Gary Tanashian's  Instablog

Below is a copy of this week's free eLetter that went out this morning.

Goldilocks Ends & 'Currency Wars' Begin

Amid continuing inflationary policy, the US Dollar is at a critical juncture by both daily and weekly charts. Euro targets 142+ and the Yen approaches our target. Currency war kicks off; gold just sits there biding time.

From last week's eLetter:

"A Goldilocks atmosphere was expertly created in large part due to the fact that Operation Twist (yes, we are still dealing with its effects) by its very definition held long-term interest rates down (buying long-term T bonds) while sopping up any money supply implications and inflationary signals by sanitizing the process with the sales of equal amounts of short-term bonds."

Policy makers have not found a new way to indefinitely manage the economy. Traditional laws of economics have not been repealed. The Federal Reserve used the equivalent of a macro parlor trick to dampen inflation signals and help produce today's Goldilocks atmosphere, which features stocks rising now that the public and its mainstream money managers feel the worst is over with respect to the Fiscal Cliff non-event and the Debt Ceiling noise.

But in economics and macro finance, there is is always a price to be paid for unnatural (read: man-made) distortions. The Fed ran out of short-term bonds to sell and now something has to give, as its ongoing inflationary operation is now unsanitized.

A bearish Head & Shoulders pattern has formed on the currency for which the Fed is supposedly a steward. If the neckline breaks, the measured target is 76.50.

The weekly chart of USD targets 74 off of an even more significant H&S, with the baby H&S of the first chart merely representing the right shoulder of the big daddy H&S.

A breakdown in the US dollar would confirm that the recent tick higher in Adjusted Monetary Base is the beginning of a new trend up in inflationary policy.

Unsurprisingly, USD's chief rival, the Euro is in an inverted and bullish H&S. We have been targeting 142 in NFTRH since the break above the neckline. The Euro appears to be attracting a 'long Euro/short Yen and gold' momentum (read: hedge funds) crowd playing the opposite game to that from mid 2011 when Yen and Gold rose strongly in reaction to the Euro crisis.

Yen has been played to the hilt by the hedgies. We have had 106 as the downside target since the neckline to the massive H&S broke down. Yen could be a heck of a contrarian play for a counter trend rally, as the short-covering should be massive.

Meanwhile, the currency that resides outside the system bides its time. Gold is unofficial money and with all the hype about currency war people who are not patient may have expected a rocket launch in the precious metals.

Here we bring it back to the Euro and realize that too many unhealthy would-be gold bugs came aboard during the acute phase of the Euro crisis in 2011. That is being worked off now in gold's ongoing consolidation.

Bottom Line

US dollar looks bearish. Euro looks to complete its rally to 142+ where it will by the way, encounter a bigger picture DOWN trend line. Yen is bearish but due for a whale of a short-covering bounce soon.

In the near-term some currencies are bullish and some are bearish. But the US Fed, Europe's ECB and the BOJ are not going to engineer their way out of their respective 'inflate-or-die' predicaments. Gold may have a few more months of correction/consolidation but that is a drop in the bucket when viewing its entire history as a monetary anchor to value.

Biiwii.com, Twitter, free eLetter, NFTRH

We have noted repeatedly that Operation Twist served to benefit strategic areas (like housing) with its purchases of long dated Treasury bonds, which kept rates down on the long end. We have also noted that Twist sought to sanitize these asset purchases by selling short-term Treasury bonds to keep the yield curve tame and snuff out any inflation signals that would come from a rising money supply. Enter Goldilocks.

It's all lies. It is a painting rendered by a most brilliant of Fed chiefs playing tricks with the nation's bloated debt load. People are buying the stock market now and they (and their investment fund managers) probably don't give a damn about what created the rally. It's Goldilocks and that's all they are concerned with.

(click to enlarge)

I distinctly remember watching the first yellow highlighted bullish pattern form. Here, don't believe me? I am a perma bear? Here's the post from back then (7.3.12):

Housing Index Targets Higher

I did not buy it because I find it difficult to buy things that I either don't believe in or are entirely dependent upon overly powerful people doing things that should be illegal in order to manage markets to desired outcomes.

But the chart was the chart and it was bullish. HGX has since gone on to much higher levels than I had anticipated as it carries along the absolute dumbest, most greedy money on the planet in tow. These people were hiding in foxholes last summer.

Just remember that if you want to go chasing this market. These people are your co-sponsors.

Risk vs. reward on the broad US stock market stinks. I was not afraid to call it bullish last summer and I am not afraid to call it what it is now.

http://www.biiwii.com

Behold the beauty of this title:

Investors Most Optimistic on Stocks in 3-1/2 Years in Poll

As I was reviewing this morning's news items the above headline stuck out like a sore thumb.

A little stroll down memory lane:

In May of 2012 NFTRH 188 used this graph among other indicators to get bullish on a risk vs. reward basis, stating "and then there is this beauty… the dumb money has lurched hard to 'risk off'.

Smart/Dumb money confidence, May, 2012

I personally took some pretty good grief for writing Dumb Money Sold in May and Went Away over at Contrary Indicator Central - AKA the Seeking Alpha comments system - to the version of the article published at SA. The most memorable of the responses by defensive bears was "Gary = Dumb Investor". I considered these comments to be of great value, because to be an effective contrary market player you must, almost by definition, appear dumb to most people a lot of the time.

This bullish orientation, although very difficult to maintain during last summer's volatile ups and downs extended through year-end, with another personal watershed sentiment anecdote coming at Thanksgiving, when an extended family member and CFA advised that all the best fund managers he dealt with were mostly in cash and expecting a Fiscal Cliff-related market crash in December.

Here is the current state of sentiment (both graphs courtesy of Sentimentrader.com):

Smart/Dumb money confidence, January, 2013

We have ended the bullish risk vs. reward regime, although the model portfolio continues to hold some global bull positions. It is obvious that confidence is being restored and those same fund managers are now chasing the broad US stock market higher.

This is of course a recipe for near term destruction of bears who are actively positioned against the market because right now, momentum and a heck of a lot of dumb, greedy money are propelling it higher, with all sorts of happy media stories providing a tail wind. That is the short-term.

Longer term, especially considering that the current sentiment structure has degraded significantly (from a contrarian view) and that long-term Treasury yields are likely to rise with asset markets, this momentum should burn itself out before too long.

A long-standing potential target for the S&P 500 is 1550, and this could extend up to new all time highs above 1576. Yet still, the market is very bearish on a risk vs. reward basis.

(click to enlarge)

Yet I am not so much talking about the proximity to a potential triple top, the state of the monthly MACD or any other technical signs when offering a bearish view for 2013. I am talking about human herding behavior; not among NFTRH subscribers or readers of this site. Nor am I talking about the readers of some websites that may publish this article.

But think about the great investment and fund manager herd out there under pressure to invest OPM (other peoples' money). Think about the Goldilocks backdrop that has taken center stage now that we've gotten through the Fiscal Cliff non-event. The backdrop comes complete with a rolled over Federal Reserve, continuing to promote inflationary policy with few signs of inflation, which are always lagging to the public.

'It's a new and great contrarian phase of bullishness!' thinks the investment management herd as the financial media that so reinforced bearish perceptions in 2012 goes the other way toward full perceptions-reinforcing bull horn mode.

(click to enlarge)

The new story that the mainstream seems to be pumping is that the VIX (what some people call the fear gauge) is no longer relevant. Well it was pretty relevant at each of the last three spikes. Although notably, VIX has broken a support level here. If it remains below that level, the trudge toward an actively bearish stance against the market could be long and tedious, just as the white knuckled bull stance was last spring and summer.

The bottom line is that sentiment is very definitely aligned in a bearish risk vs. reward structure now. But this condition can endure and people who are invested should at least be aware that the backdrop is becoming unhealthy in its over bullishness. It is possible that a good interim correction will come along and clean up the sentiment backdrop. In that event we will be open to a more bullish 2013, if other components of the analysis indicate a positive view.

But the longer the current situation remains as is, the more dangerous the market becomes with the likelihood that the next correction could be severe at best, or more likely the end of the cyclical bull market and start of a new bear. So move forward aware of the current sentiment backdrop. It's mirror image worked out last year.

biiwii.com, Twitter, Free eLetter, NFTRH

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: No positions were mentioned.