10/25 Daily Commentary

The G-20 gave a tacit rubber-stamp of Fed money creation.  On Friday I stepped aside after the SP futures diamond broke upward at the close.  I shorted DJ futures, gold futures, and crude futures Sunday evening.  Today I bought 4% DXD when DJ futures approached but did not touch April highs and covered the crude futures in anticipation of an afternoon rally which materialized.
The effect of monetary manipulation front-running the election has negated I1, which measure market sentiment.  If the Fed is not content with market sentiment, which is deflationary, then it has within it's means the ability to create money.  This money weighs on the dollar and inflates assets denominated in dollars.  Since the dollar is the current reserve currency asset prices around the world also inflate in dollar terms.  The G-20, by not condemning the Fed for inflating their currencies relative to the dollar, has given tacit consent.  This means there is little international pressure on the Fed to eliminate or reduce the amount of QE it intends.  The German central bank is the most outspoken on the blatant dollar debasement and all parties turned a deaf ear to Geithner's proposal to reverse gravity.  Setting currency purchases by governments and central banks to achieve artificial current account surpluses and deficits is central management at it's worst.  Currencies convertible into nothing have limited impact on long-term economic trends.   See The Gold Standard later in this post.
So, today was a profitable day, as all futures trades as well as DXD purchased are all well in the black.  I1 has slowed but not stopped the general market inflation brought about by money creation.
The following table shows I1 values and SPX values with bottoms (B) and tops(T) marked.
                           I1      SPX
20100901 25.28408 108029
20100902 25.06659 109010
20100903 25.51281 110451
20100907 27.91625 109184
20100908 29.58433 109887
20100909 31.06375 110418
20100910 32.49334 110955 T
20100913 32.15619 112190 T
20100914 31.46442 112110
20100915 29.76997 112507
20100916 27.14117 112466
20100917 24.71507 112559
20100920 22.96243 114271
20100921 22.29074 113978
20100922 21.8606   113428
20100923 21.19671 112483
20100924 21.17547 114867
20100927 20.82228 114216
20100928 20.55654 114770
20100929 19.79494 114473
20100930 18.6971   114120  B
20101001 19.4164   114624
20101004 19.8343   113703
20101005 20.45848 116075
20101006 20.9075   115997
20101007 21.40699 115806  
20101008 21.63835 116515  T
20101011 19.81698 116532
20101012 17.54623 116977
20101013 13.80057 117810
20101014 9.866532 117381
20101015 6.519855 117619
20101018 3.461369 118471
20101019 .8808112 116590
20101020 -1.812707 117817
20101021 -3.515924 118026
20101022 -5.542804 118308
20101025 -5.851898 118562
20101026 -6.125878               B
20101027 -6.012274               B

As can be seen I1 did a good job advancing into the SPX high 9/10-9/13, a double top.  From 1122 on 9/13 I1 did slow the advance to a .115% daily average into 9/30.   The top 10/8 saw another period of slowed advance into today's 1185.62 of .16% daily average with another 1 or 2 days to the bottom. 
Friday offered an opportunity to step aside during the G-20 whose outcome I called as inflationary (in dollars) on Friday. 
In addition to the G-20 the estimate of Fed bond purchases has been ratcheting up over the past month.  I have no doubt that the Fed is facing political pressure to maintain bouyant markets in advance of the election and that is affecting the statements issued.  It has been obvious that the Fed for the past month has been pulling out all the stops to attempt an inflationary outcome both to overcome economic weakness and to avoid market meltdown prior to elections.  To maintain other than minimal stock short positions until evidence arrives of the bearish trend is howling at the moon.  The evidence of trend reversal lies in the DJI 5-minute, 370-unit EMA which is at 11,139 and would be broken at 10,994. 

Last week my position was 6% SDS and 1% DJ futures. Currently it is 6% SDS, 4% DXD, and 2% DJ futures. I also hold short gold futures. 
The dollar rallied last week beyond the buy signal level in it's 90-minute M/A.  It then reversed that signal after the G-20.  So currently we have 3-waves up and down from last week's low.  Heavy resistance exists at 77.48-77.55.  This is top of wave 1 down and the 90-minute M/A, currently on a sell signal.

Dollar index is in a potential 5-wave down to finish it's decline as long as 77.48 is not violated by more than 3 ticks.  What I have a hard time explaining to some followers is the effect of dollar weakness on stock prices.  As long as dollar is weak stocks will avoid any waterfall decline.  If a new buy signal is issued in the DX 90-minute M/A by advancing .45 beyond the M/A on a 90-minute close then stocks should already be approaching their own critical support break. 






The Gold Standard
In convertible markets the inelastic supply of gold would alter the general price level of all countries to achieve equilibrium in manufacturing and services sold.  High imbedded costs meant a general decline in the level of prices for all goods and services for a country because the level of imports would exceed the level of exports and gold would flow out.  The amount of money would decrease and every product would decrease in price in terms of specie per unit sold.  This would also have a depressing effect on the overall level of economic activity.   If government programs were a source of increased imbedded costs due to programs redistributing wealth then government revenues were themselves merely a flow of specie and if the costs associated with the programs exceeded revenues then bonds were sold not convertible into specie directly.  However, the amount of debt issued increased the manufacturing costs because taxes would be increased to pay the increased interest expense and debt repayment.  This would have the effect of causing gold to flow out as exports decreased and/or imports increased and would suppress the general price level and overall economic activity.  Thus, it was a given that increased debt as a % of GDP had the effect, after the initial purchases of goods, of diminishing economic activity.


The Uncle Ben Standard
When the Fed seeks to influence market sentiment by money creation it has the power to do so until the Fed itself becomes over-extended and reduces it's market operations to neutral. In the history of the Fed this is the first period of prolonged money creation without a bear market as a justification. Since the 1930's, loan activity followed Fed rate policy and open market policy (credit followed money). Ben is a student of the 1930's and is doing what academics have published should have been done in the 1930's. The fact that this is a different economic environment is irrevelant. By 1937 debts had been liquidated and the overall level of indebtedness was very low. Today debt is increasing from an historically high base. Credit is not the solution since lenders and borrowers do not wish to increase their already high risk. If credit is not the solution then money is not the solution, if economic stimulation is the goal. The other effect is to suppress the dollar. As long as the balance between excessive money growth and external capital flows rewards dollar outflow then stocks and commodities will catch bids by leveraged speculators playing the carry trade. They borrow money cheap in dollars that are depreciating and buy anything that trades in dollars, anything. How long this game can go on is dependent on how long they have ready access to ultra-cheap dollars. The catchup in carry trades happens overnight with leveraged positions unwound in global futures and currency markets. Left to their own devices the markets would have already been flowing into the dollar as dollar-denominated markets declined.