Monday, June 20, 2016

Fractal Condition of Several Key Markets At Mega Turn Points

Back in June I posted "Fractal Condition of Several Key Markets At Mega Turn Points" where I submitted that there was about to be a big turn into either bull or bear mode (I was thinking bear at the time) and since then, these markets have indeed made a decisive turn. I have reposted the original article in black, and I have added in red what each of these has done since June.

Recently I wrote an article on gold's fractal dimension showing that it had built to a high level not seen for at least 10 years. Well you may be scratching your head asking "fractal what?" I briefly explained that it is a "high math" way of quantifying any moving object's reversion-to-mean force after it has been in a trendless state for awhile.

For something that can be charted, like a market, there are two dimensions. The fractal dimension at any point is a mathematical summation of something's behavior as either something that can be described with one dimension (a strong, straight-line trend) or by two dimensions (a meandering, chaotic range). Thus the dimension is calculated as being between 1.0 and 2.0 (between one and two dimensions).  We typically just take the decimal portion and refer to it like basis points.  So a fractal dimension of 1.35 is just called "35".  This "line vs chaos" thing in theory happens at all different time scales, minutes, years, what have you, and you have to divide all this rightly for it to mean anything in the scale that's significant to you.  The guiding mantra of all fractals is always "same thing, different scale". 

This also applies to the geometrical rescaling and repeating that markets tend to do.  Back in early February, I wrote an article, "Gold's Bull/Bear Status" on gold's apparent "new" bull market, which is likely just a repetition of a rescaled, typical, and oft repeated bull market fractal that is really all one bull market

Anyway, enough math.  After looking at gold, and seeing that it currently has a very unusual fractal condition, I looked at several other key markets and found that there is a similar fractal abnormality in them as well. First, let's look again at gold: (click on image to view)

As the graph shows, gold is currently at 55, highest in 10 plus years, presaging a very strong trend coming, either up or down.

Since June, gold has moved down from the top of the range shown, but the fractal dimension is still at 55. So gold is still moving in a range, undecided how to dissipate the 55.

Gold is linked to many other markets, so let's take a look at the US dollar with this measure:

"Historically unstable" would be a good description of the dollar's fractal behavior since the 2014 power move up and subsequent chaotic range. The peg-to-peg gyration from 30 to 60 is very unusual for a major index, especially a supposedly stable currency, even on the weekly scale as this fractal dimensioning is calculated.

Since June, the dollar quickly reversed this formation break back to the upside, reflated the fractal dimension back to 60, and the dollar has been on a tear since, dissipating its fractal dimension down to 45. 

Of course gold is also supposed to be an inverse play to the stock market, although I beg to differ with that take as there have been extended periods with both rising gold and stocks, with 2002 to 2007 being a prime example.  But historically, and especially lately, gold is inversely related.  So let's look at stocks via the Russell 2000, because it is a broad stock market and it is a leading group. Let's calculate some fractal dimensions:

Amazingly, we find that the stock market is also jam packed with the highest fractal energy level in over 10 years.  But just from this, we don't really know which way it wants to go, up or down, from looking at these graphs as they just show its fractal condition. 

Since June, the Russell has blitzed to the upside, deflating its dimension down to 52. This is still very high for a major index and suggests a lot more upside to come.

Is there something that we could check that could be more suggestive of the direction ? 

Consider copper.  "Every bull market has a copper top" is ancient wisdom, noting that copper puts in a top somewhere in the late stages of a bull.  And it is referred to as Dr. Copper because it has a PhD in economics.  It did indeed peak clear back in 2011 before the transports, European banks or any other leader.  Copper has put in attempts at bottoming ranges amidst a pronounced decline, and recently it has attracted attention to the $2.00 level as a major line in the sand.

There is the technical read where $2.00 is a Fibonacci level.  But then there is the basic fact that the world's biggest trafficker in dangerous derivatives, Deutsche Bank, is highly levered to Glencore, and Glencore is very highly levered to copper staying above $2.00 a pound.  An article, from Business Insider recently explained "Barclays: Glencore Is In Big Trouble If Copper Gets $0.30 Cheaper".  Copper was $2.34 at the time. The article states at the top:
Glencore is a strange hybrid company, both a commodities trader and a mining company, and it has a complicated balance sheet loaded up with different kinds of debt.  There are a lot of different ways to analyze the company but perhaps the best way to think of it is like a bank that's hitting a crisis, like Lehman Brothers ... if the price of copper falls below $2/lb, you begin to get some seriously sweaty palms in Glencore's finance department
If this level gives way, it will be a serious debt problem with the banking system.  And because $2.00 is also a psychological level, breached only in the March, 2009 and January, 2016 market debacles, it would also involve a confidence shock to all the other markets.  In fractal terms, this is how copper looks now:

Each of the ranges in the decline where the fractal dimension went to over 50 resulted in a sharp collapse downward.  The $2.00 per pound line in the sand is right at the red arrow I've drawn illustrating the current range.  And currently we have copper at a fractal dimension of 55, the highest of the entire decline, strongly suggesting another sharp drop, this time through the $2.00 barrier.  Of course, the direction could be up from here, but there is a very strong primary trend at work with copper, so the more likely outcome of the fractal situation is a continuation of this primary trend. It's showing no signs of reversal.

Since June, copper's dimension continued to build and slammed hard on 60 (the upper peg) and has since gone into a power climb with current dimension at 45 - still a lot of room to power climb.

Oil is in a similar but much less profound state of weakness.  It went to an extreme fractal dimension of 60 (monthly) in mid 2014 with oil seemingly stable at around $105.  The massive move to $45 in just 6 months that followed sent the fractal dimension to below 40 in a flash.  On the weekly scale, the fractal dimension went to 52 in mid 2015 with oil steady at $60, went back down to 30 as oil plummeted to $28, and is swiftly going back up as oil struggles in the $40s.  It is a similar plateau and plummet progression as copper, but not nearly as fractally strong, and with the primary down trend in question as oil is trading well above its 200 day moving average.

But there is yet another market index with a once-in-10 year fractal event going on where the direction is probably more clear.  Let's take a look at the VIX:

The fractal dimension reacted strongly to the 2008 event with a big build to 53, then a big dissipation clear down to 34.  It didn't seem to react as strongly to the 2011 Greece scare, as if it knew it was just a passing cry of "wolf".  But it has again gone to an extreme level, being violently pegged at 60 for some time now.  So there would seem to be an extremely large move coming. But if it were down, it would be to an absurd VIX level of around 10 or less. 

Not that this hasn't happened before.  We were cruising into 2007 up until March with the VIX at 10-12 before hardly anyone was worried about housing, or anything.  But in our day, this would imply that stock markets will sudden go to a PE of 30, or an unprecedented burst of earnings will suddenly materialize from a weak economy seemingly beyond the resuscitation of monetary policy, the rising debt defaults will suddenly stop from the mountain of shaky loans, interest rates will "normalize", the lion shall lie down with the lamb, and pigs will fly.

Since June, the VIX has stayed pegged about as low as it can go and its dimension is still pegged at 60.

It may not be just your imagination that the global economy, markets, and interest rates are going into some kind of twilight zone. The cold science of fractal analysis backs you up on that.

The collective fractal wisdom is saying buckle your seat belts, and the VIX is saying a big move will either be another big decline in stocks or a sudden trip to nirvana. I guess we could be going to nirvana, but until the evidence is convincing, it may be wise to make some preparation the other way.

Since June, we have gone to nirvana. How long will that last? I don't know, but there is a lot of fractal energy that says enjoy the ride!

If you would like more information on the fractal dimension in markets, you can read the works of Benoit Mandelbrot, who discovered and wrote about this phenomena in all areas of science. He coined the label "fractal" and founded the Chaos Theory approach to analyzing markets.  His book The (Mis)Behavior of Markets has been called "the deepest and most realistic finance book ever published".  There are a few product offerings that give you an FDI (fractal dimension index or indicator) along with the RSI and other technical indicators. One is from QUANTSHARE  Trading
Software.  If you are a programmer, there is code written for this calculation by AmiBroker and others.  You can also use someone's code at MetaStock with their Indicator Builder feature.

Monday, June 6, 2016

Gold's Direction - The State of the Trend vs Wave Countng

If you pay much attention to the wave analysis, Fibonacci, Elliot, what have you, the next significant move in gold is surely down to $1150ish.  You can sample some of what these types are saying now herehere, and here.  I am a kindred spirit with the wave people in that I am mostly a technical analyst. The chicken scratching means all the world to me.  But the fib levels and other cycling methods usually don't interest me much.  But when there seems to be a lot of these practitioners saying the same thing - well, you ignore them at your own peril.

There seems to be a difference of opinion now on gold between trend analysis and the wave counting.
I have found that one of the most consistent means of looking at the health of a trend is simply by moving averages.  Of course you've probably heard of the "golden cross" or "death cross" when there is a crossing of the 50 day moving average with the 200 day, either up or down.  But one good way of seeing if a trend is intact or changing is by looking at what I call MAPS - Moving Average Pair Support.  This is the 140 day ema (exponential moving average) compared with the 200 day ema.  It is the best divider I know of between a bear and a bull market.

Major market averages typically obey the MAPS division pretty well, but gold in particular obeys it very consistently.  Let's look at how gold has behaved in its bull/bear transitions since the late '90s by viewing them with MAPS: (click on images to enlarge)

Here we see that the moving average pair was down-sloping and acting as resistance in the bear market, then a violent breaking out above MAPS followed by a cross between the moving averages.  From then on, MAPS acted very consistently as support in the new bull market.  There was something of a breakdown of this in early 2003 as the MAPS slope switched to negative and gold went well below this negative slope.  But if you will recall, there was a lot of unusual stuff going on in the world at the time.  The US was getting ready to invade Iraq, which we thought was chock full of bio-weapons, and gold went on a tear, bending the moving averages sharply up.  Then the war was quickly won, and gold overshot a bent MAPS to the downside.

The second bear/bull transition was 2009:

The Financial Crisis of 2008 put gold into a one year decline.  This changed with a MAPS cross, after which the MAPS support was consistently obeyed for years.  Which brings us to the present:

MAPS has switched from resistance in the four year bear market, to a cross, and now to support in a new bull.  If past MAPS behavior is any guide, the persistent obedience gold has with it has begun a new chapter and the severe bounce we saw on Friday smack on the MAPS bound will probably wind its way up to new post cross highs. The cycling move to the mid $1100s would be well below MAPS, hence the difference of opinion between the state of the trend and the cycling.

If gold does in fact go to around $1150, the cycles have it there for just a month or less before flying back into the bull climb. So is it worth trying to trade a portfolio around this short term movement?  That depends on your commissions, taxes, your tolerance for aggravation, and whether you own mostly gold or the miners.  If you have a line up of quality miners (not ETFs) they can be more independent of the short term gold price than you may think, being moved by positive company developments while you have them traded to the sidelines timing a gold price blip:

As this chart shows, over the month of May, we saw a $100 move down in gold, but trying to trade a gold miner portfolio around this would have been very dicey.  So if we go another $50 down to the $1150 level, will that trading turn out any better?  Maybe, who knows.  The miners, especially South Africans, led the turn at the start of the year, and they seem to be strongly leading now.  It may be advisable to just watch gold's behavior on this bounce off  MAPS, and if it clearly weakens below it, maybe take some profits here and there.