Continuous Commodity Index signaling Deflationary Forces are in the Ascendancy

Those of us who have nothing better to do with our lives than to sit in front of computer screens watching prices change have been watching the battle being waged between the forces of Deflation and the forces of Inflation ever since the credit crisis erupted back in the summer of 2008.

On the one hand is the relentless and merciless pressure from excessive Debt and all the issues arising from that; on the other hand has been the Federal Reserve and its monetary stimulus programs, aka, Quantitative Easing or QE for short. When the Fed has entered the Fray, the forces of deflation have been routed and run off the field. When the Fed withdraws, the opponents regather and send out their war parties to hack and slice once again.

This battle can be seen through the chart detailing the price action of the commodity sector as a whole, namely the Continuous Commodity Index or CCI. As the Fed wins ground, the index rises; as the Deflation forces triumph, this index falls. Right now it is falling and falling in a big way as once again it is threatening to put in a major top on its longer term weekly chart.

Take a look at the two red support levels shown on the chart. The upper red line was the previous bottom made in the index earlier in the year which was broken early last month as traders began suspecting that the Fed was going to indeed end the QE2 program at the end of June. However, they began second guessing that notion with the result that prices were able to rebound and move back above this level and push towards 660. However, as economic data continued to deteriorate and fears of an overall global slowdown increased, the index has now dropped lower through the upper line and are pressing into the lower red line confirming that a double top in indeed in place for the overall commodity sector. The price action is indicative of a market in which a "SELL THE RALLY" mentality has replaced one of BUYING DIPS. In other words, traders are looking for lower commodity prices ahead as they anticipate deflation and not inflation. Only if prices are able to immediately move back above the upper red line will one be able to say authoritatively that inflationary forces are rising in the minds of investors.

If you will also note the particular technical indicator I have chosen to overlay on this price chart, the Directional Movement Indicator, you will see that the solid black line, or ADX, which began rising in July 2010, and accompanied the rise in the index all through February of this year (indicating a STRONG TREND HIGHER) turned down at that point indicating a pause in the ongoing higher trend. The blue line or Positive Directional movement indicator has been trending lower since December of last year while the Negative Directional Movement Indicator, or red line, has begun trending higher since February of this year. What this indicator is telling us is the trend toward higher commodity prices is over for the time being. The upside crossover of the Negative Directional Indicator ABOVE the Positive Directional Indicator, is BEARISH.While the index has not yet fallen through the lower of the two red support lines on the chart, it is signaling that weakness in the sector lies ahead.

The last line of defense will be the rising 50 week moving average what comes in near the 600 level. This level now takes on increasing significance as we move forward. You will note how it held back in April/May 2010 when talk began surfacing that the Fed was going to come up with some sort of additional stimulus to take the place of the then expiring QE1 program. Once that QE2 was announced, the index accelerated higher. Now that the end of QE2 is here and there yet appears to be no improvement in the overall economy nor any concrete steps for a QE3 or some further stimulus from the Fed, the index is breaking down once again. Should it move towards 600 and fail there, we will be entering a deflationary period.

Mr. Bernanke left the door open for further stimulus from the Fed should the economy not respond and economic data continue to reflect deterioration. One suspects that the market is going to force the hand of the Fed sooner rather than later. Again, this Fed has signaled clearly that it is deathly afraid of deflation and will do whatever is necessary to stave it off.

Additional proof of the deflationary mindset taking hold has been the relentless move higher in the bond market which is moving in a manner suggestive of global slowdown fears. While the Fed enjoys the lower long term interest rates (as does the US government which is keeping its exorbitant borrowing costs lower), they do not want a rally in the bond market of the nature that would see money exiting stocks and other assets.

Gold under pressure from SPR release and abysmal Jobless claims number

What a difference a single day can make! Yesterday, gold managed to punch through $1550 and close above that level at the end of pit session trading but as the afternoon wore on, it slowly slid lower and inched closer to $1550 once again. As the market opened for early Kangaroo trading, it then fell back below $1550 and remained a tad weaker throughout early Asian trading. That all came to an abrupt end when news hit the wires that the US was releasing some 30 million barrels of oil from its Strategic Petroleum Reserve (SPR).

Crude oil immediately swooned falling below $90 (it has since recovered). As it did, the hedge fund algorithms kicked in and began unloading commodities across the board. If that were not enough, the Jobless Claims number reminded the entire planet why those who were filling our ears with their nauseating talking points of "Green Shoots" some months ago, should have to do mandatory community service on the Discovery Channel's, "Dirty Jobs" show. The number was terrible.

That sent the risk aversion trades into high gear and out the window went everything that did not resemble a US paper IOU or the Dollar. IN looking across my quote screens this morning, the only commodity on the planet that I can see which is currently showing green is the Cocoa market. Everything else is in the red. Time to hoard chocolate.

The result of this hedge fund carnage has been to send the CCI (Continuous Commodity Index) crashing down to major chart support just below 630 and the S&P 500 to within a few whiskers' width of the psychologically and technically significant chart support level of 1250. If the CCI and the S&P crash through those levels the Fed is going to be forced to do some sort of stimulus on the monetary front as it will signal a deflationary mindset has now gained the ascendancy. Based on my reading of Bernanke's comments yesterday, I think he left the door open for such action if they believe the need should arise.

I might add here that the oil release from the US of $30 million barrels of crude is equivalent to less than TWO DAYS TOTAL USAGE here in the US. Call me cynical but while the release was much heralded as a response to the loss of Libyan crude oil in the marketplace thanks to Mr. Obama's "kinetic military action" or non-hostile hostilities over there, I believe it is totally related to the same's poll numbers which are going down the toilet faster than an unwanted baby alligator which has gotten too big for its 55 gallon aquarium. High gasoline prices are threatening to make him a one termer (I can only hope) and what best to do but to dump some oil on the market to try to knock a dime or so off the price at the pump. Here's a new flash to the clueless one - instead of these cheap political gimmicks, stop spending money that we do not have and open the country up to domestic drilling. That would actually be a much better long term fix instead of playing political games with what is supposed to be for emergency purposes. The only emergency that I can see is his sinking poll numbers and that is no emergency as far as I am concerned but rather cause for rejoicing.

Back to gold however - the failure to extend past $1550 has sent the market back down into the former range with $1550 on top and $1520 on the bottom. Buying associated with sovereign debt fears is keeping it from sinking much below that $1520 level for the time being. ECB President Trichet today said that the risk signals from the situation in Greece are "flashing red" as far as stability in the Euro zone are concerned. That is why gold is so firm on the Continent. Earlier in the session gold had just posted another all time high when priced in British Pounds and still is very close to its all time high price in terms of the Euro. Fears of some sort of contagion spreading to the big European banks are running very high over there. As long as these fears remain downside in gold will be limited, even with the hedgies throwing everything out the window.

The HUI and XAU are both moving lower in conjunction with the weakness in the broader equity markets but thus far remain above the recent lows. The XAU currently looks to be the stronger of the two indices as the large caps are holding better than the juniors generally speaking.

The Dollar is on a tear higher but has yet to take out the 76.50 level on its chart. Until it can do that convincingly, it remains rangebound also.

I will try to get a later update on gold this afternoon after we get a chance to see how things are when the dust from all this commotion settles a bit. Heck, they knocked the old crop corn market down the limit yesterday and ran it to extended limits today but it has since rebounded well off its lows. Certain markets will respond to their fundamentals once the technical fund selling has exceeded value levels. The algorithms ALWAYS overdo it - either to the upside or to the downside.

Gold chart analysis

The FOMC release this morning basically reaffirmed what most of the market has been thinking for some time now, namely, that the economic "recovery" is proceeding at a moderate pace though "somewhat more slowly" than had previously been expected. What a surprise? It is more like "YAWN".

The translation - they will be keeping interest rates near zero for the next few months, or in their words, "an extended period of time".

They repeated that the QE2 program would come to an end this month but at this point they had no intention of actually reducing their balance sheet or selling any of the $600 billion in Treasuries which they have purchased over the last 6 months or so. What they will do however is to reinvest the proceeds from maturing Treasury bonds. That will give some stimulus but compared to the massive sum of $600 billion, amounts to a drop of water into the bucket.

Gold liked what it heard and shot higher taking out the sellers who had been stalking the $1550 level. They were forced to retreat towards $1560.

From a technical perspective, the strong move past this solid resistance level, takes the market out of the recent tight range trade bounded by $1550 on the top and supported at $1520 on the bottom. It is now poised to make a run towards $1570-$1575. Downside support moves up initially towards $1540 followed by good support near $1530.

Keep in mind that this is occuring during the summer, not a time in which one generally expects to see a very strong gold market. A grinding move higher during this time frame would set this market up for a move to a fresh all time high later this year when the seasonally stronger period of the metal arrives. This just further underscores how currency concerns are moving gold as distrust in paper currencies continues to increase. Gold is signaling investors' lack of confidence in their monetary authorities and political leaders.

By the way, Gold priced in British Pounds set another all time record high price today.

Impact from Dodd-Frank

I have fielded quite a bit of emails from people scared out of their minds because of a rash post over at a widely read website which tends to post first and think later. That is the problem with this Wild West of the Internet - too many are interested in "first scoops" and not in arriving at solid conclusions based on analysis.

The regulations which have Forex.com issuing a statement to its clients to close out their gold and silver positions affect US based Retail customers on non-regulated over the counter markets. It will not have any impact on the COMEX market or any other regulated futures markets.

If anything, this will serve to drive more business towards the Comex which is a regulated futures exchange market. The regulations are attempting to stem US-based retail investor activity in non-transparent, non-regulated over-the-counter markets.

Keep in mind that in this day and age, the more "clicks" a website gets, the higher it rises in the "ratings" and the more advertising revenue its owner gets from paid ads. This sort of thoughtless sensationalism is a perfect example of that.

Eric King interviews Jim Sinclair and Trader Dan for a special report on the mining shares

Eric King of King World News, this weekend, interviewed my good friend and legendary trader Jim Sinclair, and myself, to get our thoughts on the recent price action of the mining shares. I highly recommend that our readers take a bit of time to listen carefully to this piece. I think you will come away both enlightened and encouraged by what you hear.

http://tinyurl.com/3kubx6o

Trader Dan on King World News Weekly Metals Wrap

Click on the link below to listen to my regular weekly interview with Eric King of King World News on the Weekly Metals Wrap.

http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/6/18_KWN_Weekly_Metals_Wrap.html

CME Group lowers margin requirements for Gold futures

As of the close of business this coming Monday, CME Group has lowered the margin requirement for its gold contract from $6,751 to $6,075 per contract. Maintenance Margin also moves lower from $5,001 down to $4,500.

While not a large drop, it always helps on the speculative front when margin rates are lowered.

HUI - Gold ratio reflects the return of a deflationary mindset

If one examines the ratio of the HUI/Gold you can determine whether or not a deflationary mindset or psychology is prevalent among investors/traders.

Note that when the credit crisis erupted in full force in the summer of 2008, the mining shares underperformed drastically against the price of gold as the gold shares plummeted along with the rest of the broad stock market.

It was not until the Fed announced the inception of QE1 in the fall of 2008, that the gold shares began to outperform gold. As a matter of fact, they led the market higher.

Now that the Fed has announced the end of QE2, the gold shares are seriously underperforming against the price of gold bullion as you can see by the sharp move lower in the ratio early this year.

This is the basis behind the ratio spread trade being played by the hedge fund community and why they are able to push the shares lower seemingly at will. As long as a deflation mindset is in place, the shares will underperform against bullion. Not until we get a return of inflation fears (that will come if the Fed moves ahead with some sort of additional monetary stimulus) will the mining shares outperform gold.

I have had some critics rail against me for detailing this strategy but I can tell you from a trader's perspective, it has been an effective and extremely profitable trade. It will stay in place as long as it works and makes money for those who are using it. The hedge funds are simply too large for any other market players to take them on and challenge them on this trade. Only a shift in the deflation/inflation mindset will shake them out.

If rumblings of another case of Fed action on the stimulus front begin to surface, this ratio trade will begin to turn as the smartest ones plying it will exit while they can still secure those paper profits.

In the meantime, one has to be extremely selective in which mining stocks they buy. The weaker ones will be and are the targets of the ratio trade while the stronger ones are more resistant to its effects, even though they are seeing weakness at the present time. Once the market for the shares turns, the strongest ones now will be the leaders on the way back up. Fundamentals will ultimately determine their share prices even while these technical plays are dominating at the present.