The Slow Train Wreck Difference

In two earlier articles (The Market Technicals - Get Back In The Water? and The Fear Roller Coaster - Are We There Yet?) I pointed out some striking similarities between now and mid-2008 - the lull before the annihilation. Here, I'd like to add some more similarity, but then consider a major difference.

Technical formations have predictive power because they resolve themselves up or down at a rate much better than 50%. How useful they are depends on how far away from 50%. The head and shoulders formation, for example has about a 65% success rate for predicting a trend change. One of the formations with the highest success rate is the descending wedge at about 90%. This is a bullish signal where a quieting down trend breaks strongly to the upside. If you apply it to the VIX, the market's fear index, you get another bullish signal (bearish for the stock market).

If you look at what the VIX did during 2008, you see not one, but two descending wedges:



The formation was 2 for 2 over this time with both breaking sharply to the upside. Both ran the VIX briefly below the critical 20 level that typically divides bull from bear markets, but it couldn't stay there for long. And they both dropped the VIX below the 140/200 day ema moving average pair for a short time and induced a negative divergence between them.

So what's the VIX doing now?



Egad ! The very same thing. We're definitely in a descending wedge and it has put us below a VIX 20 and the moving average pair. So are buyers of the present rally chumps being set up for the kill? Is it the end of the world again once this formation breaks?

Well, let's just curb our apocalyptic fervor. The market is way overextended on the upside and a correction is likely not too far away. But there are powerful fundamentals at work that make now much different than 2008. There is the basic and powerful economic cycle that tends to overrun a lot of other concerns. In 2008, it was on the downside. Now it is going the other way, albeit in a very subpar recovery so far.

But maybe more important than that is something that Michelle Caruso Cabrera of CNBC points out about the European banking crisis, which presumably would be the catalyst for another end of the world sell off. She is CNBC's guru on the scene in Europe, and she calls what is happening there now a very slow train wreck version of the very fast and surprising train wreck that hit the US in 2008. And Jim Cramer has said that, even though half-measures being implemented, the kicking of the can down the road, is reviled by us all, it buys time for the banks to collateralize and capitalize and do whatever needs to be done - critical time that they did not have in 2008. What made the sell off of 3 years ago so bad was the prospect of a lockup of the financial system, but now the Germans and others have made it clear that they will print money as needed to prevent that.

A market correction is very likely soon, which will break the wedge on the charts and carry out a repeat of the downturn, but how severe that downturn will be is very uncertain. That will all depend on how well the banks and governments in Europe are using their time to ready themselves for defaults, CDS kick-ins and who knows what. The shape of the upcoming correction will give us a clue as to how severe it will be. As in May of 2008, we now have poked our nose above the 140 day ema, but the turn out of the first VIX wedge back then sent the S&P decisively back below the 140. If a correction now looks to be holding near the 140 nicely, then we may have some clear sailing ahead. It would be a very positive sign for the market.

But if it breaks strongly back below the 140, batten down the hatches. Europe's troubles don't seem to matter lately, investors are fatigued with it. But in the next major correction, they will revisit what they're doing over there, and if they like what they see, we may derail from the 2008 path to apocalypse - the slow train wreck difference. A sell off to a little below the 140 on the Russell would be your 10% bull market correction, so how the next significant downturn behaves around this critical moving average pair is going to be critical. One should be cautious until then.

Safe Haven Confusion And Gold

Ever since the 2008 credit crisis sent droves of investors diving into safe havens, there has been much disagreement on just what is a safe haven.   Real estate has always been a nice alternative to the other markets, but lately it's been the genesis of all our other problems.   Bonds have likewise been the alternative to a shaky stock market, but now bonds are a dirty word, being the embodiment of the dirtiest word of all - debt.   Then there is gold. But the '08 credit scare smacked it around alongside everything else, except the US dollar.

So is the USD, the traditional safe haven, the one to turn to now?   It is the world's dominate reserve currency.   And even though "currency" is something of a dirty word now, isn't the USA and its currency the prettiest pig in the pen?   There are detractors of the USD who point to things like the Swiss franc because Switzerland has little of the debt issues of the US, Europe, or about any other major currency printer.  Currency in general is an attractive safe haven because of its relative stability.  If it goes the wrong way, you won't get hurt too badly.

Just perusing some actual headlines over the last couple years or so, I get dizzy following the fingers pointing me to a safe haven:

"Is Gold Now The Last Safe Haven Standing?"
"Gold Squashed By US Dollar Safe Haven Buying"
"Swiss Franc Is Now A Cheaper Safe Haven"
"Neither Gold Nor The Swiss Franc Retains A Safe Haven Status"
"The Dollar Has Become The Currency Of Last Resort"
"US Dollar Losing Safe Haven Status"
"Gold Not a Safe Haven - Don't be Fooled"

 It makes my head spin.

OK, let's think about this logically.  Or would that be our first mistake?   Whether it's logical or not, gold has to be considered a currency.  While most of gold's demand is jewelry, the thing that moves the price needle in times of investor upheaval is investor demand.   Despite Ben Bernanke's congressional denial, gold is money, which is why banks and governments hold it in reserve instead of, say, aluminum.   The US dollar index is a measure of the US currency strength relative to a weighted basket of 6 competing major currencies.  To be fair, gold should really be included among the dollar's competitors.  Instead, the euro is given a whopping 58% weight in the basket.  Can you imagine what the dollar chart would look like if you substituted gold for the euro at a 58% weight?  It would be one ugly chart indeed over the last 10 years.

If you grant the US dollar the position of safest paper currency in the world over the last 40 years, and I think even the current detractors of the greenback would do that, then what would happen if you compared it one-on-one with gold as an event safe haven?  If you were to construct a chart of all the modern stock market scares, defined as those events which ran the market's fear gauge, the VIX, to values over 40, and looked at the US dollar index performance relative to gold over the time frames of the debacles, what would be the safe haven score between the two?   This would be strictly a currency comparison - the best of the paper issues versus the metal one.   But since currency is usually the most stable of all the other safe havens, even real estate, art collections, or what have you, this would be a track record of the best of the best of the safe havens.   Here is what such an ultimate safe haven chart would look like: (click on image to enlarge)



There was no VIX back in 1973, it was invented in the '80s.   But if there had been, it almost certainly would have run to well over 40.   So I have awarded it an honorary position on my chart of debacles. The '73 bear has only been equaled by the '08 horror.

So this is a Dodge City salon brawl between all the safe haven contenders, and it makes me wonder where the dollar's title of "chief safe haven" comes from. Granted that its -3% average over the 6 stock market dives isn't bad, but wouldn't gold's +39% have to be considered better?   You could say that gold is undependable because it goes through bull and bear markets.  But 2 of the 6 cases above were during bear markets in gold, and gold still outperformed the dollar.

Investors fairly new to the market may only remember the '08 crisis and how gold was shaded by a nice climb in the dollar.  But over the course of this huge decline in stocks, gold actually winds up even - about what the dollar's long-term average is.   So gold's worst showing roughly equals the dollar's average.

This anomaly of 2008 may not be easily repeated.   This scare event was about a liquidity lock-up and a systemic failure.   So gold, being less liquid than dollars to buy a hamburger with, was dissed in favor of dollars.   We have a repeat of this banking crisis in Europe now, but this time it is a very slow motion train wreck in lieu of the very fast motion surprise version of '08.   Now the banks are collateralizing and capitalizing as we kick the cans down the road to buy time and embark on a print-money-as-needed policy to slow down the train wreck to a case of stagnant economies and who knows what, but maybe not a repeat of the '08 horror.   This may return gold to its more typical safe haven behavior as it did in the August 2011 case.

This chart also shows another major consideration.  It pits a safe haven that has been outperforming paper currency over 40 years of sound money against a safe haven now frenetically being debased with the printing press.   If gold has been the better haven in the past, when we had sound currencies, it certainly should be in the future, when we probably won't.  Yet we see an exponential rise in dollar safe haven trading matched only by the exponential rise in the supply of dollars.   Compare that with the flat gold production numbers we have in the world today.  And the FOREX market cap dwarfs the stock market and even the bond market, with the entire gold industry market cap less than that of Walmart!

Investors diving into the dollar for safety from today's problems is like Dorothy diving into a windmill to escape the approaching tornado.  If there is ever a radical reallocation of the flight to safety trade, market cap-wise, it will be like pouring a bucket into a thimble - potentially explosive for gold.

This radical reallocation is foreseen by many analysts, like Simon Black of Sovereign Man:

Dubai, Greece, Latvia, Ireland, Spain, UK, etc. all give investors a lot of reason to worry. Ironically, when things get really bad in the rest of the world, investors rush into the US dollar as the ultimate flight to safety.  I know I don’t have to tell you that this line of reasoning is utter nonsense. Institutional money managers realize it too– the prospect of loaning money to the largest debtor in the history of the world for 30-years at less than 5% is certifiable lunacy.

With a stable currency like we've had for 40 years, the above graphic shows gold to be the superior safe haven.   If we get the kind of currency meltdown many predict, we could see a radical improvement in gold's already best-of-the-best safe haven status.   As Simon Black goes on to say:

In a flight to safety, institutional money still flows into the dollar.  Gold will not truly break out until there is a bifurcation in investors’ mentality regarding safety.  To put it more clearly, when worried investors start piling into gold instead of the US dollar to protect their assets, this is the sign that we are charging towards the top.  For now, it’s not happening yet

But what if it is starting to happen now ?