Three similar graphs

Take a look at these three graphs ( open in new windows separately)

Copper



Crude oil



Dow Jones Industrials



All these three graphs have a few things in common.

- MACD has given a crossover from very oversold levels.

- A double bottom is formed in Dow Jones on a daily chart, crude oil on a 240 minutes graph and copper on an hourly graph.

- Dow Jones is nearing its short term resistance level and RSI is getting into a congestion zone; Crude oil has formed a bullish engulfing pattern with a strong break on the RSI; copper HG has tested $1.78 three times in the last three days

There is a possibility of a significant rally in crude oil and copper as i mentioned in the last crude oil post. Short term resistance level of $72 was the top yesterday and $76 may see some more profit booking.

Copper is looking set to touch $2.08 and $2.25 after that breakout.

Money market conditions

In the last few months the Federal Reserve and other central banks have tried to ease money market conditions by lowering interest rates. Every country in the world is on an interest rates cutting spree.

This table shows the recent moves of major central banks.

TED spread has been seen as an important indicator of money market liquidity conditions. There is another important indicator which can reflect the liquidity conditions in interbank market. The LIBOR-OIS spread. One of the recent Fed article explains -

The LIBOR-OIS spread has been a closely watched barometer of distress in money markets for more than a year. The 3-month London Interbank Offered Rate(LIBOR) is the interest rate at which banks borrow unsecured funds from other banks in the London wholesale money market for a period of 3 months. Alternatively, if a bank enters into an overnight indexed swap (OIS), it is entitled to receive a fixed
rate of interest on a notional amount called the OIS rate. In exchange, the bank agrees to pay a (compound) interest payment on the notional amount to be determined by a reference floating rate (in the United States, this is the effective federal
funds rate) to the counter party at maturity. For example, suppose the 3-month OIS rate is 2 percent. If the geometric average of the annualized effective federal funds rate for the 3-month period is 1.91 percent, there will be a net cash inflow
of $2,250 on a principal amount of $10 million [(2 percent –1.91 percent) × 3/12 × $10 million = $2,250] to the bank from its counter party.

A bank borrowing at the 3-month LIBOR rate of 2.10 percent that enters into a swap to receive at the 3-month OIS rate of 2 percent has a borrowing cost equal to the effective federal funds rate plus 10 basis points. Entering into the OIS exposes the bank to future fluctuations in the reference rate. However, the bank can guarantee
itself longer-term funding while still paying close to the overnight rate. Because the alternative would be rolling over the funds on a daily basis at changing overnight rates, banks are willing to pay a premium. This is reflected in the LIBOR-OIS spread (defined as the difference between the LIBOR rate and the OIS rate) shown in the chart.



In times of stress, the LIBOR, referencing a cash instrument, reflects both credit and liquidity risk,1 but the OIS has little exposure to default risk because these contracts do not involve any initial cash flows. The OIS rate is therefore an accurate measure of investor expectations of the effective federal funds rate (and hence the Fed’s target) over the term of the swap, whereas LIBOR reflects credit risk and the expectation on future over night rates.


Now, the US Federal Reserve has been able to correct the yield curve by bringing the near term interest rates down. This has been achieved by lowering the Fed Funds rates but it has not been able to reduce the strain on the illiquid money markets.



US T bills have seen record inflow as investors preferred US T bills for safety of investments. Secondary market rates for T bills in US has gone below 60 year low. Have a look



As and when the interbank markets return to normal liquidity conditions there would be a huge inflow of money into other asset classes.

Crude oil conundrum

Crude oil prices have given their first weekly positive close in last five weeks. There is little evidence that the downtrend has ended but a positive bias is now emerging in the markets. We open up the next week with a new month. So there could be heightened activity in the crude oil market on Monday.

Over the years I have seen enough sharp swings in commodity markets when a new calendar month begins. There are two important developments in the long term crude oil price graph. The long term trend line has not been breached untill now and prices are oversold to the highest degree compared to last seven years. Have a look -



Crude oil prices are expected to move up to $72 and then $76. Current rebound may last till $80 and we may see some selling pressure at those levels. $63 should hold as a strong support if this upmove has to last.

Market Mayhem - Decline resolving

Equity markets have never be more correlated. World stock markets have performed equally bad in comparison to each other in the month of October. The US markets have given their worst ever October performance and there is little respite in terms of price rise as yet.

Indian equity markets along with the other Asian markets were hammered down beyond belief. The 'bad news' has started flowing in steadily now as the bear market unfolds. Equity markets would bottom out much before the real economy, as is the case with all bear markets. However there are a few important factors which are giving disturbing long term signals. The inflation expectation of the whole market seems to be one of severe deflation. The yields between regular ten year treasuries in US and the treasury inflation protected securities (TIPS) stood at an incredibly low level of 0.92%. This means the US treasury market is signaling a remarkable slowdown in price rise and in reality is pricing in a falling price scenario. If high inflation is bad, then deflation is even worse.

Another important market that is falling significantly is the gold market. Gold prices have been falling steadily since last two weeks and there is little momentum in the prices as yet. Though chart studies show $700 to be a important support level but the record rise in Gold ETF redemption's have put a question mark on the sustained medium term uptrend.

As I wrote previously that god may be starting a fresh upmove towards $1200 mark if it doesn't close below $734 on international spot markets. I was wrong on that part as it closed below $734 yesterday on a weekly basis. Now the important thing to notice is if the inflation expectation in the world economy remains so weak as they are right now, there is little incentive in holding gold in the medium term. The Elliott wave structure suggests that prices can decline to $544 before basing out.

The Indian equity markets have seen a big slide in prices. Price deterioration has been steep in all Asian markets. Indian markets performed badly in the month of October. From a valuations point of view the markets are in a screamingly valuable zone. These prices are suitable for long term investors to make portfolios. Looking at price graph for Nifty it seems the current uptick will eventually get sold into. Have a look at the revised Elliott wave count.



As I mentioned previously that we are in the final leg down of the bear market which began with a decline from Nifty high of 6357.

The first leg down which ended at 4448
Second leg was a counter trend upmove which ended at 5299
Third leg is the current move which has extended down to a low of 2253

The current fall i.e. the third fall is nearly 1.618 of the total downward move of the first fall.

From the current price levels a further upmove to a range of 3500 to 3700 can be expected. Since we are in the fourth wave of the decline of wave C it can end at the termination of the lower degree fourth wave which was at 3780. There any move to that level may get sold into and then the final leg of the current decline will begin. Nifty has seen a selling climax and final downward move may be truncated and may see formation of a bullish contracting triangle. The fall from 3500-3700 range will give one of the best opportunities in decades to buy into the Indian markets.

It is important to note that we are nearing the 2010 deadline of the kondratieff wave for which Nikolai Kondratiev was jailed. According to his analysis the credit cycle would bust by 2010 and leverage would come down to 10:1 as compared to 40:1. We are indeed working towards that level.

Munch on the credit crunch!!!

A $700 billion dollar bailout plan was on the radar screen of every investor and trader. It came and went. I was surprised by the market reaction. Bear markets have a common trait, all good news is sold into. It happened again today as well. I was speaking and expecting this from the last one week. It was very evident in the FedSpeak and ECB's remarks that all Cenbanks would ease on rates. Again the market didn't move much. Its not important to be a bull or a bear in markets. You just need to be very objective. The current bear market began with two broad important themes -

A. Inflation induced by crude, food and money

B. Stressed interbank markets due to a rise in foreclosures and rising defaults

Investment banks all over the world took a lot of risky loan assets on their books in order to sell it off in the form of CDOs and other leveraged instruments. The underlying loans assets of these instrument were housing loans. Quite a few of them were of inferior quality because banks didn't care about the creditworthiness of the borrower as they would sell these loan assets in a bundled form to investment banks. Underlying loans were quite disastrous like NINJA loans - No income, No job or Assets loans and Alt-A, subprime et al. MTM losses forced banks to raise capital which become scant as Central banks reigened in money supply to ease inflation.

Then came the headlines made famous by the financial press. Toxic debt made the issue even messier. I was quite curious to find an exact number which can define the extent of 'money' that is required to set the mess to rest. There were a few estimates. Like $1.3 trillion net of the toxic debt, $5 trillion of financial aid required, $60 trillion of gross worthless mortgage CDS and $1300 trillion mess worldwide in all sorts of loans.

I really don't know which number is the correct one. I don't even care whether any number is correct or not, neither does the guy who has put in his money in some supposedly 'risk free', 'large cap' stocks. It is quite simple and evident that the total liability of poor mortgages and inferior assets that banks held in their balance sheets is too big to be cleaned up quickly. As I picked up some of the financial magazines for the current week I noticed a glaring similarity between investor sentiment, the crowd psychology and the headlines. The businessWeek headline read - Is it safe YET? The NewsWeek read - It's not as bad as you think! and the rest. In the last one month the sentiment among the investors world over has went from bad to worse, the volumes have suffered considerably, futures in stocks are gyrating like drunkard and all of a sudden the indispensable CRUDE OIL doesn't matter anymore.

Most of us would believe or like to believe that history repeats itself. It is indeed repeating now. We are very much on the some line as we were just 100 years ago. Reading a few books about the great market crashes will let you know that the first decade of the 20th century suffered the same fate as the world economy is suffering now. JP Morgan came to the rescue then and again it stands tall though on crutches provided by the Federal Reserve and the political clout of the US government. There are quite a few articles in economist and the ET on the similarity between 1907 and 2008.

Many banks fail in every big recession and there is a massive slowdown that follows. Credit is the backbone of most business and when it dries up it leave lot of people and businesses very hungry. Currently there is lack of trust which is the life support of the financial system. Banks and other financial institutions have serious doubts over each others financial health and credit worthiness. The action of the US government by purchasing corporate commercial paper is a direct way of lending to corporates at rock bottom rates. This would provide much needed funds to corporates who require quick cash to run their businesses. It would infuse confidence in the system as well.

The U.S. Fed, ECB, BOE and other major central banks moved today to slash key interest rates as part of an ongoing effort to quell financial turmoil. I think this step is a crucial one and a number of cuts will help revive confidence in the system. Though the problem right now is not the cost of borrowing but the availability of credit. The inter bank market across the world are virtually still and there is very little activity that is happening. Still lower rates would increase risk taking capacity and help household spending and business spending in the short term.

Is the main street unaffected by the current crisis ?

If we move to look at the real economy and see what has been the past trends in the bear markets, we would notice some signals. Firstly this bear market has been in place well before the actual economy has shown signs of remarkable slowdown. Most stock indices have been cut in half and there has been comparisons drawn to 1930s. There is little by way of comparison right now. Unemployment in the US is at 6.2%, it was at 25% in few months of the bear market. 4000 banks failed in 6 weeks, 26 have failed or rescued in last one year. There was a glut of inventory, which is quite low at present. To top it all in present slowdown, each commodity has seen a rise in demand in the last one year. So real economy has not suffered as much as the financial part of it due to faulty troubled assets. But it will show signs of slowdown in near future which would be much more visible.

I think its pretty outlandish to think that the real economy doesn't undergo a slowdown if banks fail. It is for sure a hit on everyone pocket as growth slows and wage and price inflation fades. It leads to stagnation or low growth in the standard of living. The current crisis is a mix of things.

A. It was created by cheap loans to people who could never repay. These loans were bundled up as 'assets' and sold to the smart money as high yielders. Some banks were actually trading even the bundles.
B. Inflation forced the central banks to raise rates, which stopped the vicious circle of cheap credit ballooning asset values beyond reason.

C. The world grew 25% more in just 10 years. World population has accelerated to 6.6 billion. One out of every 8 person on earth is an Indian, and 1 out of every 5 is a Chinese. Indian economy grew at an average of 8.5% in last three years and Chinese economy grew at 10.5% for the last three years.

Now the question to most of us right now ( it is actually always the supreme question) is - Where are we headed ?

Stocks indices have come off their highs in a gradual manner which has been steep for some markets like shanghai. There has been a conscious effort from central banks to help stabilize the financial markets, especially from the US, EU and Japan.

In purely technical analysis terms there are very little signs of trend reversal yet. Though my studies say that we are very near to end of price corrections or probably a bear market low. It might take the market some time to recover but the price correction might get over in few weeks time. In my previous posts I have mentioned the fall in Nifty as to be an important part of the bear cycle. All upmoves have been counter trending and surprisingly very short. Threre would be more counter trend rallies unless we have a set low in place. For that to happen we must have some price pattern which hints ate it. I think it is getting formed in the daily graphs of most of the Asian stock Indices.

Talking about levels I feel 3370 should not be broken on Nifty on a daily close. If we close below that level, we will get into further price deterioation.

I will post graphs on Nifty with the wave count. Gold elliott wave count has served quite well in the last 6 months and the current upmove its getting stronger by the day.

I would be posting regularly in the next few weeks.


Sahil Kapoor

Comments are welcome.