Friday, November 20, 2009

Dollar doomed? Not so fast

If you ask the average Professional Trader/Investor their opinion on the Inflation/Deflation debate, chances are they will tell you we are headed into a period of hyperinflation, Gold is headed to $5,000 an ounce, and the U.S. dollar is done for. This is evident by the EXTREMELY bearish sentiment numbers on the U.S. Dollar, and the EXTREMELY bullish sentiment numbers on Gold. Very few traders think the dollar is putting in a major bottom and commodities and equities are putting in a major top. This extremes in sentiment to one side of the trade is precisely why I take a contrarian view. I do think the dollar is currently in the process of making a significant bottom. This is supported by both the technical and fundamental aspects of the U.S. Dollar. Fundamentally, what we saw last Fall (2008) was consumers and businesses deleveraging, going into conservator ship mode. The credit markets were almost completely frozen, and debtors were racing to find dollars to pay back their creditors. In order to accumulate dollars, people had to sell their assets, and buy dollars. This simple supply and demand relationship sent asset prices plummeting and the value of the U.S. Dollar soaring. It does not seem to me that this process of debt retirement is finished. Essentially, for so many years, consumers have been short U.S. dollars (borrowing in U.S. Dollars). When the dollar is weak, and asset prices are on the rise in terms of dollars, the music in musical chairs is still playing, and the consumer can continue to borrow at low interest rates and withstand a substantial sum of debt on their personal books. However, when asset bubbles (in the most recent case the housing bubble) pop and the music stops, prices and asset values plummet, and people start to pile out of the "Short Dollar" trade, essentially "covering their shorts" by selling their assets in order to pay their debt. The fear that ensues in markets after asset bubbles pop act like a domino effect. Prices fall, which induces more selling, which in turn causes prices to fall further. This process is completely necessary to rid the system of excesses. However, in doing so, there is a substancial CONTRACTION in the money and credit supply, thus leading to DEFLATION, not inflation. Inflationists will argue that the fed can always just print more money and keep the money supply up through that method. It is true that the fed can print as much money as they want, but I think a fundamental issue that people miss about the Inflation/Deflation debate is the fact that you can lead a horse to water but you can't make him drink. Bank credit has contracted since the March bottom in asset prices, and this implies that banks are unwilling to lend. The money is not getting out into the economy, and even the supply of money that is added, is dwarfed by the volume of credit destruction, or in other words contraction. I also think people commonly mistaken the definition of inflation. They think it refers to the supply of money in the economy. In fact, M3 is determined by the supply of money and CREDIT, and what we have seen these past few decades is credit inflation, not monetary inflation. With Banks leveraged up 30:1, 29 dollars of credit was created for every dollar deposited by a saver in a Bank. While other banks were not as leveraged, there still was credit being created out of thin air. What started in 2008 is what I believe to be a multi-year process of debt retirement, deleveraging, credit contraction, and thus DEFLATION, not inflation, as many people argue. After the system is cleaned out of all its excesses, can there be inflation and thus reason to worry about the dollar? Absolutely, but all the talk of the dollar losing its reserve status and losing all its value is most likely off by a few years. Consider the Stock Market bottom in early March. Nobody wanted to buy stocks when the Dow was trading at 6,500. Everybody was talking about the Dow going to 5,000, more layoffs, bankruptcies, and the complete collapse of our economy was not out of the question in the minds of most. Of course, none of that happened, and the stock market has rallied 50%+ since. Now all of a sudden stocks are attractive again, and complacency has returned to Wall Street, specifically in commodities. It is this extreme level of bullish sentiment, that convinces me commodities are due for a reversal in the near future, possibly after a blow off top in Gold, just like we saw in Oil in the Summer of 2008, when it hit $147, only to crash to $35 by the end of the year. The "gloom and doom" pessimism that existed in the stock market in March now exists in the dollar. Consider this daily Chart of the U.S. Dollar Index a measure of the value of the U.S. dollar against a basket of currencies. From a technical perspective, momentum on the downside has clearly been waning, and the Dollar looks just as attractive at these levels as stocks did in march; To a contrarian, that is.

Friday, November 13, 2009

Hello! I am new to blogging and am an an avid follower of Elliot Wave Theory, a Theory Devised by Ralph Nelson Elliot in the 1930's, which proposes that Financial Markets move not in random patterns, but rather in defined fluctuations called Elliot Waves. The theory and its implications I find are quite interesting. Consider my write-up:

Elliot Wave Theory and Robert Prechter’s theory of Socionomics: A Question of Causality

Robert Prechter, CEO of Elliot Wave International, a financial market forecasting firm, has devised a theory called “Socionomics”. One may hypothesize that markets and trends in society move in random patterns and are impossible to predict. More importantly, people say that news (i.e. failing banks, news of contracting economy) forms trends in the market. Robert Prechter would say otherwise. Instead, he believes that Social Mood governs trends in the stock market as well in as in society in general, but more on that later. The basis of this theory is, in my opinion, simply astonishing and more interesting than any theory I have ever come across. Let me start by explaining Elliot Wave Theory, a form of market technical analysis. Ralph Nelson Elliot in the 1930’s developed a theory that stock prices do not move in random movements but rather in defined patterns called Elliot Waves. These “Elliot waves” consist of 5 waves in one direction, called motive waves (i.e. up if the trend is up, down if the trend is down), which is then followed by a 3-wave corrective move in the opposite direction, called corrective waves. Fluctuations in the stock market can be labeled as either impulsive or corrective, with either a 1-2-3-4-5 labeling (motive changes in stock prices) or as an A-B-C move (corrective). Elliot Wave International utilizes Elliot Wave theory to forecast trends in the stock market. However, Robert Prechter developed a theory called Socionomics based on Elliot Wave theory. This theory mainly concerns causality of events in society, and presents ideas contrary to what many people believe. He himself has a contrarian view on things, and has been consistently accurate in his predictions; most notably in the stock market (he called the bull market beginning in 1982 and ending in 2000, as well as the 1987 crash just 2 weeks prior). How? His contrarian view on things allows him to identify changes in trends in social mood and in quantifiable terms the stock market. For example, the Daily Sentiment Index (DSI) a technical indicator, indicates the percentage of traders that believe the stock market is headed higher. In March 2009, when the stock market put in an intermediate term bottom, only 2% of traders thought the market was headed higher. One of those people was Robert Prechter. When the majority of people believe something is going to happen, it usually doesn’t. Almost nobody was buying stocks in March 2009, except with the exception of Prechter. Similarly, almost nobody was selling stocks in October of 2007, when the market was making new nominal highs, as well as peaking, except Robert Prechter and his clients. The tendency of people to want to buy stocks as price increases can be modeled by the supply and demand curves. For normal goods and services, the lower the price, the more likely one is to buy a product (the more demand there is). However, with stock prices, generally the opposite is true on a long term basis: the lower the price, the less people want to buy stocks and the higher the price, the more people want to buy stocks. At market peaks everybody is eager to buy stocks, taking out home equity loans on their house, thinking the value of their houses will go up indefinitely, not thinking of the fact that a trend reversal could be imminent. Similarly, at market bottoms, after the market has fallen tremendously, everybody is afraid to buy stocks, and sell the stocks they do own, in fear they will lose money, however it is precisely at this time that people should be looking for bargains in all asset prices, not just stocks. This “norm” is what causes people to lose money investing. So, along with what Prechter calls “herding” (doing what everybody else is doing) most people would say that an event occurs, and people react to those events and their mood changes accordingly. Socionomics claims something completely different. According to the theory, changes in social mood move in patterns, similar to the stock market. These changes in social mood precede events in society, not the other way around. There is ample evidence, in my opinion, to suggest that this is true. In a presentation to the London School of Economics, Prechter showed a series of charts pertaining to his theory. One of the charts was of the Dow Jones Industrial Average since the 1930’s. During the Great Depression, the chart shows, as the stock market was trending down, people were not playing rock music, but depressing music instead. Women were wearing long black dresses as opposed to short skirts. Conversely, the chart shows that during the 1950’s, a time of economic prosperity, when the stock market was trending up, much more upbeat music found its way into society, women were wearing short skirts and other “hip” clothing, and social mood in general was much more upbeat. It is precisely that, social mood, which the theory of Socionomics maintains determines trends in society. As for current social trends, we are, and have been, in a bear market since 2000. Another common belief is that the stock market made new highs in 2007. This is true, in nominal terms (the Dow priced in dollars). However priced in terms of real money (gold) the stock market has been in a consistent downtrend since 1999, even before the cyclical (as well as secular(long term)) bear market was to ensue in nominal terms starting in 2000 and ending in 2003 following the bursting of the tech bubble. The following link is to a chart showing the Dow priced in terms of gold: This chart is updated as of July 31, 2008, before the stock market crash of 2008, in which the stock market fell precipitously in terms of both gold and dollars. Even though the stock market has put in a significant rally since then, it is still lower, even in dollars, than it was in July of 2008. The Dow closed at 11,378.02 on July 31, 2008, and as of the day I write this it is priced at 9,665.19 and much lower in real terms. Therefore, it takes even fewer ounces of gold to “buy the Dow” now than it did as of this date.

What does all this suggest about future trends? Nobody can say for sure. However, Elliot wave theory suggests society is going into a long term correction, in which a secular bear market in stocks should ensue (really just one large corrective A-B-C pattern, except on a larger scale than intraday). Elliot wave cites an article as evidence social mood is changing:

Another piece that I find quite interesting is this YouTube video, including an interview with Prechter, that suggests elements in nature, not just the stock market, move in fractals, or in other words Elliot Waves.

If you want to hear more of what Robert Prechter has to say, go to there are also many interviews of Prechter on youtube.