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FUNDAMENTAL VS. TECHNICAL ANALYSIS AND MORE

We all hear these terms “bandied about” in the financial press with regularity, but how many of us really understand the differences between the two?

With us now approaching year’s end, here’s a small primer that I hope you all find relevant.

According to investorwords.com – technical analysis is,

A method of evaluating securities by relying on the assumption that market data, such as charts of price, volume, and open interest, can help predict future (usually short-term) market trends. Unlike fundamental analysis, the intrinsic value of the security is not considered. Technical analysts believe that they can accurately predict the future price of a stock by looking at its historical prices and other trading variables. Technical analysis assumes that market psychology influences trading in a way that enables predicting when a stock will rise or fall. For that reason, many technical analysts are also market timers, who believe that technical analysis can be applied just as easily to the market as a whole as to an individual stock.

First, we might all do well to consider why folks bother with technical analysis in the first place.

This is perhaps best explained if one stops to consider that virtually all market activity is prompted by GREED and FEAR or simply put – emotion. Most folks would agree that when acting in an “emotional state” – one’s actions can be, at times, regrettable. From an investment perspective, what technical analysis attempts to do – with its heavy reliance on interpreting data - is to remove the emotional aspect of investment decisions.

Folks should understand that there are different disciplines that fall under the “umbrella” of technical analysis; Dow Theory being one of the more prevalent and a discipline espoused by Financial Sense’s Tim Wood – proprietor of Cyclesman.com. Another one of Financial Sense’s technical experts is Frank Barbera. While Frank is a self described “technician at heart” – I would describe his approach to markets as being more of a hybrid approach than that of Tim Wood. Any regular listener of the Financial Sense Newshour with Jim Puplava would be more than aware that Frank has a complete grasp of Dow Theory – but also tends to co-mingle / blend this approach with his knowledge of “another branch” of technical analysis – Bollinger Bands.

Readers should be aware that there are other approaches that fall within the broad stripe of technical analysis – Momentum and Moving Averages being just a couple of them.

What Jim Puplava does so well in the Financial Sense Newshour is to bring these technical disciplines together and blend them with fundamental analysis to provide his listeners with a comprehensive “real time view” of the investment landscape.

The important thing to take away is that practitioners of technical analysis believe that disciplined adherence to charts and data produce consistently superior results in the long run.

According to Investopedia.com, fundamental analysis is,

A method of evaluating a security by attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and individually specific factors (like the financial condition and management of companies).

As Investopedia goes on to say, fundamental analysis’s goal is to identify a value that an investor can compare with the security's current price in hopes of figuring out what sort of position to take with that security (underpriced = buy, overpriced = sell or short).

Regardless of Discipline, Any Analysis Is Only As Good As It Inputs

For those of you regularly read my market commentaries, you’re probably aware that my focus is highly skewed toward fundamental research – but with what many would call a conspiratorial twist.

Here’s Why:

You see folks, when I look at a chart like the one below – denoting trade in the Euro / U.S. Dollar from this past Friday, the “precipitous instantaneous drop” in the value of the Euro [appreciation of the U.S. Dollar] over 2 minute time span raises red flags:

The first of these red flags is that “in technical terms” the sharp Dollar appreciation is a counter trend move. The bias over the past few weeks has most definitely been for the Dollar to move “lower” not “higher.” This sharp, pronounced retracement begs the question, “What’s changed?”

The second red flag is that from my 20 + years experience in financial markets – extremely pronounced moves in “any market” - like the one pictured above virtually always happen as a result of “unexpected breaking financial news.”

On Friday, there was no “unexpected” financial news of any kind. Instead, at approximately the same time as this “price spike” – Treasury Secretary Hank Paulson reiterated a “stock” line [one relentlessly preached by his predecessors for the past 10 years] to the effect that a strong U.S. Dollar is in the best interest of the United States and, as such, he is a proponent of a strong Dollar.

Let me assure you, this pronouncement was neither “breaking” nor “unexpected.” The apparent market reaction to this did, however, SMACK of Official Intervention [Central Bank buying of U.S. Dollars].

I bring this to your attention because folks of my persuasion believe that monetary officials conduct interventions like the one above to “paint charts.” Heck, even prominent pundits like letter writer / commentator Harry Schultz acknowledge that the practice occurs,

Schultz, never afraid of a radical idea, takes manipulation seriously. He says: "It is fairly easy to manipulate stock indexes via just three or four blue chips, and the multinationals appear in several indexes. We've seen it before. Most stock markets were in virtual free fall and suddenly reversed into reverse head-and-shoulders buy patterns. This is a rarity. The U.S. dollar index may also be subject to manipulation."

Manipulations such as this suspected “direct intervention” at critical points can and do tend to “herd” market technicians into a specific direction – regardless of fundamentals.

The Subtle Side of Molding Market Sentiment

Other times, manipulations are more subtle. An example is illustrated from my correspondence with this particular financial reporter just this past Friday. I make specific mention of this because this particular piece has actually made it onto the front page of the business section of one of Canada’s major daily newspapers today, December 11, 2006:

The piece in question was reported Friday by MarketWatch:

By Steve Goldstein, MarketWatch
Last Update: 8:50 AM ET Dec 8, 2006

LONDON (MarketWatch) -- Worries about the strength of the global economy pressured the metals sector in London share trading Friday, though a solid report on U.S. payrolls growth and speculation of banking takeovers helped lift shares of other top British companies.

Merrill Lynch downgraded the entire metals sector to neutral on economic-growth fears and concerns about the manipulation of metals prices. …

So I contacted the author:

Mr. Goldstein;
Could you elaborate on Merrill's comments about manipulation of metals prices?

"Merrill Lynch downgraded the entire metals sector to neutral on economic-growth fears and concerns about the manipulation of metals prices

Here was the response I got:

I'll quote what they said:

Our view is that spot metal prices have been pushed to over-inflated levels by hedge / investor fund manipulation (eg 1 investor holding >50% LME Al stocks), and that there is a much greater risk to the downside from spot prices than to the upside. With slower global demand growth likely in 2007, particularly in the US, and a likely de-stocking of metals inventory in the G7 after a very strong demand growth in 2006, the risks are that base metals prices could correct ~30% from current spot levels, and this would negatively impact the equities. We continue to believe in the super-cycle, that metals prices will be stronger for longer; however, this means stronger than long-term average prices, not stronger than current spot prices. History shows us that no matter how much we believe that weaker commodity prices are already factored into equity prices, if the commodity prices re-trace, the equity prices of leveraged stocks follow. Whilst metals prices have outperformed the equities on a 12-month view, over the last 6 months, global mining equities have outperformed the LME index. In fact, as seen by the Bloomberg World Mining index in the margin chart, equities have been moving higher in recent weeks and have recovered much of the sector pull-back that occurred in early November. The laggard has been the AsiaPac mining index. However, we remain convinced that if the metals prices do see a correction from current elevated spot positions, equity prices will also correct. It is amazing to us that despite statements that liquidity will continue to flow, when sentiment

So I replied with this;

Steven;
I wonder if you bothered to question them about "a likely de-stocking of metals inventory in the G7 after a very strong demand growth in 2006."

The reality is that de-stocking of base metals HAS ALREADY OCCURRED!! - witness the all time critical lows of copper, aluminum, lead, zinc and nickel in LME warehouses.

Before "DE-STOCKING" can occur in the future - INVENTORIES HAVE TO FIRST BE REBUILT.

Rebuilding of critically low inventories would CONTRADICT this forecast - wouldn't it?

Regards,
Rob Kirby

And Mr. Goldstein then replied with this;

You may well be right -- we pass on the news, leave it to you to accept or reject.
Cheers, Steve

The HUGE Issues Here

First, these "allegedly professional" mega financial institutions sometimes put forth fundamentally FALSE and often CONFLICTED research for unknowing, unsuspecting consumers and - Second - the media so often takes this false and / or conflicted research, asks few questions as to its veracity, and presents it to the public as "NEWS" and then – only if pressed / questioned or cornered – it’s like we’re "all free" to accept or reject what they report as news.

Whatever happened to responsible journalism where errant reporting led to a retraction and an apology?

I bring all of this to your attention for a few reasons. First, a general understanding of the differences between technical and fundamental analysis gives investors greater clarity in deciphering the blur or hype of economic reporting in today’s market place. Second, regardless of which discipline you’re an adherent of – your results will always be dependent on the quality of inputs or soundness of your assumptions. The lesson here is ‘be careful who or what you hitch your wagon to.’

Remember; there’s no such thing as a dumb question when it comes to your investments. Knowledge provides comfort and it’s the basis of power!

Because events like the ones described above have a great influence on what happens to your investments on a day to day basis, understanding what is affecting your investments and sometimes WHY – might just lead to a greater comfort level and a better night’s sleep!

Today’s Market

Overseas equity markets began the week on a positive note with Japan’s Nikkei Index adding 110 to close at 16,528. North American markets also began the week on solid footing with the DOW ahead by 20.99 to 12,328.48, the NASDAQ up 5.50 to 2,442.90 and the S & P adding 3.20 to 1,413.05. NYMEX crude oil futures ended the day off .81 at 61.28 per barrel.

Interest rates eased a few basis points across the curve with the benchmark 2-year note ending the day at 4.67%, the 5-year at 4.50% and the 10-year note at 4.52%.

On foreign exchange markets the U.S. Dollar Index lost .20 to close at 83.10.

The precious metals complex shook off early losses to end the day higher. COMEX gold futures ended the day up 3.00 to 631.30 while COMEX silver futures gained .08 to 13.93 per ounce. The XAU Index added 1.35 to 144.44 and the HUI gained 3.12 to end the day at 348.15.

On tap for tomorrow, at 8:30 a.m. Oct. Trade Balance data is due – expected -62.0 B vs. prior -64.3 B. Then at 2:00 p.m. Nov. Treasury Budget data is due – expected -73.0 B vs. prior -83.1 B. At 2:15 p.m. the FOMC is due to announce their decision on short term interest rates and publish their latest policy statement which market pundits will no doubt scrutinize with their usual aplomb.

Wishing you all the best of the season as well as a safe and pleasant evening!

Rob Kirby

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