The publication for trading and investment professionals

eNewsletter

10 September 2012

EXCLUSIVE
Larry Williams Interview

Legendary commodities trader, Larry Williams, talks exclusively to the Technical Analyst about his approach to trading oil and gold.

View the online interview >

Larry Williams will be speaking via video link at the City Book Fair taking place in London on November 12th, www.citybookfair.co.uk.

Trading in Trendless Markets

Murray Gunn, head of technical analysis at HSBC, discusses how best to trade in today’s market environment.

Looking at the medium-term time frame (multi-week), most markets have been in non-trending mode. However, with range contraction and expansion being mean reverting the conclusion is that trending modes are coming up.

In a sideways market that is showing little volatility, the Relative Strength Index (RSI) and Stochastics are still the most robust oscillators to use. As with all oscillators the best signals come with divergence between the indicator and the price. In stock markets, we also like a breadth indicator of percentage of stocks above a short-term moving average to determine extremes.

We also look at Elliott Waves, as in, for example, EUR/USD (see Chart 1 below). The EW cycle is still pointing to lower levels in EUR/USD – even towards parity over the next year. The very long-term wave cycle is positive though. Despite talk of the ‘politicisation’ of this market political events and news flow have no bearing on the chart analysis. It is the market’s job to anticipate the future and that is why price movements frequently occur before a news event.

For market volatility I use what I call ‘trading regime analysis’ which is a look at the various measurements of volatility in order to anticipate whether a market will be in trending or non-trending mode. We use it to determine position sizing and also as one of our filters in determining the likely Elliott Wave cycle. For instance a very strong range expansion is likely to be a third or C wave.

Basically, the difference between short dated and long dated volatility can be a good indication of trading regime, because it is essentially measuring how fearful or complacent a market is. If short dated volatility is high relative to long dated the market is in fear mode and range expansion will probably be occurring. When it is the other way round, the market is very complacent and ranges will probably be tighter. At extremes of the curve difference, a regime shift is likely to occur. This approach can give you an edge in anticipating the market environment instead of merely reacting to it.

Click on thumbnails below for Chart 1: EUR/USD Elliott Wave Analysis

Silver or Gold?
A Look at the Mint Ratio

Rashpal Sohan, asset allocation analyst at Rathbones', takes a look at the mint ratio and explains why he thinks gold remains the better longer-term hedge against economic uncertainty.

The Mint ratio measures the price of an ounce of gold to the price of an ounce of silver. The name bears a legacy from the time the United States mint used both gold and silver for coinage, establishing an official exchange rate – mint ratio – for these precious metals.

Chart 1 below shows the Mint Ratio plotted over the last 40 years (1972 – 2012). Of note is the secular uptrend in the Mint Ratio from 1978 – 1990, highlighting a period in which Gold prices outperformed silver (red line) and the reversal in the that trend since – highlighted by the dotted blue line. But these trends do not exist in isolation, and are instead punctuated with shorter cycles that can defy these primary trends for long periods of time. Over the last two decades alone, there have been at least 3 cycles – 1998 to 2003, 2007-2008, 2011 to date – in which gold has outperformed silver, moving contrary to the grain of the secular trend. More recently, the break in the Mint Ratio below its 40 week moving average has many investors questioning whether it’s time to be piling back into silver over gold? I don’t quite think so, and I’ll explain why.

At face value, I believe the secular trend established in 1990 will hold, with silver prices continuing to outperform gold over a multiyear horizon, especially considering we haven’t quite seen the exponential blowoff phase in precious metals as was the case in the late 1970s. However, I still view the recent move in the mint ratio as a short-term tactical trade opportunity for investors with a higher risk appetite to buy silver rather than a longer term investment opportunity given the current economic climate. Silver, like Gold, has broken out of a long running consolidation wedge pattern on the back of expectations of further monetary easing by the Fed (as per Ben Bernanke’s August 2012 Jackson Hole speech). Further easing is believed to lead to a weaker dollar benefitting silver, gold and other precious metals.

The economic recovery since 2008 has been one typical of recoveries seen post-bursting of financial and housing bubbles – weak and in need of constant intervention by policymakers to support growth. In this environment, tail risks remain high. It is no coincidence, for example, that the VIX index has settled at levels close to the ’98 Asian crisis and 2000 Tech bust and appropriate hedging is necessary to mitigate downside risks. Gold in this respect stands heads above Silver; Gold is valued for its relative scarcity and (perceived) safehaven properties during times of economic and market crisis, whereas silver has a similar bent, but is more sensitive to the whims of the economic cycle owing to its greater industrial usage (over half of silver produced is used in industry and photography whereas the same figure for gold is around 10%). The beta of Silver relative to Gold, for example, currently stands at 1.6, meaning it’s 60% more volatile. Add to this the more frequent speculative attacks which silver comes under (think back to early 2011) and it’s understandable why Gold makes for a better hedge against downside risks.

In short, while I believe the trend in the mint ratio could continue in favour of the continued outperformance of silver prices over Gold, I still see this move as more of a tactical trading opportunity for investors and traders with a higher risk appetite. For investors looking to precious metals as a hedge against economic and market risks, I advise sticking with Gold.

Click on thumbnail below for Chart 1: The Mint Ratio since 1972

T: +44 (0)1483 573150 E: enewsletter@technicalanalyst.co.uk

© 2012 Global Markets Media Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by an means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of Global Markets Media Limited. While the publisher believes that all information contained in this publication was correct at the time of going to press, they cannot accept liability for any errors or omissions that may appear or loss suffered directly or indirectly by any reader as a result of any advertisement, editorial photographs or other material published in The Technical Analyst eNewsletter. No statement in this publication is to be considered as a recommendation or solicitation to buy or sell securities or to provide investment, tax or legal advice. Readers should be aware that this publication is not intended to replace the need to obtain professional advice in relation to any topic discussed.