Market Behavior and Impact on Gold

Market Overview

Markets have rallied very significantly. First burst of the rally was after election till mid-December and the second burst has been from end of January till today. Impressively, our proprietary Market Classification Model remained long stocks during this entire period. Model turned bullish soon after Brexit and has remained bullish since July’16.

Although in the hindsight one can easily say that the market rallied and it was prudent to remain long throughout this time, most of the market participants did not stay long. In fact, there have been significant bursts of pessimism during this rally. For example:

• Brexit induced anxiety
• Election related stress
• Post-election disbelief
• Post Executive orders convolution

However, these kind of market panics are the very reason why this market has been able to rally this far – Market likes to climb a wall of worry.

Now that stocks have rallied sharply over the last two weeks, we are approaching a period of consolidation. Consolidation doesn’t mean a sharp decline rather a period of sideways action like we saw in January, to digest recent gains. A potential scenario is market topping towards the end of February, according to Inflection Point Model and then consolidating till next earnings reports to justify high prices.

Once this consolidation phase arrives, other assets like Gold are likely to outperform.

Gold

Gold has been consolidating for some time. And this consolidation is supported by a series of higher highs and higher lows, which means that the next stage rally could be very significant. Gold also remains in a Bull market and would be an ideal candidate for a continued rally.

Following chart shows Gold performance over the past 2 months, where a steady uptrend is clearly visible.

 

Gold stocks are also tracing out higher highs and higher lows. In fact, following chart shows a potential head and shoulders pattern being crafted out by the Gold stocks. Once this pattern is completed, Gold miners can easily make a run for the summer 2016 highs.

 Latest MCM report included details about Gold’s uptrend and where the trend is with respect to the overall bull market.

Upside potential is further amplified by the fact that Gold performs very well in an inflationary environment and with rising interest rates, we are likely entering an inflationary environment.

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Pre-Federal Reserves and BoJ Analysis

Sideways Action Continues

This week, so far, has been as uneventful as prior week. Yesterday, markets opened higher but then sold-off towards the end to close slightly negative. Today, markets closed slightly positive. Since last Monday, market has gone net sideways without any major directional move.

Following chart shows that today we closed at the level where we close on Sept 9th, when the world was coming to an end and DJIA had just declined ~4%

Markets are like a coiled spring. And it seems like the entire world is waiting for the Central Banks. Bank of Japan is going to announce its policy statement early in the morning, while Fed announcement will come at 2 PM.


Bank of Japan and Yen

From Bank of Japan perspective, they would like Yen to decline because that was the catalyst to push Nikkei higher couple of years ago. Right now, Commitment Of Trader data (shown below) shows that the market is ripe for another decline in Yen, which means that its likely Japan will reduce interest rates further or introduce some sort of monetary stimulus.

If BoJ stimulates the market and forces a decline in Yen, we can expect a rally in the indices.


Technology getting ready for a Break-Out

While the US markets have been going sideways, Nasdaq has traced out an inverted head and shoulders near all time highs (shown below):

These highs are 16 years old and there is vacuum above this level. If this pattern holds, we can expect a sharp rally in the near future. This rally can start in parallel with central banks announcements or it can start after a decline following Federal Reserves announcement. In any case, this is a very positive development for the market.

If Nasdaq can lead the market, we can be sure that the overall market will follow and that the recession talk will substantially subside. According to Market Classification Model, we remain in an uptrend. Uptrend typically results in rallies and market participants find reasons to be bullish even in front of negative news.


Strategy Performance

Our proprietary model has been performing very well so far this year. Even with recent 2.5 month sideways consolidation, model is up 22.1% vs 6.3% rise in SP500. We will continue to monitor the performance of this model and share updates. This model will be available for investors to replicate or invest in towards the end of the year.

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Stock Market Structure

Stock Market and Bond market action suggests that both markets are consolidating. Once this consolidation is complete in the stock market, we should see a rally. 

We discussed about the potential of sideways market action and formation of a head and shoulders pattern on Aug 8th. As of Aug 21, market has traced out the right shoulder. 

Aug 8, 2016

Aug 21, 2016

Now that the right shoulder is almost complete, next step is to analyze the market structure to identify next steps. 

From an Elliott Wave perspective, market is currently in the last wave of the up-move. When we say last wave, it by no means mean that this will end the bull market. Instead, it just means that the current rally phase will give way to relatively large decline.

Recent market consolidation has helped in reducing market participants' optimism over the past few weeks, as evident from recent surveys. This will help in the next short-term rally phase. However, since the market is nearing the end of the larger rally phase which started with Brexit vote, we will see a resurgence of optimism and sharper decline.

In the above chart, a box is placed to show potential price and time range of market top based on Fibonacci relationship and IPM market timing analysis.

Overall market trend remains up. Even if the market declines, it will lead to higher prices till the time Market Classification Model is in Bull territory for the stock market.

                                                                                                                                              

MARKET CLASSIFICATION MODEL
A proprietary algorithm that classifies market conditions i.e. Bull market or Bear market. Currently, this model is suggesting a longer-term up-trend for the US Stock Market. In fact, this model is close to triggering another new Bull trigger.

Bond Market Update and Impact on Stocks -

A very quite week from all perspectives. Even with the Federal Reserves meeting minutes, the overall temp of the week remained slow. All of the major asset classes went sideways. SP500 was up +0.2%, while Bonds were down -0.5%. This kind of market action suggests that last week was very non-eventful and something big is coming-up in the near future.

We have already talked about the next stock market turn window - scheduled for around August 30th. Analysis suggests that the next turn would most likely be a near term top.

Therefore, with a turn window approaching and Jackson Hole summit scheduled for next week, there is a very good potential of market rallying next week.


Bond Market Bear Scenario

Typically if stocks rally, bonds decline. At the same time, bonds have other reasons for a decline. From a technical perspective, bond market is tracing out a bearish pattern. Following chart shows bonds consolidating in a triangular form, after July's sharp decline. Typically, this kind of consolidation is followed by a break in the prior direction.

Another reason to consider this scenario is that blue average can act as magnet on this decline. This decline will have deeper consequences for the entire market for the month of September. We will discuss these consequences in the next post.


Bond Market Bull Scenario

Just to provide a perspective on market action, good investors should also consider all the scenarios. From a bull perspective, market seems to be undergoing a sideways correction in a triangle form. This consolidation will result in an immediate break to the upside.

The problem with this scenario is that, this would mean stocks would go down. However, it seems unlikely because the Jackson Hole meeting and IPM turn window suggest a stock market rally.


Conclusion

A bond market decline and stock market rally makes the most sense. But please keep in mind that Bonds and stocks both are in bull markets, according to our proprietary Market Classification Model. MCM has kept us on the right side of the trade and has resulted in some amazing YTD results in 2016.

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