Weekend Strategy Review October 23, 2016

Posted by OMS  at October 23rd, 2016

The Dow fell 17 points on Friday, closing at 18,146.   It was up a whole 7 points for the week.  The NASDAQ finished up 16 points on Friday and up 43 points for the week.

For a while, Friday’s early decline in the Dow appeared to be the start of an impulsive move down.  But once support at the 18,050 level was reached, the market started to bounce and the Dow finished within its trading range.  The rally had all the markings of a Fed intervention, keeping the averages propped up before the election.

Given that the election is now only about two weeks away, it appears that the equity markets will remain within this trading range until the election is decided.  Additionally, because stocks have trades sideways for almost three months now, causing the Bollinger Bands to tighten significantly, it’s likely that once the uncertainty surrounding the election is over, the market will experience an outsized move.  At this point, the patterns are no help in predicting the move because the breakout could be up or down.

For the past few days, we’ve seen several gold and mining stocks start to appear on the Dean’s List.  But because UUP, the Dollar ETF has also been on the List, I’ve been saying that we probably won’t see a rally in gold until the Dollar starts to fall. This is because of the historical inverse relationship between gold and the Dollar. Well, after looking at several things this morning, this may or may not be the case right now. In other words, we could be at a point where BOTH the Dollar and gold rise together.

We saw this happen immediately after Brexit, when traders bought the Dollar as the Pound fell.  But worried European investors also bought gold and U.S. Bonds because they were perceived as relatively ‘safe havens’.  This could happen again.

In yesterday’s Comments, I talked about the sideways triangle pattern that has been forming in the Dow since mid-July. I believe this pattern has formed because most traders are not willing to take major positions with an election on the immediate horizon.

However, one thing that appears clear even before the election is that the policies that both candidates are talking about will likely result in more government spending. And to do this, they will need to borrow or print even more money to support this spending.  In other words, the policies of either candidate should be positive for gold. 

Looking beyond November, any interest rate hike in December will likely be tempered.  I believe it will probably be a face-saving, one and done situation, again depending on who wins.  Rate increases tend to support the Dollar, even if they are one time affairs.  But the Dollar will likely remain firm for other reasons.  This is because once the U.S. election in November is decided, the markets must deal with the French Presidential election early next year. And as we have seen with U.S. markets since July, this election uncertainty will likely keep a cloud over French and European markets. So even after November, there’s a lot that will need to be decided in Europe over the next 6 months.  Like Brexit, the French election will be a referendum on European immigration, social policies, and the economy.  The French election will likely pressure the Euro and ultimately decide the fate of the European Union.

We’re at a time in history where besides the Euro, all the major currencies in the world are being challenged. The British pound and the Yen are also looking weak, which supports the Dollar. Since Brexit, the Pound has fallen over 18 percent against the Dollar, and is now at its lowest point in 30 years. So even though the Dollar continues to have its problems, plagued by a massive debt over $20 trillion, it’s still the strongest currency when compared to most of the others.  We might be in one of those unique times, when for the intermediate term, both the dollar AND gold rise together.  It can happen. 

The other thing I’m watching closely is oil. For the past week or so, many energy stocks and ETFs have been moving to the top of the Dean’s List. I can ignore this!  The question is why?

When I look at the available crude oil in the world, there certainly appears to be plenty of supply.  It does NOT appear that a decrease in supply is why crude oil is rising.  There are all sorts of producers, including the U.S., who can supply the world with crude.  So IF supply is not the problem, what could cause prices to rise?  Or looked at another way, why are so many oil and energy issues now on the Dean’s List?  Hmmm?

Maybe things are not what they appear to be.

Here’s my take. There’s no doubt that the recent announcement to cut production during the meeting of OPEC meeting in Algiers has resulted in a pop of crude oil prices. But will this continue?  If prices are going to continue to rise, the producers must agree to limit production.  Will the do this?

That’s the 64K question.

In my opinion, the answer is yes. As I’ve been saying for several months now, I do NOT believe that crude oil below $50 per barrel benefits any of the major oil producing countries.  Not the Saudi’s, not OPEC, not Russia, and NOT even the U.S.  The entire world would like to see higher, not lower crude prices.

Remember, the Russian budget is based on $96 crude. The Saudi’s need to see crude above $60 to make money. Most U.S. frackers need oil between $70-$80 per barrel to be profitable. So you need to ask yourself, will the Saudi’s continue to engage in destructive tactics that will continue to lose money? Or will they embark on a path that will allow them to be profitable?  I believe it will be the latter. Crude oil prices in the $60-68 range will allow the Saudi’s and most OPEC members to make money, but keep the Russians, Iran, and most U.S. frackers under pressure.

This is why I have started to accumulate a few Call options in USO.  I bought the 20 January Calls with a strike price of 12 in the 0.56-0.60 range.  I’m betting that crude prices will be above $60 by early next year. And if crude continues to move higher, next March-April could produce some really nice energy trades.

Have a great weekend.

That’s what I’m doing,

h

Market Signals for

10-24-2016

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