Wednesday, December 19, 2012

Dow Theory special issue: Revisiting the BLV/GLD ratio

Still at crossroads?


 We have dealt with the BLV/GLD ratio on several occasions in this Dow Theory blog.

To understand why this ratio is important, I suggest you read here and here the relevant posts to get a taste of it.
If the ratio turns bearish (stronger gold) it means a hard time for bonds or, at the very least, stronger gold while bonds go sideways. Furthermore, gold will not be really to shine until the ratio turns bearish (stronger gold).

In any instance, it is an important ratio to follow.

Now we will focus on an updated chart.

Keep an eye on the green line. If violated, bonds will be up for trouble
First of all, we see that a significant trend line has been violated (pink trend line).). If you go to a longer-term  chart, you will see this is an important trend line with “seniority." Hence, its violation is clearly bearish for bonds. Here we are not talking of ratios. Bonds have flashed a bearish warning of themselves.

The straw that will break the camel’s back will be the ratio turning bearish in favor of gold. Hitherto this has not occurred. The relevant lows of the ratio to be violated are those made at the beginning of September. The horizontal green line shows the level of the ratio to be violated so that the ratio turns bearish.

The implications of a bearish ratio, together with the violated trend line, would be as follows:

·        Bonds would likely enter a primary bear market.

·        Gold, being the stronger of the two and given its “anti dollar/anti bond” nature, would be ready to go up. 

·     This would entail, either the end of the current secondary reaction within the primary bull market signaled on August 22 (for more information as to the primary bull market in gold go here) or if gold finally enters a primary bear market, conditions would be cleared for the onset of a new primary bull market.

·        While not shown in the chart, the USD is technically weak in the middle term (i.e. next 6 months). Such weakness spells trouble for bonds and eventually should strengthen gold.

As I wrote in my October 25, 2012 post in this Dow Theory blog:

Really, you are seeing a dramatic chart that epitomizes the fight of the bonds (essentially the USD) against the power of gold. Who will win? My fundamental instincts say that gold; however, you know I attach relative value to my own fundamental forecasts, and such fundamental forecasts may take long to come to fruition (longer than you can stay solvent, as Keynes would say). Thus, I prefer the technical side of the Dow Theory to guide me in a time horizon of 1-2 years. One thing is clear: The chart reflects an epic battle.

Which prompts me to finish the same way I did in that post:

Bottom line: Keep an eye on the BLV/GLD ratio. If the ratio breaks down, it may imply a big movement for gold. Even if the Fed goes frantic buying bonds to support them, and hence, you don’t see a breakdown of bonds but merely a violation of the ratio because, while bonds remain stable, GLD begins to go up, this may imply a huge movement for gold. Gold will not be ready for a real take off until the ratio, irrespective of the price of bonds, gets broken.

I’d only add that the violation of BLV’s trend line is a very bad omen for bonds. However, current gold weakness may buy some time for bonds.

Of course, those skeptical among you will say that both bonds and gold are manipulated and, hence, we cannot derive any practical value from perusing charts as they have been rendered worthless by such manipulation. Well, my answer would be as follows: Manipulation itself leaves traces on the charts. If gold or silver go down because there is naked short selling, I agree this is manipulation, but, nonetheless, they go down and the losses to those stubbornly long with no staying power (or not in physical for the very long pull) are very real.

If the plunge protection team is buying S&P futures or the Fed is buying Treasuries to prop up the market, this is manipulation but the charts will be rightly bullish.

Tools like the Dow Theory have a too long track record to be dismissed out of hand, and it happens to work even under manipulated markets.

Of course, we have to know the waters we are treading in, and we shouldn't be technical fools but good investors. If we feel a manipulated market may explode in our face, we'd better leave it alone, all the technical signals notwithstanding. With precious metals, here is where physical plays a role.


The Dow Theorist

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