Where do we stand now?

The last post was especially exhausting, and I thought it might be a good time to try and take what we know or suspect or have irresponsibly and groundlessly asserted in the face of obvious fact and see what it has to say about where we are now. This is also a good way of deciding where we should focus our research next.

Let’s start with bonds.

According to the methods we have been postulating recently, it would seem most likely that long-term yields are on the verge—probably sometime in the late summer or perhaps early fall—of pivoting to the upside, although they could make new lows in the meantime.

gold/oil ratio usually leads long-term yields by sixteen months

From a cyclical perspective, the move this month or possibly the move indicated for August 2012 will achieve a relatively new low, probably somewhere below the 2.3 mark and possibly to all-time lows.

will yields this month challenge the 2009 lows? or must we wait until 2012?

The cyclical factor in yields is less distinct than it is in the gold/oil ratio, so there is good reason, as always, to be cautious about predicting specific levels.

There is also the question of the silver/oil ratio, which we should ponder for a moment, although I want to avoid too much theoretical speculation in this post (in favor of speculation more generally, that is). This is something I have been unable to examine with greater detail, but I have had an extremely strong suspicion that the silver/oil ratio has a 16-month lead on treasuries, as well, perhaps on the short-end of the curve instead of the long.

does silver 'predict' three-month yields?

0.01 as of August 5

If it’s impact is on the ten-month note, then like gold/oil, it is strongly hinting that long-end yields are about to bottom. However, the difference is that silver/oil would be saying that from the end of this year through the first three quarters of 2012, rates will skyrocket up, while gold/oil is indicating another dip in the summer of next year.

On the other hand, if, as we have suspected, silver/oil’s relationship is with the short-end, then that would indicate that the yield curve will steepen. We have commented before about how the gold/silver ratio bears a strong resemblance with the yield curve, although perhaps more in the nature of its behavior than in its timing. Even so, if gold/silver can be used as an indicator—and we are on an unusually large stack of ‘ifs’ at the moment—then it is indicating a sharp steepening of the curve beginning sometime in the fourth quarter of this year and on into August 2012.

does the gold/silver ratio predict the yield curve 16 months in advance?

...and what about oil/copper?

In some ways 2012 seems to be shaping up like 2000, when the yield inverted and industrial commodities, as well as the dollar, shot up against precious metals.

What about the case of oil v gold?

Things get interesting here, because historical precedent suggests that gold/oil has significantly lower to go before the end of 2011, but that would require it to retrace its move over the course of the last five months and then move down convincingly below 12.6. It is possible that the 12.6 low in April was the cyclical low, but it would be very unusual for the dip to be quite this shallow.

What might it take for a sharp downturn in the gold/oil ratio before the end of the year? Assuming that gold were to remain magically stationary at its current position, then a move down to 12 in the ratio would require oil to break $130. If oil were to remain stationary, then gold would have to go to $1050. If we split the difference, it might mean oil at $110 and gold at $1300.

So, what is the forecast for gold?

The oil/gold ratio has been indicating that the Dow/gold ratio should be rising, and historically this has involved both Dow strength and gold weakness, but this has just not been the case so far.

Our other gold indicator has been more reliable. The copper/yield ratio has been consistently promising higher gold prices (or, more precisely, a higher gold/dollar index ratio) and delivering. Whatever copper has been doing, the ten-year yield has managed to ‘underperform’.

Gibson's paradox gives us...

bullish gold when the Fed is putting its foot through the floor

expect this to continue until the copper/yield ratio reverses, which may be fairly soon

In order for gold to fall, the uptick in long-term yields that we are predicting to begin fairly soon will have to outstrip any strength in copper. In short, for gold to drop, there probably needs to be weakness in at least two of the following three assets: copper, bonds, and the dollar(!).

What can we expect from copper, then? Well, unfortunately, copper is generally a function of yield/dollar, so if yields are indeed going to go up (i.e., bonds down), then the dollar will have to be strong enough to ‘hold’ copper down. Or, copper strength will have to be matched by dollar weakness. There are simply too many self-referring equations here to for me to try to forecast all the possible future permutations, but since gold has effectively been a multiple of copper, bonds, and the dollar (something I discussed during my obsession with the gold/copper equation), then these are the assets we will have to watch.

if yields turn up and outperform the dollar again, watch for copper to resume its move up

waiting for yields to take flight again?

The most important question, however, is likely to be, just how strong will this imminent rise in long-term yields be? If copper were to move up again and a modicum of confidence were to return to the financial markets, it is not inconceivable that the ten-year yield could break the back of gold by a sharp rise of its own.

In any case, if gold’s immediate future is dark to us, what can we say about oil?

Using the techniques we developed recently, both the gold/oil ratio and the yield curve suggest a relatively placid oil market, perhaps even with faint downward pressure. Klombies’s oil indicator, as I’ve dubbed it (i.e., the copper/oil ratio), having just returned to the 5:1 level on Thursday, suggests that a rise in oil is possible, but not necessarily imminent. The gold/oil ratio’s recent moves indicate that oil could become problematic next year, but for the most part, oil seems to be off the radar for the moment.

In the short-term, everything seems to be hinging on the bond market, and it is the argument here that bonds are possibly within weeks of a year-long bear market, possibly longer if yields should break below the 2010 low.


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