The Futures / Inter Market Report

Trading the World's Markets

November 2, 2007

Matthew Caruso, CMT

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Over-extended Gold, Oil & Canadian Dollar

Gold, oil and the Canadian dollar have all embarked upon major rallies since their lows in August. The recent rallies have left all three commodities at or near all time highs and people watching the markets exuberant. That unfortunately is the problem, people have become overly optimistic on the outlook of these commodities. That creates an environment where the current rate of climb in these commodities  is unsustainable without a pullback of some magnitude. It is important to remember however that the trend in these commodities is strong up and the fact that the markets are over-extended does not necessarily mean that it is wise to go short. However, given the current investor sentiment opening new long positions would in my opinion not be a wise decision. 

Back on august 24^th I wrote a weekly report calling for a bottom in silver (http://tradesystemguru.com/content/view/81/58/) looking at a number of tools including investor sentiment. Silver and gold move in tandem and gold had also bottomed at that time. In fact the rise in silver since August 24^th equaled approximately $14 000 per contract! Not bad for about 2 months time. The bullish factors that I spoke about for silver back in August have now become bearish which mean it is possible that we can have a pull back from here in silver and gold. Currently, 98% of advisors are bullish on gold. When this group comes to a bullish consensus markets are due for a pullback as can be seen in figure 1. Most instances of high sentiment as outlined by the green line, have led to pullbacks in the market. The blue line is a different measure of sentiment that is less sensitive. When both measures are showing optimism the likelihood of a pullback increases. As I have previously said, this does not create a shorting opportunity immediately, but signs of a trend change should be watched very closely and given the strength of the recent climb, a fall may be quick and steep.  

 
Figure 1 Chart by genesisft.com

Another market that has been on the strong climb has been crude oil. Oil closed at a record high Friday and 99% of advisors believe that it will climb further. Other instances of bullish advisor sentiment are shown in figure 2. When this group is very bullish, the market is at or near a climb and due for a pull back. It is really important to study the sentiment in the market because too much optimism shows that everyone is viewing the market with a bullish bias. That usually occurs when prices climb so much that people’s emotions sway their thought process towards what they see happening. Time and time again, too much optimism occurs at tops. 

Will this be the top of the bull market in crude? I cannot answer that now. Many people have spoken about how we are approaching the same price level in crude as we had in the 1970s and that our economies will not be able to work with such high levels. There are many differences between the 1970s crude oil climb and now. Firstly, the 1970s oil climb was due to a supply shock, and currently it is due to an increase in demand – which is much more bullish and has the possibility to persist longer. Also, the barrel of crude oil of the 1920s is not the same as today. What do I mean by this? Well, advancements in technology have impacted every aspect of our lives and economy. Cars are more efficient today than they were 30 years ago, and so are most processes that use crude oil. This means that the same barrel of crude today is actually a greater amount of energy than the crude used in the 1970s because more efficient use of it allows us to obtain more from the same amount. Therefore, although we are approaching the same inflation adjusted price as in the 1970s, we in fact are still  purchasing energy at a lower cost because the same barrel of crude allows us to extract more energy from it thanks to advancements in technology. Therefore, although crude is due for a pullback, in the long run it is possible that prices can climb much higher.

Figure 2 chart by genesisft.com 

Lastly, 95% of advisors are bullish on the Canadian dollar, another overly optimistic reading. The Canadian dollar in recent time has been acting like a petro-dollar thanks to the large oil reserves in the Canadian oil sands. That mean that trend in oil largely impact this currency, and gold as well to a certain extent. The outlook for the Canadian dollar is largely dependent on the trend of crude oil. As we have already discussed, a pull back is likely, but longer term higher prices can be seen.12

Figure 3 chart by genesisft.com         
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