The Ebb and Flow of Funds

I've been meaning to write about this for a couple of days and this is the first chance I've had to get it done.

What set me off was a headline I saw scroll by on ZeroHedge the other night. Some meathead from Deutsche Bank was claiming that "the supercycle move for commodities was over" or some such nonsense. This, of course, caught my eye because:

I keep hearing that Deutsche Bank continues to teeter on the edge of bankruptcy/insolvency.
Deutshce Bank is also a major bullion bank and several folks have reported that the April Beatdown was a desperate action, initiated to save a bullion bank from default.
I think all the Elliott Wave stuff is bullshit and I particularly don't like the snake oil selling practitioners like Prechter.

At any rate, I couldn't get the thought out of my head that some might believe that this latest bull market in commodities was kaput. Clearly lots of people do think this though and, no doubt, that is partly the rationale behind all of the hedge fund gold selling.

Speaking of which, did you see this chart yesterday? Bloomberg put it out and it was picked up by nearly every gold/silver site. It shows in graphic detail what I have been trying to tell you for months. Namely, that the buildup of Spec short interest is at historic levels and this has led to a transference of "short liability risk" from The Cartel to the Specs.

Again, why are the Specs so bearish on gold? Well, one of the reasons is the overall crappy performance of commodities, in general. For a reversal in price that squeezes the shorts and resumes the bull trend in gold, one of the things we'll need is a reversal of this Spec flow of funds. This is something that TraderDan has been harping on for months. Personally I think that this is too narrow of a point of view but, for the purposes of this post, let's go with it.

The question lays out like this:

Gold is going down because commodities in general are going down
So gold won't likely go back up until commodities in general go back up
But if the "commodity supercycle" is over...
How can gold ever reverse? It will just keep going down, too. Right?

I know that many of you feel this way, having been misled by newsletter writers and the stooges in the mainstream financial press. So, I thought I'd take this argument head on by looking for a bottom in commodities or, specifically, the Continuous Commodity Index. Because, if:

Commodities bottom and reverse, then
The flow of Spec/Momo/HFT/HedgeFund/MoneyManager funds will reverse, too, and
Gold and silver will reverse and trade higher, not lower.

Let's start with a linear scale, 25-year chart for the CCI. Note that the current trend began in late 2001 and continues to this day with one exception...2008. Recall the extreme volatility and illiquidity of The Great Financial Crisis. Because of the unusual nature of that period, I believe that the move down and through the trendline was a simple "overshoot". Confirming this idea is the clear evidence that, once things settled down a bit in 2009, the index moved back above the trendline and continued higher. Again, though, look closely at that drop. It went all the way to a spike low of 322. However, the action centered for six months around the 350 level. Why is that important? More on that in a minute.

Next, let's take a closer look at this linear chart. I've tried to replicate the same red trendlines here as shown above. What do we see? Two things:

The move down this week has seemingly broken the trendline again, just like 2008.
The index looks to have considerable, horizontal support beginning near 500 and reaching all the way down to about 450.

OK, let's stop here and recap what we've found so far.

A definable trend has been in place for 11.5 years. (That's a long time.)
But this trend has given false signals before, especially during TGFC of 2008.
Just like 2008, the trend appears to be breaking again.
Considerable chart support looks to reside between 450 and 500 on the index.

Earlier this week, we used a logarithmic chart to analyze the 25-year trend in gold. The reason for using a "log" chart over a linear chart is that it affords the viewer a better comprehension of change over time when the change in question is substantial. Therefore, I thought that next it would be helpful to review a 25-year logarithmic chart for the CCI. Hmmmm. What do we see here?

Notice that I've drawn two trendlines. One connects the beginning of the move in late 2001 with the 322 low of 12/08 and the other connects the beginning with what, to me, is a more accurate low of 341 in 03/09. Follow those lines along to present day and what do you see? Like the linear chart, support appears to be between 450 and 500! As Mel Allen would say: "How about that?!?"

But wait, there's more. If you continue reading, you'll not only get this evidence, but we'll also throw in some Fibonacci numbers! All at one, low price!

So, let's look at some Fibonacci numbers. First, for reference, here's another chart, this time with the actual highs and lows written on it and no trendlines.

Now let's break out the calculator and do some math.

The move began at 184 and topped at 615 in July of 2008. That's 431 points. The correction that followed bottomed at 322 but I've described that above as an "overshoot" caused by TGFC of 2008. The true bottom was dug out over a period of about six months and it was centered right around 350. So, the move UP was 431 points and a Fibonacci 61.8% correction would be a 266 point drop. Drumroll, please...615 - 266 = 349. Hmmm. Isn't that interesting?

Now let's look at current day. Recall that above, I drew all sorts of lines on all types of charts and everything seemed to point to support and a bottom for the CCI, somewhere between 450 and 500.

If we use 349 as the low for the first correction and mark the second high as 691 in April of 2011, that's a 342 point rally. If we are currently experiencing another 61.8% retracement, we should expect a bottom near 480. Why? 342 x 61.8% = 211 and 691 - 211 = 480.
If we use 184 as the low that marked the beginning of the bull market in 2001 and 691 from April of 2011 as the latest top, we get an overall move of 507 points. If on this broad sense, we were to look for a Fibonacci retracement, we don't need to start at 61.8%. Instead, we need to look at the Fibo number preceding it which is 38.2%. If we use that Fibo level, what do we get? 507 x 38.2% = 194 and 691 - 194 = 497.
So the linear and log charts show support between 450 and 500 and the Fibos tell us to expect a bottom between 480 and 497. Works for me!

OK. Right now you're probably completely numb and wondering what the heck was the point of all this. I understand how you feel so allow me to sum up:

The goon from DB truly is a DB and he is either hopelessly wrong or intentionally deceiving everyone in the hopes of adding fuel to the commodity liquidation fire.
I believe that the bull market in real assets that began in 2001 continues unabated.
This current correction likely has a little ways farther to go, however. Perhaps a much as 10% more, taking the CCI down under 500 before finding The Bottom.
Once a clear bottom is found, the Flow of Funds from Specs will reverse and all "commodities", including gold and silver, will trend higher into the next short-term top, whenever that happens.

Finally, you and I both know that gold and silver specifically have been manipulated lower for a number of reasons and will soon move higher again based upon their own fundamentals and not the whims of the Specs. A short squeeze or LBMA/Comex default brought about by physical demand will move prices higher regardless of how soybeans and crude oil are trading. But the point of this exercise was to address the "traditionalist" view of the commodity markets and bring that view into line with where all of us in Turdville see things headed. I hope I've been able to accomplish just that.