Putting Everyone to Sleep

Watching the financial markets has lately become the equivalent of watching paint dry. Such periods of extremely low volatility are however invariably followed by periods of very high volatility. All that is required to make the markets break out of their ranges and become a lot less 'dull' is a trigger event. A number of potential trigger events have recently come and gone, with none of them providing sufficiently exciting information to decide the issue one way or the other.

Keep also in mind that the initial break from the 'dull' trading ranges could turn out to be false as well. In other words, it is possible that just as a move of consequence appears to be getting underway, its directio reverses again. This is just meant as a caveat, as in the majority of cases, the break from a 'dull trading range' tends to be meaningful.

The charts below have been updated during Thursday's session, so they do not show closing levels. A point we would like to make here is this: there will probably be an advance warning somewhere, in a corner of the markets that perhaps isn't widely watched. We would keep a close eye on credit spreads, the yen, SKEW, the VIX, etc. with a view toward spotting divergences and/or breaks of important technical levels.

Let us look at a few data points that may influence market behavior from here on out.

Inter and Intra-Market Data Relevant to Stocks and Gold

We have picked a series of charts that are important for both stocks and gold. At the moment we assume that gold and the stock market are likely to continue to be negatively correlated in whatever major move develops next. While we obviously don't know for certain which direction the markets will ultimately take, there are a few warning signs in evidence for 'risk' assets while sentiment on gold and gold-related assets remains in the gutter.

This does not necessarily mean that stocks will fall and gold will rise. It only tells us something about probabilities. Money supply growth remains brisk enough to support risk assets, but we also don't know for certain where the 'critical threshold' for money supply growth nowadays is. One frequent threshold was the 5% level in terms of annualized growth of money TMS-2 (current growth rate: approx. 8.25%), but both higher and lower threshold levels have been observed in the past. All we know for certain is that the medium term trend of money supply growth has turned down.

The RUT-SPX and the NDX-SPX ratio: the former continues to lag, while the latter has lately recovered – click to enlarge.

VIX and SPX – with the VIX below 12, the premium embedded in near term SPX options is about as low as it gets – click to enlarge.

We have shown this one before: with margin debt dipping after a large and almost uninterrupted advance, an initial warning signal has been given – click to enlarge.

A recent summary of high yield spreads from the WSJ.

The JNK-TLT ratio – the support level indicated by the blue dotted lines needs to be watched. It would be bearish for stocks (and bullish for gold) if it breaks – click to enlarge.

Support/resistance in dollar-yen (this is an inverted notation, i.e., a rising level indicates a stronger yen and vice versa) – click to enlarge.

A divergence between macro risk indexes and the SPX has lately developed (the index is a mixture of the Citi macro risk index, the Westpac risk aversion index and the UBS G10 carry risk indexes) - click to enlarge.

The Rydex ratio (Nova/(Nova+Ursa)) remains ensconced in lala-land - click to enlarge.

Spot gold daily – a triangle pattern has formed that should soon result in a break – direction as of yet unknown – click to enlarge.

The recent decline in GTU's discount to NAV suggests an upside move in gold is more likely – click to enlarge.

Enthusiasm in the gold sector is not just muted, it is non-existent – click to enlarge.

Regardless of the next short term move, the  Coppock curve indicator suggests that gold should move higher over the long term. It has only turned up from similarly oversold levels two times before in history: in 1976 and 1982. On the first occasion a huge rally followed (+700%), on the second occasion the rally 'only' amounted to 100% – click to enlarge.

Conclusion:

A big short term move in both stocks and gold is probably fairly imminent – big relative to recent moves that is. It is not possible to tell yet in which direction the breakout will be, but a number of inter-market signals may provide us with advance warning. At some point the fact that stocks are heavily overbought and over-loved, while gold is heavily oversold and widely hated is likely to lead to long term trend changes in both.

charts by stockcharts, sentimentrader, WSJ, barcharts