$GOLD:$CRB

The Most Important Chart

by Brian Bloom, Beyond Neanderthal | June 1, 2010

Right now, in my view, the chart below is the most important chart in the book. It is a distilled proxy for investor confidence, world-wide, in the integrity of the financial system.

The ratio of the gold price to the commodities index can be found at http://stockcharts.com/h-sc/ui , courtesy stockcharts.com. When the chart comes up on your screen, enter the following in the space marked “symbol” $GOLD:$CRB

If this chart breaks to new highs (above 5) then it will be evidence of a vote of confidence in gold versus commodities – i.e. that the investment world is no longer viewing gold primarily as a commodity.

Personally, I prefer to view the market from a distance – by making use of weekly and monthly charts. The weekly chart below shows a 3 year view.

One should not try to second guess whether it will or will not break to new highs. Clearly, there is more at stake now than at any time since the World Depression and the world’s Central Bankers will do everything in their power to prevent such a break out.

But one should also recognize that if there is a breakout to new highs in the above chart, then this will likely be accompanied in a breakdown of the Dow Jones Industrial Chart, which is a proxy for underlying expectations of “future” direction of the US economy.

The chart below, of the $INDU (DJ Industrial Index) shows a severely oversold position and the “possibility” that the market may bounce up from here.

The “hopeful” technical indicators on the above chart are:

The RSI oscillator is standing at 36.24 (the market usually experiences support at this level)
The 45 day moving average is above the 200 day MA
The MACD oscillator appears to be wanting to “tick” up

Unfortunately, when one takes a step back and one looks at the weekly chart (see below), one sees a weekly oscillator that is not yet oversold, and one sees an MACD chart which is evidencing a non confirmation of “falling tops” relative to the rising tops in the Index Chart itself.

What this means, (on a balance of probabilities) is that if there is a bounce it will likely be temporary.

On the daily chart of the DJIA, the thing to watch for is a cross over of the 45 day Moving Average below the 200 day MA. If that happens it will probably represent the last “sell” signal.

Once again, one should not try to second guess the outcome here. There is too much at stake. If that sell signal manifests, it will likely represent evidence of the commencement of an unwinding of the entire financial system – for which there is no historical precedent.

In years gone by we could hope for the economy to heal itself in time. Now, because of the humungous amounts of debt and derivatives in the system, there will be no self healing. It will be necessary to tear the old building down and build a new one, from the foundations up and starting with a new energy paradigm/s to replace fossil fuels, the internal combustion engine and coal fired power stations.

The chart below, courtesy BIgcharts.com, shows the same picture as above, but from the perspective of a decade and on logarithmic (percentage movement) scale

Explanation:

I have highlighted the relevant non confirmation of rising tops in the Index Chart and falling tops on the MACD oscillators (MACD = Moving Average Cumulative Differential – which reflects the distance between the 12 week and 26 week Moving Averages, in this case). When the blue line is pointing down, it shows that the 12 week MA is approaching the 26 week MA (bearish). By contrast, if the blue line is pointing up then it shows that the 12 week MA is approaching the 26 week MA on the upside (bullish).

When the blue line crosses over the red line (the 9 week MA of the Blue line) it reflects a technical sell signal if this happens from an overbought situation – which, in this case, it did a few weeks ago – AND FOR ONLY THE THIRD TIME IN TEN YEARS. (I drew the reader’s attention to this when it happened at that time). The previous times were:

In 2004. This was followed by two years of sideways movement on the Index itself
In mid 2007. This was later followed by the market crash of 2008
A few weeks ago.

Arguably, to use a baseball analogy, a few weeks we witnesses “strike three”.

The reader’s attention is now drawn to the red line of the RSI oscillator. This oscillator is more meaningful when one looks at its peaks and troughs (a peak is typically followed by a pullback and a trough is typically followed by a rise in the mother indicator – in this case the Industrial Index). In this case I want to draw the readers attention to the fact that the index recently penetrated below the horizontal halfway line between the peak of 80 and the trough of 20. Of course, it might bound up from here (because it is oversold) or it might continue going (because a downside penetration shows relative weakness). Because of “strike 3”, in my view, the odds favour a continuation of the downside.

Having said all this, it cannot be stressed sufficiently strongly that one should not try to second guess the outcome here. There is too much at stake. However, whether you should be invested in the market is a whole different question. Based on fundamentals, the market is overvalued. Investors should not be invested in anything other than special situations.

Now, just by way of a reality check, one should bear in mind that the above is all in respect of investor expectations of the future.

The chart of the Baltic Dry Index below (courtesy http://investmenttools.com/futures/bdi_baltic_dry_index.htm ) reflects what is actually happening regarding the tempo of world economic activity. The Baltic Dry Index appears to be encountering some resistance at the first yellow line (the June 2009 top) and still needs to overcome the resistance of the second yellow line (the November 2009 top) before anyone can claim that the tempo of “actual” business activity is in a confirmed rising trend.

In clear language, if the Baltic Dry Index rises above the second yellow line then this will represent confirmation that the “green shoots” flowing from Central Government stimulation following the September 2008 crash have taken root. By contrast, if the Index falls below the rising dotted trend line, it will very likely indicate that the central government attempts at stimulation have failed.

Based on my understanding of economic theory, there was never any question: The attempts at stimulation were never going to succeed. They were implemented against a background mindset of politicians attempting to protect their entrenched power positions and the positions of the financial and industrial backers.

Conclusion

The party is over. However, the fat lady has yet to sing. If, in your cups, you insist on hanging around to hear the fat lady sing then you may still some dregs in the punch bowl. But, typically, there is no fun in that. It’s better to go home and sober up. There is a lot of repair and reconstruction work to be done before we can start thinking about our next party.

Contact Information

Brian Bloom | Beyond Neanderthal | Sydney, NSW, Australia | Email | Website