Gold Price

Since late 2014, I had been thinking that the price of gold might stage a nice and tradeable counter -
trend rally over the second half of this year. There was the usual seasonal pop in early 2015 as gold
piggybacked seasonally strong action in the oil price, but the action over Half 2' 15 has lacked any
zip. Gold Price

With the global economy growing slowly and continuing evidence of excess capacity in industrial
production, key gold price indicators such as the oil price, sensitive materials prices, and the CPI
have simply not supported the traditional inflation hedge strategy for gold. Moreover, the $USD
has remained elevated and the US monetary base has continued flat. As outlined in the post just
below on stock market fundamentals, I expect some improvement in key gold price indicators such
as a higher average oil price, a rise in the CPI, and for good measure, a weaker $USD, as we
progress through to the end of 2016. Since the expectations outlined below are not at all dramatic,
gold traders will have to count on the inherent volatility of the gold $ more than they normally do
even if the projections are ball park.

The painful process of mothballing excess industrial capacity could take an extended period of time
so it will be vital to see at least a modest increase in global economic demand to generate much
trader interest in oil, commodities generally, and PMs.

Stock Market -- Fundamentals Through 2016

My little business outlook through next year would ordinarily be regarded as the plainist of plain
vanilla, but in today's sloppy environment, it seems positively heroic. There is sufficient monetary
liquidity / credit availability in the US financial system to support business sales growth of 5%
and SPX net per share growth of 6% by year's end 2016. This estimate includes improved physical
volume growth and an increase in pricing power from 0% today up to 2%. I expect the WTI oil
price to average in the mid - $50s per bl. and for global economic supply and demand to come into
modestly better balance as demands lifts a bit and on an expectation that shut ins of unprofitable
capacity accelerates. I am looking for the $USD to lose ground down to the 85 - 90 area and for the
the Fed Funds rate to rise up to 1.00% by year end 2016 as the Fed gradually restores normalcy
to the system. The key assumptions in all of this is that US monetary velocity or turnover stabilizes,
and that consumer, business, and banker confidence will support it.

I figure that SPX net per share will increase from $115. this year to $122 next year and that the
p/e ratio for 2016 will be at 17.7x. Thus I look for the SPX to close out 2016 at about 2160 or
modestly above the earlier in this year record close of 2135. If these projections are well in
the ball park on profits growth, inflation and the Fed, the market could receive an extra boost
from significant rotation out of bonds into stocks.

I do have a simple fair value model of the SPX based on longer term assumptions of business
volume growth, the inflation rate and earnings plow back rate. The model has the SPX fairly
valued at 1870 for 2015 and 1985 for 2016.

Every 7 - 10 years the world seems to go through a period when Murphy's Law -- Whatever
can go wrong, will -- begins to nip away at our institutions, economy  and markets. The US
stock market has sometimes sailed right through these periods, but you folks need to be extra
vigilant in the years straight ahead to see where Old Murph might surface, and what disturbing
developments might do to confidence and the markets. We are definitely moving into a period
where shit assuredly happens!
 

SPX -- Weekly Technical

The market remains in correction mode and continues on an intermediate term sell signal. Recent
 price action does throw the idea of a quick spike or "V" bottom as occurred over 2012 - 2014
into doubt. My longer term, smoothed momentum indicator is at a mild -4. This compares to a
mild -7 at the worst of the 2011 correction, but does show the market to have near term vulnerability, 
 even if it was to subsequently recover and move well higher in the months ahead.  SPX Weekly

The chart shows significant technical damage to the SPX. The evidence on the chart is not sufficient
to imply that a bear market has begun. Simply look back at 2011 and also recall the fierce, positive
whipsaw that happened in the latter part of 1998. However, even if the market recovers and moves
on, the protracted deterioration of momentum as seen in the MACD  panel of the chart, suggests a
rapid and dramatic positive reversal in MACD would be the less probable case.

The bottom panel of the chart shows the intermediate term stochastic. It is giving an oversold reading.
The norm is to get two of these a year and they are often tradeable even in a more marked downturn.
This is the first one since late 2012. An oversold stochastic reading can whipsaw, but they are always
interesting and require attention.

The reasonable possibility of further near term market weakness notwithstanding, I am guessing that
the market will experience another extended, but mild upturn which could carry to a new high for
the SPX. This is based on a fundamental judgment as opposed to the current technical position of
the market and I would not bet on it until we see positive reversals in the indicators shown on the
chart.

SPX -- Daily Chart

It has often been said that the current bull market has been one of the unhappiest in history. It is
true that there has been a continuous litany of caveats, complaints and criticisms. With QE 3,
most of the querulousness was swept aside as the market made a tightly drawn beeline nearly
relentlessly higher. With termination of all QE by the Fed in latter 2014, the path of the market
has been more tortured. Without the big tailwind of a huge period of liquidity growth, the worries
and insecurities of investors and traders have resurfaced. The economy has returned to sluggish
growth, the Phillips Curve (falling unemployment leads to increasing inflation pressure) has been
absent, and the Fed has been talking about returning monetary policy toward normalcy with boosts
to short term rates while the economy continues not to behave normally. With the substantial drop
in the market going into Sep., and a subsequent struggle to recover, market consensus has
dissolved and insecurities reign. SPX Daily

The SPX is no longer oversold short term on a momentum basis. I am partial to momentum
measures on an intermediate term basis and the extended time measures of RSI and MACD are
still deteriorating on a trend basis. So, I have the market on a technical sell signal, and since these
are trend following measures, there is precious little chance I will catch the bottom if a more
sustainable rise occurs.

Other favorite indicators such as the TRIN and equities only put to call ratio contine to signal
that the market is at a substantial oversold position with an elevated p/c ratio and strong selling
pressure captured by a rising by a rising TRIN  

Note also the progressive decline in the % of SPX stocks selling above their 200 day m/a's
(bottom panel) to an oversold position.

These oversolds are tempting and suggest a stronger market is out there in the not so distant
future. The problem is that when players have a welter of insecurities, churning volatility can
continue on for several weeks. (As noted above, I will probably miss the low).             

Monetary Policy

2015 marks the sixth year of economic recovery. Yet, it was not until the late summer of 2014
that the expansion was mature enough to warrant an increase in short term interest rates. The Fed
passed on those moments. Now, the indicators that have best worked in the past to forecast that
a rise in the Fed Funds rate (FFR) was timely suggest that, if anything, the FOMC  should take a
step to ease monetary policy. Production growth momentum has been slowing, capacity utilization 
indicates continued slack, banking system liquidity is ample, and the demand for non - financial 
commercial paper has begun to ease.

With a slowing economy based on monthly data, the Fed was correct to pass up a chance to raise
the FFR in 2014 when economic momentum was strong. Here we are now with a sluggish economy
and little if any inflation impetus. Since the economic recovery began in early 2009, the pace of
expansion has slowed significantly in the wake of each QE termination. The monetary policy
factor that has dogged this economic recovery has not been interest rates, but periodic turn offs
of the liquidity tap.

The question of raising the FFR now seems more of an academic issue than a genuine economic
one. Now one could argue that if the fate of the continued progress of global expansion hangs in
the balance because of a 25 basis point increase in the FFR, we have perhaps been deluding
ourselves over whether the world can climb all the way out of the economic hole we dug for
ourselves earlier in the prior decade. So, from an economic perspective, maybe a couple of bumps
up in short rates will not prove very destructive at all.

My concern with monetary policy is whether consumer, business and lender confidence will remain
strong enough to transition away from economic growth driven by central bank expansion of
monetary liquidity to progress fueled by internally generated funds from economic activity boosted
by the continued private sector credit growth. My preference would be to monitor how this
transition is proceeding before pushing up the FFR especially since private sector liquidity appears
adequate to support it. Let's first  see if industrial output can regain momentum with rising operating
rates and if the consequent cyclical pressures start to push up the inflation rate.

Do Not Forget Commodities....

The commodities market remains cheap. Since 1970, the CRB Commodities Composite has spent
precious little time below 200, where it sits now. Granted, that which is cheap can remain so or get
even cheaper. However, since the direction and momentum of the commodities market tends to lead
inflation or, deflation, and since the way commodities go can have a major impact on the general
price level, it may be worth your attention now. CRB Weekly

The top panel shows the yr/yr % change for the weekly price. A 52 week decline is very substantial
by historical standards and it is worth noting that the flattening out of negative momentum through
2015 happens to coincide with a topping pattern for the US dollar (the dollar still rules in the
commodities market). A further run - up in the dollar in 2015, should it weaken the CRB further,
would strengthen the outlook for eventual global deflation, which would be a very undesirable
outcome given the still elevated level of debt leverage in the world. I like the USD long term, but
think it is well overdone to the upside at the current level of 96. It is reasonable down in the 87-88
area in my view.

The CRB and other broad commodities composites remain heavily oversold and are at large discounts
to fair value measures based on cost of production plus a reasonable measure of profit (For more,
see Commodities Market from 7/30/15).

Check out the bottom panel of the chart. It shows the relative strength of the CRB compared to the
SPX. It does not get much lower than the .10 you see there, and since the continuation of the RS
line at .10 extends beyond the downtrend line for RS since the summer of 2012, we might be
looking at an interesting situation, relatively speaking.

US Stock Market

The Correction 
When I look back on the suddenness and violence of the recent price decline, I still do not see the
sharp outlines of an oncoming iceberg that made the other guys jump ship. Naturally, the history
of the market is littered with price corrections, and Lord knows, one was perhaps long overdue.
However, I still think the guys jumped ship too early.

The correction has greatly widened the playing field as seen on this daily rendition of the SPX 
The market is currently challenging the steep downtrend in place, but with the employment report
and a three day weekend just ahead,  players could wait for the unofficial end- of-summer return
of the heavy hitters next week from holiday. Given the new broader range for the market, an
elevated VIX (bottom panel of the chart) seems appropriate.

Valuation
The basic market directional fundamentals I use to judge the market are still intact in favor of a
rising SPX although liquidity growth is far less robust. On that score, I ended my low risk
view of the market in the closing months of 2014. At the SPX high of 2135 set earlier this year,
the market traded about 19.5x 12 months net per share. That is an elevated level by any sensible
long term measure. However, although a p/e ratio has substantial empirical content, it is also
heavily influenced by investor confidence. Because of this psychological element, it is very hard
to use valuation successfully to time the market. And so, in this case the market received a quick
p/e haircut on rapidly waning confidence (I hope that players do not go for a buzz cut and bring
the market below crucial support in the low 1860s on the SPX).

I do use a valuation measure based on long term trend earnings and I give heavy weight in estimating
a 'fair value' p/e level based on a  long term measure of the earnings plow back ratio (Higher plow
back implies faster longer term earnings growth and a higher p/e multiple). Long run trend earnings
for 2016 stand at SPX $117 a share, and my fair value p/e based on a 60% plow back ratio is 17x.
So I see the SPX as reasonable at about 1990. Note too, that the previous high of 2135 did not
represent a significant overvalued level with my approach).

Concluding....
There is fear in the market and with guys like me, there is quizzicality. In turn, my indicators show
an impressive oversold condition is also in place. We will just have to see how it all plays out.