It’s the time of year for those yearly inane predictions about the year ahead. Here is mine... As an investment, buy gold, precious metals, and precious metals stocks. While there are other potential successful investments for the year ahead, gold, precious metals, and precious metals stocks present the best combination of fundamental and technical qualities that appear to be sustainable over the long term. While some other ideas appear more suitable to shorter term trading opportunities, the trends in gold, precious metals, and precious metals stocks appear to be both secular and strong. Some charts are presented tonight that describe what I mean. 2007 Theme - Monetary Inflation For a host of fundamental reasons, the value of paper currencies are being decimated; and while this can be hidden over the short term with the careful spinning of economic data, market manipulation, and rhetoric, in the long term these factors become less effective. There is a relatively new secular trend that is both clear and decisive. This is the relative price of gold compared to other commodities (as represented by the CRB index) as shown in the long term chart below. As you can see, there has been a fairly benign relationship between the two since the mid-1990s. However, beginning in mid-2005, the price of gold has shot up in a linear and consistent manner relative to the price of commodities. If it were economic growth that was driving the prices of both gold and commodities equally, then a continuation of the long term trading range between the two experienced before 2005 would be expected. The fact that gold has outpaced commodity prices by a wide margin suggests that is not growth, but rather something “monetary” in nature that is causing the out-performance of gold.
While oil and energy stocks are another potential positive theme for 2007, it is not as positive as that of gold. Below is a long term monthly candlestick chart of the price of crude oil. At the moment, oil may be forming the right shoulder of a head and shoulder reversal pattern. However, this pattern is not a valid one until (and if) it is completed. The long term secular bullish trend in oil must be respected. Clearly, the area of about $58 per barrel is an important technical support level for light crude oil.
The long-term monthly chart of gold looks more bullish than that of oil, as gold has been truer to its moving averages and the recent correction appears to have been relatively milder and shorter compared to that of crude oil. I like gold, precious metals, and precious metals stocks more than oil and oil stocks for the following reason. Whereas oil appears to be prone to more meaningful moves (both up and down) arising from fundamentally based news releases, and a lot of moving parts affecting its fundamentals, the force behind gold’s advance – monetary inflation – is both consistent and predictable. And if there are potential “moving parts” that affect the price of gold, practically all of these moving parts tend to be positive to gold’s price. Although a good fundamental case can be made for a long term secular bull market for oil, it is bothersome that slowing growth in the economy of the largest consumer of oil, the US, must reduce demand from oil’s biggest customer. While there are other customers out there to provide increased demand, the dynamics behind oil’s fundamentals are more complicated than that of gold. While I’m bullish on oil and oil stocks; I’m more bullish on gold, precious metals and precious metals stocks.
2007 Theme – Falling Dollar Long term trends deserve respect and so does the long term trend of the US dollar, which is down. This is bullish for gold.
2007 Theme - Interest Rates An important theme of 2007 is the direction of long interest rates. The long bond enjoyed a recent multi-month rally and many an analyst hopped aboard the bullish case for bonds. This case was based upon the Fed reducing short interest rates which was to have a positive effect on the long bond. While the secular trend in interest rates is still down (bond prices up), one cannot ignore that long interest rates may have bottomed several years ago. The chart below of the 30-year treasury yield illustrates the long term down trend of long interest rates. Exactly where you put your trendline is a matter of personal preference; but clearly interest rates are in a secular downtrend. This makes it easy for analysts to jump aboard a bond market rally (interest rate swoon) because they have been mentally conditioned from decades of falling interest rates.
However, the shorter term interest rate chart of the 10-year Treasury note suggests that interest rates may be heading upward. As you can see, in spite of the bond market rally beginning in the spring of this year since mid-2003, the 10-year note yield has made a series of higher highs and higher lows, as indicated by the blue lines on the chart.
In the shorter term, long interest rates appear to be heading higher. Note the bearish position of the 20+ year Treasury Bond ETF. (When the ETF price goes down, interest rates go up.) Wednesday’s positive economic “data” for housing clearly had a negative effect upon long bond prices.
2007 Theme - Housing Bear Market Dirty as it seems, I think that bearish positions against homebuilders makes sense from a value investor’s perspective. The homebuilders are in a secular bear trend which was ushered on with the completion of the head and shoulders reversal pattern late this spring. Since that time with a backdrop of a lot of noise about “scraping along the bottom,” the US homebuilders have rallied back to near the neckline of the head and shoulders pattern. If interest rates head up as described above, this won’t be good for housing or the homebuilders, and the long term downtrend in the US homebuilders is likely to resume.
The similarity between the technology bubble and that of US housing can be clearly observed with the side-by-side view of the long term charts of two of the respective blue chips from each of these sectors – Cisco and Toll Brothers. Clearly each of these stocks has experienced their own stock market bubble. However, whereas Cisco topped near 70 and bottomed at about 8, Toll brothers, less than a year and a half from its bubble top, has not bottomed as of yet. Housing bubble deniers may want to examine the chart of the twin bubbles below.
2007 Theme – Bull Market While considering fundamentals such as valuations and dividends, it’s difficult for me to give the bull market the benefit of the doubt. But as a technician, that is exactly what must be done. The Wilshire 5000 composite, which represents the broadest cross section of the US stock market, is approaching the same highs that it did at the height of a known and accepted stock market bubble.
There is still significant reason to fear this bull market; and this is not just some idle bear’s “wall of worry.” There are cracks in those sectors that reflect economic strength including semi-conductors and transports. Note that the transports have made a series of lower highs, followed by an (imperfect) head and shoulders pattern. It is now rallying back to its neckline on “Home Alone” volume.
The cyclical semi-conductor sector looks similarly weak in the intermediate term.
High P/E stocks generally don’t do well in an economic slowdown. So it is of concern that the Nasdaq 100’s bull market appears to be on its last legs. Maybe this is an early warning, but in the recent past a break of its 20 day price channel signaled a trend change in the Nasdaq 100. On Friday before a light trading volume rally, the Nasdaq 100 broke its 20-day price channel. As with any technical tool, this is not a silver bullet, but rather something to sound a warning that an important multi-month trend may be changing.
Speculative sectors, nanotechnology and biotechnology are also looking technically weak.
Finally, Nasdaq volatility has broken a downtrend….
And S&P 500 volatility cannot go to zero. Can it?
In summary, the clearest theme for 2007 appears to be the bull market in gold, precious metals and precious metals stocks. Other less certain themes include the bull market in oil, US stocks and the bear market in housing and the dollar. Have a great New Year. Martin Goldberg
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