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Wednesday 22 February 2012

Unprintable Money

It really is a funny old world that we live in. The British Pound was hammered overnight when some meeting minutes were released showing that two of the seven members of the British MPC voted for more QE than the others. Why this matters nowadays who knows?

The UK is generally seen as a pillar of fiscal rectitude these days as it is taking steps to rein in government spending and to keep public debt at levels where it might credibly be repaid someday. As a result it has taken quite a bit of criticism from the US and much of the EU, where plans for managing government debt at a sustainable level are being disregarded outside the PIIGS.

On the other hand the UK is currently running deficits of 10% of GDP, and has now printed money to buy UK debt of $350bn, something over a third of all UK government debt currently outstanding. In effect most of the huge deficits run in the last three years have been financed by printing money. That it is seen as a pillar of fiscal rectitude nonetheless speaks volumes about the profligacy of the countries to which it is being compared.

This is the backdrop for the huge bull market in gold that has been running since Gordon Brown, the inept UK Chancellor of the Exchequer, announced in 1999 that he would sell 395 tons of gold, almost 60% of the UK's gold reserves,  in order to buy interest-bearing US treasuries. Those sales were made over the next two years and immortalized his name in the famous Brown (double) Bottom of 1999 and 2001. Gold hasn't looked back since and at today's prices that decision has cost the UK over $20bn so far.

Gordon Brown went on to become an even more worthless Prime Minister in due course, and has a further enduring legacy in the shape of the vast deficits he bequeathed to the next government. He has now retired to Scotland, and commands large fees on the lecture circuit explaining why his disastrous legacy was unforeseeable and not his fault. Perhaps he runs into Alan Greenspan doing the same every so often.

Gordon Brown's argument for selling the gold was that it paid no interest, but nowadays the 0% real return on gold looks very generous, against negative real returns on government debt in the US, UK and others. Central Banks also can't print more gold to debase it, which is a huge advantage against the increasingly debased currencies of the western world, so there is every reason in my view for the bull market in gold to last a lot longer and go a lot higher.

Short term however, gold is at a crossroads. On the daily chart an IHS has formed that would take gold to test the 2000 area if it plays out. It is fully formed now and testing the neckline. There is also a possible double-bottom in play that would target 2100. I've marked both up on the daily chart below:
In the short term though, gold is showing negative divergence on the 60min chart, and may retrace here. I have rising channel support in the 1728 area, and a move below that would set up a short term double-top indicating to the 1650 area. I'll be watching that channel support carefully:
On the equity charts I was watching carefully for a break of rising (sort of wedge) resistance on SPX to see whether the Vix Buy Signal might boost SPX through resistance. That didn't happen and the high yesterday was exactly at the resistance trendline level I gave yesterday morning. The retracement that followed then bounced at the rising support trendline that started to break down last week, showing that trendline is also still in play.

There are two things to note from this. The first is that until that resistance trendline is broken on SPX, this is a topping setup, and the most likely break direction is downwards. The second is that is that these (sort of) rising wedge trendlines are now very close together, and will in fact cross in about a week. The range between those trendlines is less than 10 points now, and getting smaller by about 2 points per trading day. We are extremely likely to see a break one way or the other by the end of this week:
The NQ chart today looks pretty much the same as it did yesterday. The narrow rising channel from the December low is still holding, and strong resistance at 2600 is also still holding. I have the channel support trendline reaching 2600 on Tuesday next week, so as with SPX, we are likely to see a break one way or the other this week:
The Transports chart has been the weakest of the major indices over the last few days, and there has already been an almost 5% pullback from the high there, as well as a break with confidence of rising support from the October low. Looking at the chart this morning though I'm seeing a hit of support from the last significant retracement low, and that has formed the left shoulder and head of a possible reversal H&S. A reversal here would also be on significant positive RSI divergence on the 60min chart. We might well see Transports bounce strongly here to form a right shoulder.

This weakness in the Transports index is also a Dow Theory non-confirmation (so far) of the new highs on the Dow. It is a large non-confirmation as the index is some 9% short of the 2011 high it will need to exceed to confirm the new highs on Dow. Nothing to get really excited about yet in my view however, I've seen these non-confirmations last quite a while in the past before without any serious top happening. Interesting, but as with Vix Signals, often not significant:
EURUSD looks important for immediate direction here, and the obvious direction is up to the IHS target and trendline resistance in the 1.339 area. A bullish pennant appears to be forming that would have a target slightly over 1.34. I'm concerned by the breakdowns on GBPUSD and AUDUSD however, and it may be that EURUSD will go the same way, so I'm watching pennant support in the 1.3215 area and the IHS neckline in the 1.318 area. If EURUSD closes an hour below 1.318 the current bullish setup will be badly damaged and we might instead be looking at a bearish double-top. That bearish scenario is worth considering as more details of the greek 'rescue' are published. Rarely has even an EU plan been so ill-conceived, so dependent on unrealistically optimistic economic assumptions, and so harsh on the electorate on whose strong support the durability of the plan will depend. Failure seems likely to be just a matter of time:
I was accused of being wishy-washy yesterday and I cheerfully admit to that again today. The uptrend is still intact, but so is the strong bearish setup and SPX is now bumping up against both trendline resistance in the high 1360s and strong resistance at the 2011 high in the 1370.60 area. Despite the Vix Buy Signal, the bearish engulfing candlestick on Vix, and the (currently) bullish looking setup on EURUSD, I wouldn't suggest to anyone at this level that going heavily long would be a good idea, and until we see support break again on SPX and break on NQ, shorting this may also have a very unhappy ending.

Overall however I'm still leaning short. Until we see SPX and NQ break resistance, the topping setup I was looking at last week is still very much in play, and it is the bulls that have something to prove here.

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