market is really taking-off. This is evident from a sharp rally in the bonds over the last 2 weeks. Some might attribute it to the declining stock market but a bull market keeps on rising and people find reasons for the rise.

As a confirmation of the trend, bond prices have just completed an inverted Head and Shoulders pattern (shown below):

We have been discussing this pattern since December, as following charts was published here on December 21.

As bonds rally and stocks decline, we are short stocks and long bonds. Being long bonds gives us cash flow in form of dividends and being short stocks allows us to take advantage of the downside.

Like any market, this bond rally will come across obstacles but the constant cash flow and the diversification provided by this investment is invaluable, along with the potential for capital gains. At the same time, it will provide a very good opportunity and probably the last opportunity for people to buy homes at very low interest rates.

As market gets more volatile, it will even make more sense to invest in bonds. But the good time to invest in any asset class or stock is before the major move happens and the news becomes public. Let's see when the stock market bounce happens, which might provide added insight into the long-term (6 months to 1 year) market trajectory.

After all is said and done, there will be a very good opportunity to buy stocks down the road.

New Year and the Stock Market

Happy New Year. Although today is the first trading day of the year, markets opened at negative 300. From a such a negative opening its very hard to make a come back and close in the positive territory. And market declines on the first day of the year, odds of a losing year are at 50% based on historical data (link).  

At Understand, Survive and Thrive, we suggested that the market has undergone a trend change back in September (link).  However, we suggested that shorting opportunity is not here, and we should wait for a market rally. Experience shows that markets rally after a sharp decline for two reasons:

1. To entice weak hands into the market as buying opportunity
2. To shake shorts who were early to the game

Once the mood changes, markets start their decline phase, which is persistent. At this point, the possibility of a prolonged decline has increased sharply. In fact, several of the high fliers like MSFT, NetFlix and others are down big today, which shows that the leadership is now leaving the market.

This is also evident from the structural integrity of the market. Stock market patterns can provide very valuable insights into the performance of a particular stock or the over all market. We discussed in December (link) that the market is tracing out a Head and Shoulders pattern, which symbolizes potential trend changes. That pattern is still in plan. But now another Head and Shoulders pattern is visible in Nasdaq (shown below).

Once this pattern is completed, which is almost complete, we can see a sharp sell-off to the downside. This could take the prices down to prior base level i.e. potential 6%+ decline from current levels.

One might ask what can cause such a decline. Although there are many reasons that we will read in the news for today's decline, earnings will be the primary driver, which start in 2 weeks. As economy weakens, earnings will dwindle and stock market will follow. So in the situation what an investor must do?

Following are some of the strategies that we are applying to navigate through this situations:

1. Invest in assets that are in bull markets (Bonds)
2. Exit longs from stocks
3. Short indexed ETFs with predefined mix of diversified assets and risk mitigation startegies
4. Keep powder dry for upcoming bull markets in other asset classes

 

Fed Decision and its Impacts

After 6 years, Federal Reserves raised the Fed benchmark rate. While on one hand it signifies the fact that the underlying economy is doing well because of which Fed increased the rates, it also suggests that the market should embrace the new normal i.e. upcoming higher interest rates. Higher rates can impact many different walks of life ranging from savers to home owners.

Higher rates mean lower bond prices and could impact:

1. Home buyers
2. Credit Borrowers
3. Real estate investors
4. Savers
5. Equity investors
6. Bond investors

Although one can write separate blog posts for every individual class, the major theme will revolve around increased cost of credit. With increased borrowing cost, it will get difficult to buy homes, borrow for credit card purchases, borrow for investments in real estate or other venture, thus reducing the flow of money in the economy.

It will also encourage corporations and individuals to save and at some point make equities less appealing, as they will be able to get higher rates without added risk. Please don't get me wrong - savings are the engine of long-term economic development, while spending helps in the short-term.

Since the rates and prices move in opposite direction, rate increase by Feds means that bond prices will decline. However, contrary to this simplistic idea, UST's proprietary bond market analysis suggests that longer term bonds are still in a bull market. It is one of the 3 primary asset classes that is in a bull market.

Therefore, bond investors should not be scared by this Fed hike. Bonds will continue to do better for some time. This also flows well with our discussion on objective trend following, in the last blog post. Objective investing requires one to analyze asset classes holistically rather than event based analysis. And at this point, holistic picture based on proprietary indicators is suggesting that the bond market will do better. This could mean:

1. Stocks are going to perform poorly to push interest rates down even with fed hikes
2. Fed fund rate hikes will be in contrast to economic reality, and could result in yield curve inversion

Both of the above scenarios are bad for economy and investors. In the next few posts, we will discuss:

Detailed discussion on potential causes of bond yield decline even with Fed's increased rates

Alternative investments, according to their state - Part 2

Elliott Wave analysis of current stock market

Asset allocation options

Tax implications 

Revisiting Objectivity and market trend

Let me know if you think the best time to buy homes is about to come or has already passed?