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Geopolitical market update

Perhaps the most interesting aspect of the market action over the last two months has been the persistent resilience of the stock market as it has largely recovered from the fearful expectations that were present in late August.  If you remember, the morning of August 24th saw the Dow Jones Industrial Average open down more than 1,000 pts before recovering intraday.  Immediately afterwards, many analysts were predicting the market would make lower lows.  In the 2 months since the panic climaxed on August 24th, we can looked back and see the market has stabilized.

Just because the market has stabilized, doesn’t mean that the risks that were present in late summer no longer exist.  China is still mired in a substantial economic slowdown.  The Federal Reserve’s Keynesian monetary policy has Janet Yellen and the FOMC boxed into a corner.  Similarly, Congress game of playing “kick the can” with the national debt ceiling is looking more and more like “kick the grenade.”  The Eurozone remains a complete disaster with deflation strengthening its grip as the continent braces for the cultural and economic impact of the largest migrant crisis to hit Europe in hundreds of years.

These geopolitical developments are real risks to the global economy and are likely to persist in the years ahead.  Sovereign governments around the world, because of their general irresponsibility and fiscal mismanagement, are facing massive liabilities and potential insolvency.  The depressed price of oil is going to exacerbate an already volatile political climate in the Middle East.  With all these major geopolitical risks combining to create an almost perfect storm of economic turbulence, it is important to consider the U.S. dollar as the asset most likely to outperform well during a possible season of crisis. The dollar remains the reserve currency of the word has recently signaled that it is ready to resume it’s advance relative to other global currencies.

GFC_OCT1

Since March of this past year, the dollar has been in a major sideways consolidation pattern.  The specific type of pattern where price has a significant rally and then goes sideways is called a “Flag-Pattern” or in this case a “Bullish-Penant” and it is a common type of continuation pattern.  We at GFC expect the dollar to rally in the months ahead and to ultimately climb to new highs as the U.S. dollar is likely to benefit from its perceived safe-haven status.  With all the current geopolitical risks still in need of reaching a point of resolution, the dollar is likely be the main benefactor of international capital flows in 2016 and beyond.

Fed’s rate decision impact

This past week saw increased volatility as the Federal Reserve predictively decided to maintain interest rates at zero percent.  It was the 55th consecutive time that the Federal Open Market Committee met and agreed that the cost of money lent to banks should be free.   This unprecedented period of easy monetary policy by the Federal Reserve is a sad commentary on the health of the U.S. economy.  GFC forecasted the FOMC’s rate decision 5 days in advance via our new Twitter Feed!  GFC invites you to follow us on Twitter for important market tweets and commentary.   https://twitter.com/GeoFrontCapital

Inside the FOMC’s released statement they explained their rational for leaving interest rates unchanged, citing global economic instability, recent market volatility related to China’s contraction, and inflation levels below their preferred target of 2%.   The only dissenting Fed vote came from Richmond Fed President Jeffrey Lacker who voted for a rate hike of 25 basis points.   The near unanimous decision reflects just how worried the Fed is about a potential negative market reaction. We at GFC suspect the Fed is also concerned about the prospect of a strengthening U.S. dollar which would serve to exacerbate foreign capital flows coming out of Europe and into the U.S.   The goal of successfully deflecting foreign capital flows into the U.S. dollar is conceivably the Fed’s #1 goal at this time. Rising interest rates would likely strengthen the dollar, make it harder for debtors to fulfill their financial obligations, and therefore contribute to an increase in domestic deflation.

As our readers are aware, GFC has maintained a bullish stance on oil for the last 3 weeks since it broke out above its downward sloping trendline.   After spiking about 30% from the low, oil traced out a triangular consolidation pattern.    Triangles are typically continuation patterns, meaning they break out in the direction of the prior trend which, immediately before this triangle formed, was up.   As you can see in the oil chart below, oil broke topside out of the triangle on Wednesday and climbed to $47.69 before reversing. Often times when prices break out of important trendlines, they often revert back to the trendline to test the breakout’s validity.

fed_rate_decision_Sept2015

Oil sold off after the FOMC rate decision and retested the trendline by forming an intraday low at $44.22, which is the precise location of the former triangle resistance line, which is now support.   The support boundary of the triangle created a lot of support in the $43-45 range and this most recent low appears to be an ideal place for oil to continue rising toward $50 a barrel.  If oil is able to close below $43.50, then our bullish interpretation would be invalidated.

Another commodity that GFC has a bullish outlook on is gold.  We believe gold made an important bottom on July 20th at $1,071 an ounce.  From this low, gold rallied almost $100 to $1,170.  Over the past 3 weeks gold retraced about 2/3rds of this $100 rally and made as late last week resumed it’s climb upward from $1,099.  Gold seems to like the Fed’s decision to keep the cheap money flowing as it climbed more than $25 in the wake of the FOMC’s rate decision.   In the 4hr Chart you can see that Gold traced out an impulsive  5-wave Elliott sequence and is then declined in 3 waves into the $1,099 low.   GFC believes gold is in a 3rd wave which is the most powerful wave and should draw gold significantly higher to over $1225.


fed_rate_decision_Sept2015-4

Additionally, Gold created a bullish engulfing candle on the weekly chart and also of importance is the fact that MACD closed the week positive.   Considering the wave structure and the prospect of a delayed Fed Rate hike into the foreseeable future, the prospects for gold to rise in the weeks ahead look promising.  Near-term, gold may experience a slight retracement early next week, but GFC expects gold to climb much higher over the intermediate term.

fed_rate_decision_Sept2015-2

The most volatile response to the Fed’s rate decision arguably occurred in the FX markets.  The dollar initially sold off as expected immediately following the news.  However, today the dollar rallied ferociously and looks poised to continue its surge.   The Euro makes up over 47% of the US Dollar Index which is comprised of a basket of global currencies.  Because it accounts for such a large share of the weighting within the index, it is often referenced as a reliable proxy for where the dollar is headed next.

fed_rate_decision_Sept2015-3

The EURUSD has been consolidating slightly upwards for the last 6 months ever since it made a low at 104.62 on March 13th.   The consolidation since then has been very ugly with no definable trend.  Last month EURUSD made a high of 117.13 and sharply reversed.  There is a potential that today’s price action signals the resumption of EURUSD’s imminent decline.   Ultimately, GFC is expecting the Euro to fall below parity with the dollar and potentially much lower.  If prices are able to close below the recent upward trendline it would signal that the next significant selloff in the EUR is underway.

NEWS UPDATE:  GFC will be offering paid subscription services providing weekly market commentary, insights, and analysis starting in January 2016.    For more information on how to subscribe click here.

Tesla’s numbers don’t add up

A recent post in the Wall Street Journal highlighted some of the shortcomings of Tesla Motors, the darling tech startup which has continued to gain traction as its stock soars sky-high.  However, as this article and others point out, there are some deep concerns investors should be aware of in terms of long term sustainable growth.

Highlights:

  • Precipitous cash burn rate for multiple capital intensive initiatives, increasing operating expenses.
  • Model 3 will be competing with other major established manufacturers, and other electric vehicles with similar technology have struggled.
  • Tesla is depended on Li-ion technology, which has potential technology and future supply issues.
  • Tesla Powerwall is simply not competitive in today’s market with cheap reliable electricity.

First and foremost is the issue of cash flow.  With its stock near all-time highs, this summer Tesla was able to secure $750M revolving credit agreements with several banks, which should give it some more flexibility for near-term goals.  It will likely need to tap these finances as costs continue to rise.  2015 Q1 results showed Tesla ending the quarter with $1.5B left on its balance sheets, compared to $2.3B in September of last year.  For its most recent quarter filing this burn rate continued unabated when Tesla showed it had just over $1B of cash and equivalents remaining.  This volcanic burn rate is combined with a number of incredibly capital intensive initiatives.  Tesla is planning on releasing its new Model X later this year and is ramping up development of its upcoming Model 3.  Car production, let alone car development, requires ample cash flow to survive.  Tack on the new residential and commercial storage products announced this year along with the building of the Gigafactory, a new battery factory, and Tesla (and its investors) are leveraging a hefty bet that its new cars will be a hit.  Even with the new Model X selling well by the end of the year, Tesla will continue to burn through cash and will more than likely need to secure additional financing.  With its stock continuing to climb, it is very likely Tesla will look to tap additional funds by issuing additional shares.  This dilution, depending on the size, will most likely have mixed reactions from investors.  Up until now investors have been betting on Tesla based on its ability to deliver an innovative product.  Now investors are starting to take a hard look at the numbers and are anxious for stability, especially for life beyond Models S and X.

Model 3

Announced a little over a year ago, the Model 3 is Tesla’s continuation of the product line and philosophy of starting with luxury cars and moving to more affordable mass market vehicles.  This new model is expected to be priced starting at $35,000 before subsidies, which puts it in competition with the BMW 3 series and Audi A4.  This poses a challenge for Tesla, as they begin to enter a lower price market they also are entering an increasingly crowded one.  Not only do consumers have a wide range of choices, they also tend to be brand loyal and nearly all major car manufacturers are in the process of releasing all electric cars.  In the case of the Nissan Leaf, sales were and continue to be sluggish.  Issues with battery degradation, range, and performance in cold weather climates have hampered sales.  Tesla will have to contend with these same issues as they expand, using the same battery technology as the Leaf.  Furthermore consumers who once had to deal with $4/gallon gas can now fill up for a little over half that.  Oil prices have continued to plunge as output stays steady, and Goldman Sachs and others are predicting continued depressed oil prices into 2016 and longer.  This adds to the decreased attractiveness of electric cars as consumers are still anxious about a vehicle which is still lacking in many categories.

Battery Technology

Tesla states their new Gigafactory would reduce production costs by 30% for their cars and Powerwall products.  The important distinction here is the reduction of production costs rather than an increase in efficiency.  Tesla is making a huge bet by committing itself to the current Lithium Ion battery technology which is in a continual state of refinement and development.  As new Li-ion technology comes on-line, Tesla will need to continually update its manufacturing process.  More concerning is the current world supply of Lithium keeping up with demand.  Lithium is also used in batteries for consumer electronic devices and in a number of other industrial products, such as lubricants.  As Lithium becomes more scarce, increasingly inaccessible sources will need to be tapped, increasing the price of Lithium.  This in turn will increase the price of batteries, which already accounts for a considerable portion of the production costs of Tesla’s cars.  Another reality is Li-ion batteries have a predefined life.  After a number of charging cycles they will no longer hold a charge.  No amount of maintenance can bring them back to life aside from a complete replacement which carries considerable costs.  By contrast, a conventional car can be incrementally repaired depending on the fault, i.e. a damaged head gasket can be replaced without replacing the entire engine.

Tesla Powerwall

Already there has been considerable criticism for the Tesla Powerwall since it was announced. It is worth noting first the device and concept itself is not novel.  Companies have developed similar solutions for residential homes which are partially or fully off the grid, or for other “green” applications tied with a solar/alternative energy source.  The problem is these systems never caught on – they remain a niche market for a simple reason: they are not economically viable and their capacity is limited.  Even with hefty state and federal subsidies, the residential application for this technology will be looked over in favor of cheap and reliable utility power.  Forbes Magazine calculated using the Tesla Powerwall in conjunction with solar panels would incur a cost of $0.30/kWh, compared to an average of $0.125/kWh for U.S. consumers.  This is a steep price gap which will not be filled anytime soon.  Furthermore, the current capacity of the Powerwall, 7kw and 10kw, cannot meet the demand of current U.S. homes even as they become more efficient.  With a typical residential AC unit, fridge, and other large appliances running, it is possible to drain a Powerwall within a matter of 2-3 hours.  Add in electric ranges, dryers, and heaters, and the Powerwall would drain even more quickly.  The Powerwall also has to contend with converting the stored DC electricity into household-usable AC electricity, a conversion which significantly reduces efficiency.  Add in the predefined life cycle, and the Powerwall will remain a toy for the environmentally-conscious rich.  Homeowners will be much better served upgrading their appliances for more energy efficient models and utilizing new energy efficient lighting technology such as LED.

Battery recycling, infrastructure, and alternatives

All of Tesla’s products have one thing in common – they all depend on Li-ion battery technology.  Although Li-ion batteries use less toxic materials than previous rechargeable battery technologies, a comprehensive strategy for recycling batteries needs to be developed, especially in light of a potential Lithium shortage.  Furthermore, the cost of infrastructure is enormous and often overlooked.  Building new charging stations and installing chargers in homes costs thousands of dollars.  The automotive industry would be better off adopting technologies which use existing infrastructure and can be retrofitted onto existing vehicles.  Biofuels can begin to fill this gap and are a cheaper, more reliable, and environmentally renewable technology.  In essence what Li-ion technology in electric cars is trying to replace is the gas tank, which is an obviously more complicated solution that what exists today.  As history has shown with the prospect of Hydrogen cars, technology is limited not only by costs of energy but also the method of storing that energy.  Unfortunately for applications like vehicles, gas is still a more efficient, cheaper, and more stable way to store energy than Li-ion batteries and will be for the foreseeable future.

Trend Reversal in Oil

This past week GFC published an article describing the possibility of a significant bottom in the oil market.  As it turns out, market observers didn’t have to wait long for the bullish price activity to commence.  From it’s low of $37.73, oil rallied 20% and closed the week at 45.27 after reaching an intraday high on Friday of 45.87.   Keep in mind that percentages always look larger when prices break away from smaller bases.  Nevertheless, we perceive oil’s recent rise to be of significant importance. A variety of technical indicators (MACD, RSI indicating bullish divergence, and the imminent break of a 2-month resistance line)  foreshadowed the most recent rise in oil and it has indeed been quite forceful. GFC forecasted the possibility of a significant increase in oil when we wrote:

“..if oil is able to solidly close above this recent 2-month trendline, it would signal an opportunity to enter into a long position and bet on a retracement rally which should be rather sizeable considerable the scope of the decline”  -GFC’s Update on Oil’s Decline 8/26/15

As the fate of the market would have it, oil proceeded to break this trendline during the very next trading day and the bulls haven’t looked back since.  Here is an update chart depicting oil’s break of the trendline.

OIl Reversal

MACD is now clearly indicating oil is in a bullish trend.  Furthermore, on this weekly chart below , you can see that this past week, oil made a new low when it bottomed at $37.72 and closed the week substantially higher at $45.27 which has formed a bullish candlestick pattern on the weekly chart.

Oil Reversal 2

The fact that this candlestick is forming after a 5 wave elliot-wave decline implies that oil has significant room to rally in the weeks ahead.   Ultimately, prices have the potential to retest the wave 4 highs in the $60 handle before the upward.  Oil speculators should now officially consider the new trading environment in oil to be amicably bullish and remain long this new trend until changing market conditions signal otherwise.  The rapid rise of the last two days represents massive levels of short-covering which has naturally occurred at what appears to be the exhaustion of a 2-year decline.  GFC will update our readers when we believe the overall bearish trend is likely to resume.

Update on Oil’s Decline

The Chinese economic slow-down is sending huge shock-waves throughout the investment landscape.  Commodities in general have been crushed as fears over decreased demand from China breathed new life into the downward trajectory of commodity prices.  The price of oil has been declining since August 28th, 2013, when it made a swing-high above $112 a barrel.  Today, after a declining period of almost 2-years, oil is trading below $39 per barrel after a total percentage decline of more than 65%.  GFC has already alluded to the devastating implications this price decline is going to have on the domestic shale-producers and fracking industry as the price of economic viability for their industry is between $60-70 a barrel.  Our research has also revealed that almost 20% of all corporate junk-bonds belong to the energy industry.   When these bonds come due, we are likely to see a wave of corporate defaults directly related to the prolonged and depressed price of oil.  However, against the recent backdrop of this historic oil decline, there are positive technical signs that oil is close to a bottom and a sizable bounce is very possible.

Looking at a recent daily chart of oil, you can see that on June 24th, oil’s decline began to embark on another leg lower which has been a sustained decline.   Furthermore, this decline over the past two months has formed a very valid trendline which has acted as resistance on 4 or 5 separate occasions.  Additionally, on the daily chart, the MACD (Moving Average Convergence Divergence) indicator is still indicating a bearish trend.  However, it is also very close to potentially turning to bullishness.  Additionally, if oil is able to solidly close above this recent 2-month trendline, it would signal an opportunity to enter into a long position and bet on a retracement rally which should be rather sizeable considerable the scope of the decline.

Aug 2015 Oil 1

 

Looking at oil on a weekly chart, we can see that oil has traced out a 5-wave decline from August of 2013.   Wave 5 is currently nearing its ending point.   The price of oil has been trading as though it is intent on testing the January 2009 low around $33 which was carved out during the financial crisis.  While we at GFC predict the price of oil to ultimately break though the 2009 low , however we  currently view the 2009 low price area as an attractive level for oil to stabilize and mount a retracement rally.   As you can see on the weekly chart, the RSI (Relative Strength Index) is indicating a bullish divergence as price declines into this area.  Oil prices are making new lows, but RSI is displaying a lack of momentum and is failing to confirm these new price lows.

Aug 2015 Oil 2

Additionally, GFC’s proprietary oil contango index is indicating selling capitulation among major oil investors.  For the past few months oil contango levels have remained at relatively high levels indicating institutional entities were keeping elevated amounts of oil stored in off-shore tankers and were hoping to unload it domestically at higher prices.  Currently GFC’s contango index is indicating oil is being moved to market and sold at current prices which should serve to drive oil to new lows in the near future.    With contango levels showing more moderation, it seems institutional investors continue to be cautious about future oil prices.  Stabilization in these levels and an increase in contango should indicate a more bullish outlook for oil prices; this has so far not materialized.  GFC is committed to monitoring the oil market and will be sure to alert our readers when trading conditions in oil turn amicably bullish.

 

Global economic update

The month of July saw a marked increase in volatility in financial markets as the growing specter of deflation continues to looms large over the global economy.  The month started off with yet another new debt rescue deal which essentially placed another Band-Aid on the sucking chest wound that is Greece and the untenable Eurozone debt situation.  July also saw a continuation of China’s equity market collapse, which has so far erased more the three trillion dollars in market capitalization from the Shanghai Composite index.  Asian investors luckily experienced a brief pause amid the panic selling mid-month as Chinese government efforts, combined with the People’s Bank of China (PBOC), were temporarily successful in stemming the avalanche of selling.  However, by the end of the month, China’s equity markets looks as though it has effectively resumed its decline as the Shanghai Composite closed down over 8% on Monday, July 27th as over 1600 stocks on that exchange traded locked limit (10%) down. Despite unprecedented levels of intervention exhibited by the Chinese government and the PBOC, equity prices continued to fall this week amidst a new torrent of selling.

Recent price action in Asia may offer a clues to potential market dynamics Western investors are likely to experience in the future. It is important to understand that China’s equity markets were indeed in bubble territory earlier this year as the their share-markets experience over a 150% ramp up in just the last two years as they retested the pre-financial crisis highs of 2007.  Technically speaking, the Chinese equity market looks like has experienced a classic “Blow-off top” after an exponential rise.  Blow-off tops usually revert back to where the advance started, which in the case of the Shanghai Composite is SIGNIFICANTLY lower.  Currently the U.S. stock market does not appear anywhere near as susceptible to a decline of the same magnitude as China. However the recent market behavior within Asia is already creating shockwaves that are reverberating throughout the financial system.

Perhaps the most under-reported aspect of the Chinese slowdown is the effect it is likely to have on the demand for oil.  China is the 2nd largest economy in the world and has been largely accountable for the majority of new energy demand in the 21st century as its economy has boomed.  The recent slowdown in China represents a major headwind for the price of oil.   Additionally, with all the forced liquidations occurring within the Chinese equity market, one has to wonder what other assets might the Chinese begin to sell in their mad dash to generate cash?

The most attractive resource that the Chinese have at their disposal with the ability to generate desperately needed cash, is the $1.3 trillion worth of U.S. Treasury bonds they collectively hold.  Reports have recently surfaced that the Chinese have begun to unwind their massive positions in U.S. fixed income market. This development combined with the existing low levels of liquidity in the U.S. bond market presents a dangerous combination that may lead to sharply lower bond prices later this year.  GFC imagines there aren’t going be a lot of investors willing to step in and place a bid against the prospect of the largest holder of U.S. treasuries unloading their positions on the open market.  Add in the fact that this scenario could develop simultaneously with the prospect of a Federal Reserve beginning to raise interest rates for the first time in 9 years later this fall and you have a strong recipe for a significant sell-off in bond prices.

With China’s bull market experiencing a significant setback, the prospect for healthy global economic growth appears extremely dim.  The GDP growth rates for the United States and the Eurozone have been anemic as they’ve considerably lagged growth rates in emerging markets.  Additionally, U.S. inflation has consistently been recorded beneath the Fed’s inflation target of 2% since the financial crisis began.  Additionally, whatever inflation the economy has registered in the last 6+ years has largely been due to “cost-push” inflation where prices rose as a side-effect of increased taxes and a more burdensome regulatory environment.  This is in direct contrast to the healthy “demand-pull” type of inflation the fed is desperately hoping to achieve where prices rise naturally due to increased economic activity.

The next several years is likely to shed a bright light on the failure of central banks as well as sovereign governments in regards to their abilities to stimulate and manage the global economy and implement effective monetary policy.  The perceived omnipotence of governments and central banks in regards to economics and monetary policy is long overdue to be forcefully challenged, and rightfully so.  We at GFC will do our best to help our readers navigate the volatility which we fully expecting to encompass the global investment landscape.

The global interest rate lift-off has begun!

GFC has been monitoring the price action in global bond markets closely over the past few months, and the recent price action appears to be portending a dramatic rise in interest rates that should gain momentum in the second half of this year.  As many other prominent economists have pointed out, the global bond (debt) bubble is shaping up to be the mother of all bubbles.  Years of artificial manipulation from central banks has led to the lowest interest rate environment anyone alive on planet earth has ever experienced.  Conversely, the central governments which have mostly constituted Western civilization for the last 250+ years are about to drown in the sea of debt they have accumulated.

One of the defining characteristics of the systemic risk that is now readily apparent in the U.S. bond market is the shockingly low level of liquidity.  Dealer inventory for fix-income markets has shrunk since the financial crisis while mutual fund assets, ETFs, and other financial derivative products related to fixed income have grown dramatically in size and scale.  The attached chart from Citi depicts the precarious situation developing for anyone thinking about trading a substantial amount of bonds.

chart123123123

These liquidity conditions are sure to usher in severe volatility as it is unlikely that dealers will be able to maintain tight price spreads when everyone rushes for the exits all at once.  Eurozone bond yields have experienced dramatic moves so far this year.   Most noticeable are the cracks appearing in bunds, which are the German equivalent of U.S. Treasury bonds.  The interest rate on the 30-year German bund bottomed on April 17th when it yielded just 40 basis points.  However, earlier this month on June 10th it was trading at 1.629%! -A move of over 120 basis points in less than two months! Likewise, the rate on the 10-year German bund traded down just below 5 basis points in April.  It’s incredible that anyone would lend the German government money for 10 years and only required five one hundredths of a percent in return.  The default risk should alone should be higher than 5 bps,  but what bond traders are essentially saying is that the inflation risk in Europe has gone negative and they are staring the prospect of deflation squarely in the face.

During this time in April when global bond yields were near their lows, legendary investor Bill Gross, who holds the distinctive Wall Street title of being the “Bond King” called German bunds “the short of a lifetime.”  So far he has been 100% correct, and the 10-year German bond rallied over 100 basis points from it’s low as bond prices fell.  We at GFC believe that this past April was just the first of many opportunities to go short German bonds like Bill Gross did.  This is likely the first move in a new secular trend that will likely last many years into the future as government finances in Europe and United States begin to unravel as creditors realize that have been playing a fools game with short-sighted and fiscally irresponsible politicians.

Looking domestically to interest rates on the 30-year Treasury bond, we can see that since late January 30th rates for U.S. government debt have had a substantial move upwards.  Rates bottomed at 2.22% and recently made a high at 3.23%.  From the chart below you can see that during this move, prices traced out a 5-wave Elliott Wave impulse pattern which implies that the trend has changed direction. It appears as though the 5-wave impulse pattern is complete and we should now expect some type of an ABC correction to retrace this signature move.  The target range for the correction to end is highlighted in the green box in the chart below.  After this forecasted correction is over, it will most likely represent an excellent time to short bonds once again, with an even more dramatic rise in interest rates likely to follow later this year and into 2016.

chart2jkadljkasd

The low which was made earlier on January 30th,was likely the end of the a 34-year secular trend of declining interest rates in the United States dating back to 1981.  We at GFC cannot underscore enough how important the significance of this potential trend change is.  In layman’s terms, it means that the trend has changed from a 34 year environment where it had become easier and easier for the U.S. government to borrow money (which led to unmanageable levels of accumulated debt) to now an environment where it is going to be harder and harder for the U.S. government to borrow money as the cost of borrowing is set up to rise exponentially. From now on, the government of the United States is going to have a tougher and tougher time paying its bills.  If you are in the market for a mortgage, lock in a low interest rate now while you still can!  General expectations going forward should include widening budget deficits, an increased emphasis on tax collection, and extreme political upheaval.  The global interest rate lift-off has begun!

Market forecast update

In this update GFC would like to go back and remind our readers of some forecasts made over a month ago in GFC’s April 2nd article “Positioning for (Intermediate-Term) Dollar Weakness” and provide an update to how some of those forecasts have panned out.   Market dynamics are always fluctuating and we would like to update our readers on what market moves they should expect next.

The first chart shown below is when we advised our readers that a top in the dollar had likely occurred and that they should expect to see a weakening U.S. dollar index in the weeks ahead.

update1

Below is what unfolded after GFC made this market call….

update2

As shown in the above chart, shortly after this GFC forecast the dollar to weaken,  it finished retraced slightly higher and then dramatically sold off and prices immediately sunk to our cited target range.  In the near term we expect the dollar to bounce from this support level, but depending how volume characteristics evolve over the coming trading days, the dollar may have further to fall.  This was a minimum target objective that has been achieved.  If any compelling market opportunities develop regarding the dollar we will update you.

The next chart we would like to update is our forecast for oil.   Last Month GFC predicted oil to rally as believed it has formed an intermediate term bottom and was likely to rally as the dollar weaken.  After its initial bounce off the bottom, oil completed a 50% retracement which is where we predicted oil to rally to over $58 as seen in chart from April 2nd below.

update3

Again, this is what occurred in Oil after GFC predicted it to surge…

update4

Furthermore, it worth highlighting that while it was rallying, Oil formed a very distinct support trend-line which experienced multiple touched.  Zooming in on a 4HR chart highlight this support line which was broken yesterday.  We expect oil to substantially pull back to at the last the $56 area and possibly much lower over the intermediate term.

update5

Our forecast for a bull rally in gold has not materialized thus far.  We are still anticipating there to be a high probability that gold will attempt a rally towards the $1,300 level.  It should be noted that gold hasn’t broken down out of its trading range either, which implies that it has been build cause to rally soon.  We will keep monitoring these market developments as they occur and do our best to keep our readers posted.

Rally like its 1999

Despite a rocky start to the year, the NASDAQ and other indices are still trading at or near all-time highs.  Recently, GDP and other data suggest the economy is still struggling however, and despite the apparent recovery the Federal Reserve continues to keep interest rates historically low.  The rationale for this extreme measure – now 6 years and running – is often shadowy at best.  Economic data is inconsistent and notoriously unreliable and seems to be contradicting what the wider equity markets are showing.  However, there seems to be a correlation and the Fed’s plan is at least working to prop up the equity markets. But the reality is that cheap money not only leads to higher markets, but subsequently fuels bubbles.

One of the more memorable bubbles is the tech craze that took over the NASDAQ in the late 90s, producing gems like WebVan and even spilling over and enabling corporations like Enron.  Again, we’ve already seen incredible valuations for technology companies that have very little to no assets or physical goods, instead basing their valuation on IP and source code.  There is legitimate value in IP although that IP must drive operating profitability and this has seemingly become irrelevant – again – as companies like Twitter, LinkedIn, and Amazon have PE ratios measured in generations.  But this isn’t something new; we’ve been living in this environment for at least the past five years (if not longer).  Investors seem to be comfortable with the idea of a perpetually unprofitable company, provided their stock continues to rise based on either their potential or talent.  Many IPOs have come and gone since the financial crisis, and generally most have proven to be a success on the surface.  The Valley is still pumping out startups at a steady rate, but at what point will this growth become unsustainable?

One of the more recent startups that stood out from the rest is Magic, a service that at its core enables lazy people with discretionary income to text a service to get theoretically anything they want (sans illegal activity).  Basically, Magic will Google whatever service you’re looking for that is available in your area, mark up that service, and charge you a premium for the trouble.  Say for example you want milk and eggs.  Text Magic and they’ll contact Instacart or a similar service, charge you a premium and have the goods delivered.

We have trained operators standing by 24/7 to answer every one of your requests. Send us a text message, and we’ll get you what you want. We’ll order what you need from the appropriate service (e.g. DoorDash, Instacart, Postmates, etc.), and deal with them so you just automatically get what you want, like magic

This sounds like a good idea until you realize a similar system could easily be set up within a few hours using Twillio, a stock website template, and a few warm bodies to answer text messages.  Nothing (apparently) innovative was developed, no special AI to answer or fulfill requests, not even a dedicated app was developed.  What is more remarkable however is the funding this startup raised.  After completing Y Combinator and posting on hacker news, Magic received $12M in Series A funding from Sequoia Capital.  We’ve gotten to a point where a company with no assets, and now no substantial or novel IP, has closed VC funding measured in the millions.  It’s telling that Sequoia Capital has enough money to justify a $12M investment in a startup of this nature.  Cash has once again become incredibly cheap, and cheap to the point that investments are flowing into tech companies with little prospects for profitability and sustainability.

NASDAQ1

From a technical perspective the NASDAQ is looking prime for a pullback.  Recently both Twitter and Linkedin have posted less-than-stellar earnings, and cracks are beginning to show as the index tries to break through critical resistance.  The NASDAQ is perilously close to the all-time high set back in the 2000 tech boom and is showing signs of struggling to continue the upward trend.  As shown below, there are two critical resistance and support levels now in place, both at just under the 4800 level as well as the 4200 level. This chart also shows the development of Doji, further indicating resistance as the index remains close to the high set in early 2000.

NASDAQ Daily

Furthermore, the chart above shows trend lines converging to form a rising wedge, which broke through on the downside in early March.  The index then confirmed the lower trendline as resistance and then continued to break down further.  This indicates the trend which has developed since late 2014 is now over, and compounded with the additional resistance as the index reaches all time highs suggests the NASDAQ is starting to run out of steam.  But for this to be a confirmed reversal, sufficient selling volume will need to be seen, which so far has not materialized.  Until this is confirmed, the index may continue to test resistance until a breakout occurs in either direction.

A sovereign debt crisis Is brewing

The western financial system appears to be destined for a financial crisis of epic proportions.  The governments of Europe, Japan, and the United States have become flooded with debt, and these debts levels continue to rise to more unmanageable levels every single day.   The United States has incurred over $18 Trillion dollars of debt. If one considers future unfunded liabilities such as Medi-care, Social Security, and a vast assortment of entitlements promised to American citizens, then the number owed by the U.S. Federal Government is well over $100 Trillion.  With this is mind, a sensible person must begin to question: What is the viability of this amount of money every being successfully and honestly repaid?  Furthermore, contemplating the viability of a successful debt repayment against the backdrop of relentlessly unsuccessful sovereign debt negotiations in Europe should leave a person with a pretty concrete conclusion:  Western governments are going to drown in the sea of debt they have accumulated.

One of the greatest ironies that exists in the financial arena is the fact that the yield on U.S. treasury bonds are often referred to as the “riskless rate” or “risk-free” rate of return.  What makes this terminology so ironic is that that virtually every single government in the history of the world has defaulted on their debt.  There are very few exceptions. More specifically, from our preliminary research, GFC has identified a cyclical pattern of sovereign defaults that occur globally every 70-90 years on a large scale.  It should be noted that during WWII, almost all the industrialized nations of the world defaulted or came dangerous close to default.  This led to the creation of the Bretton Woods monetary system in 1944 where the United States assumed the leading role of managing the reserve currency of world.  That was 71 years ago,  and despite a clear history of cyclical defaults, financial professionals look at yields trading in the U.S. Treasury bond market and refer to them as “risk-free” implying there is absolutely zero risk of default.

Proponents of today’s sovereign debt levels contest that everything is manageable because we’ve successfully managed similar debt levels before.  It is true that during WWII, the last time the U.S. came dangerous close to default, the United States debt-to-GDP ratio exceeded 100% as it does today.   However, there were some stark fundamental differences between the debt accumulated during WWII and debt the U.S. government is on the hook for today.  GFC believes it would be beneficial to highlight these differences to the reader who may be unaware.  The differences are as follows:

  1. The debt sold by the U.S. Treasury department in the 1940s was predominantly sold to American citizens in order to finance and win the war. During the war the Treasury developed an incessant marketing campaign directed towards Mom and Pop investors urging them to buy war bonds.  Many patriotic Americans bought as many war bonds as they could afford in order to help do their part in financing the great conflict.  Today, very little of U.S. debt is held by average American investors.  Instead, much of the debt has been sold to foreign central banks, financial institutions, and foreign government creditors.  Therefore it is equally important to understand that the interest expense that is being paid on today’s $18 Trillion of debt is not necessarily being recycled into the American economy the way it was after the conclusion of the war, but rather the interest coupons are being exported out of the American economy. The debt used to finance WWII literally paid dividends stimulated the American economy until the 1970s as Americans collected a stable interest check for 30 years and were able to reinvest that money back into the American economy in whatever way they chose.
  2. The maturity duration of the bonds sold to finance WWII was long-term paper, generally close to 30-years which provided a great deal of stability for the Treasury. Today, much of the U.S. debt has been continually rolled over into shorter and shorter durations at lower and lower interest rates to where today the vast majority of U.S. debt resides beneath the 7-year mark on the yield curve.  This makes the debt we are carrying inherently unstable and highly sensitive to a change in interest rates.   If interest rates were to rise significantly, the Treasury would have to roll over a disproportionate share of the total debt in a relatively short amount of time which would drastically raise the cost of financing the existing debt.    To put that into perspective, it could be argue that today’s U.S. treasury debt is tantamount to the mother of all adjustable-rate-mortgages.
  3. The debt accumulated in the 1940s and the debt accumulated in the last 30 years were put to use in remarkably different ways. To win the war the U.S. invested heavily in industrial capacity, which later after the war was converted to commercial use. The U.S. became the largest producer in the world and subsequently became the largest exporter of manufactured products in the world.  The trade surplus achieved after the war undoubtedly helped reduce the national debt.   Today, the majority of the debt has gone to finance government largess, undeserving corporate bank bailouts, and general economic consumption.  The manufacturing capability of the U.S. economy today is a shell of its former self.  Service sector jobs now define the U.S. economy as the trade deficit continues to widen. The United States today has extremely little to show for all the debt that has been borrowed.

Even with interest rates near historic lows, the U.S. Treasury still paid $230 billion dollars in interest expense to foreign creditors last year, which represented just the annual burden of carrying this monstrous amount of debt. In reality, that $230 billion is the annual bill that the American tax-payer had to cough up in order to pay for fiscal profligacy in Washington.   If the 30+ year trend in bonds ever reverses course, the annual interest expense for American tax-payers will definitely get a lot bigger.  The baby-boomer generation collectively entering retirement represents a tectonic shift in the relationship between Washington and its historic tax-base.  The boomers are in the beginning stages of transferring from productively employed members of society who pay income taxes, to people who are retired, pay no income tax, collect social security, and now healthcare benefits from the federal government.  In short, America’s largest demographic asset is in the early stages of transforming into a massive liability on Uncle Sam’s balance sheet.  The implications of this for the Treasury bond market are utterly disastrous as this will be occurring on top of an already over-indebted fiscal situation.  The politicians in Washington will soon be facing a nearly unsolvable challenge where kicking the proverbial can down the road will no longer be an option.

One well known economist who has impressively tracked the evolution of this crisis in detail is Martin Armstrong.  Armstrong is famous for building proprietary computer software based off the number pi which is allegedly capable of tracking global capital flows in real time.   The defining aspect of his computer model that it is widely regarded as superior to other economic forecasting models in its ability to incorporate historic market cycles and then make market timing forecasts to a precise degree.   Recently (for at least the past 5 years) Martin Armstrong’s economic confidence model has been highlighting the date of September 30th, 2015 (or 2015.75 as his model says) as being of extreme importance for the global economy.   Martin himself seems to think this could represent the high in sentiment in sovereign debt markets and sentiment shifts away from public assets to private.  We at GFC find this date to be extremely intriguing to say the least. Armstrong believes this time period could represent when the change in trend pertaining to global bond yields is likely to occur.  We thought it would at least be beneficial for our readers to be aware of this date so they have the opportunity to monitor sovereign debt markets closely as the date approaches.  If Armstrong is correct, being short sovereign debt is likely to be a very prosperous proposition in the years ahead.  A financial crisis of epic proportions is undoubtedly brewing in global bond markets. The only question is: when will all this debt spiral out of control?