Dow Theory spells trouble for bonds: Clouds on the horizon

We have been talking in this blog about stocks, gold, silver and their miners. However, we kept silent as to the US treasury bonds.

First of all, I must admit that bonds are not so easy to be analyzed under Dow Theory. Dow Theory works best when applied to correlated markets (i.e. SPY and Transports) but when correlation is too high (i.e. 10 Years Bond and 30 years Bond) then, instead of having two similar, but different markets, we end up having two almost “cloned” markets.

Thus, Dow Theory analysis of the US Treasury market should be made indirectly, by applying Dow Theory to its ratios. In my opinion the two most relevant ratios to be applied to the Treasuries are: BLV/GLD (the long term Bond ETF versus Gold ETF) and the BLV/SPY. By looking at the ratio we can see the patterns that develop and we can apply Dow Theory to them.

Furthermore, and independently from ratios, gold strength (i.e. its being in a primary bull market) tends to spell trouble for bonds. Why? Because gold is to the USD what kryptonite to Superman. The stronger gold, the weaker the dollar and a weak dollar spells trouble for bonds too.

So, armed with the direct observation of gold, its relative strength and the above mentioned ratios, we can derive a pretty accurate technical picture of the long term treasuries.

And how is this picture?

Not very pretty.

First I will analyze the “negatives”:

A) Bearish aspects for Bonds.

First of all, we now that gold is in a primary bull market. Go to my post “August 22, 2012. Dow Theory signals a new primary bull movement in gold and silver?” which you can find here to learn more about the details and implications. In this post, it suffices to be said that a 50% price gain in the next 12-18 months would not be uncommon.

I can imagine a substantially lower USD if gold goes up by 50%. Such weaker dollar would spell trouble for long term bonds.

Secondly, the BLV/SPY ratio turned bearish on 01/20/2012. This means that since that date stocks were holding the upper hand. Look at the chart below. You will see that the trend of the ratio, even for those still weak in Dow Theory, is clearly down.

The ratio of long term bonds to stocks is bearish suggesting stocks hold the upper hand

However, we know under Dow Theory that confirmation is necessary to derive valid conclusions. The confirmation I'm looking for, should come from the BLV/GLD ratio and hitherto this ratio has refused to confirm (more on this below).

B) Mildly bullish aspects for bonds.

What about the BLV/GLD chart?. Well, according to Dow Theory, and in spite of a secondary correction in favor of gold currently under way, the ratio is still bullish for BLV. If we look at the chart, we see that the ratio is just about to violate the previous significant secondary reaction low. However, this hasn’t happened yet. When this occurs, technically, almost all bets are off.

However, the BLV/GOLD ratio refused to confirm the breakdown of bonds

I said “almost” all bets are off, because technically, gold, in spite of being in its own bull market, is still weaker than the SPY and SLV. Such relative weakness of GLD give the USD, and consequently bonds, a respite. You can find more details as to the implications of the relative weakness of gold in my post: Is really gold glittering? Who benefited most from QE? which you can find here

 

Finally, and although I shed more importance to my Dow Theory studies, look at the trend lines in the charts. If the lower trend line is finally broken, this is a further sign of real trouble for the bonds. But, as of this writing this break has not occurred yet, but it is about to occur.

Conclusions:

1)     the USD is threatened by the primary bull market in gold.

2)     This may spell trouble for US Treasuries.

3)     The BLV/SPY ratio is bullish for stocks suggesting relative weakness of long dated treasuries over stocks.

4)     The BLV/GLD is still bullish suggesting the GLD is still not ready to fully shine or bonds ready to die.

5)     GLD is weaker than SLV and SPY further suggesting that the USD that Armageddon is not yet with us.

Have a nice day.

Sincerely

The Dow Theorist.