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I've made a few references recently regarding the divergence of falling crude oil price and rising imports. Let's now take a look at the retail gasoline. On Chart 1, you can see the spike in retail gasoline price and the sharp decline in demand at the end of August and the beginning of September as a result of Hurricanes Katrina and Rita's disruption and destruction. However, the demand has since been on the rise, but the price continues to fall. The demand has risen to 9.231 million barrels per day while the average regular gasoline price has fallen to $2.38 per gallon. The demand and the price have thus formed a mirror image, or an inverse correlation, after mid September. We all know that the price is determined by the law of supply and demand in a free market. Assuming we're in a free marketplace, unless excessive amount of gasoline supply has been pumped into the system, rising demand usually drives up the price. Let's check up on the gasoline supply next.
The supply of gasoline comes from either the imports or the production. Looking at both the imports chart (Chart 2) and the production chart (Chart 3), we see the spike in imports and the sharp decline in production occurred at about the same time, at the end of September and the beginning of October. It's self-evident that the increase in imports during this period was to make up for the temporary production interruption caused by the hurricanes. They offset each other. Other than this variance, there's no discernable change in the gasoline supply. The imports have since dropped back down to 1.131 million barrels per day, and the production has returned to the 3-month average production level of 8.5 million barrels per day. Hence, we have the anomaly of rising demand and falling price with little change in supply. This divergence serves as a non-confirmation of the current gasoline price downtrend. And, just like all other divergences, sooner or later, it has to be resolved.
Next, let's take a look at the correlation between the retail sector and the mortgage refinancing volume. Since there's been no meaningful increases in the real disposable incomes, we're well aware that the strong consumer spending comes primarily from extracting equities from their homes through cash-out refinancing. The retail industry has the propensity to move in the same direction as the mortgage refinancing volume. But divergences do happen from time to time. So far, there have been 3 such divergences in the second half of 2005. Chart 4 shows the refi volume (red curve) has been in a downtrend since June, and so has the Retail Holders (Stock Symbol: RTH). However, there were 3 occurrences where the RTH strayed from this positive correlation. Each time it led to stock market sell-off. RTH was peaking in July while the refi volume was "slip-sliding away". RTH topped out on 7/25/2005. The Nasdaq topped out on the following Tuesday and started its triple-digit fall the day after that, on Aug. 3, 2005. On Sep. 6, RTH and the refi volume went their separate ways again. A week later, the Nasdaq was on its way to losing more than 90 points. Over the last 2 weeks, the weekly refi volume dropped 2.8% and then 3.4% respectively, according to Mortgage Bankers Association, yet the retail sector rallied. So, will we see a three-peat of the Nasdaq decline starting this week? It's quite likely. The recent retail sector rally isn't just diverging from the refi application volume; it's also diverging from some of its own technical indicators.
One of the technical indicators that shows such negative divergence is the MACD. This 11-day 15-minute intraday chart (Chart 5) shows the divergence between the uptrend of RTH and the downtrend of its MACD. Friday's high of the Retail Holders was not confirmed by the MACD. By the way, I removed the histogram and the 9-day signal line from the MACD just to clean it up and make it more visible. In any case, the retail sector's not the only one that shows technical divergences. The DJIA (Dow Jones Industrial Average) and the S&P have also had their share of the divergences. I've already written about the DJIA in my regular Thursday Update. Let's take a look at the S&P.
This 15-minute 11-day intraday chart of the S&P, too, shows similar divergence between the price and the MACD (Chart 6). I can go on with a few more examples, but I'm sure the point has been made here. With the abundance of non-confirmations in various areas of the financial market, a major reversal of the current state of the market seems inevitable.
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