Archive for August, 2008

The Gold CYCLE

The 34 year gold cycle guides liquidity flow from equity to gold, as money shifts from paper to hard assets.

Peter Cogan mentioned about the Gold crisis cycle of 34 years in his article on predetermined periodic cycles of optimism and pessimism. The 1967-68 Gold crises, which climaxed with the end of Bretton Woods system followed the 1933-34 Gold crisis. The article written in 1969 issue of CYCLES was visionary and is the only reference in nearly 70 years of CYCLE literature. But the more interesting part is that the CYCLE is still valid and working. After the gold crisis of 1967-68 we saw the crisis of 2000, where people believed in technology stocks and the paper dreams they offered compared to the hard asset.

Crisis, as Chinese put it is danger with opportunity. The 2000 Gold crisis created more than a decade long opportunity. And the 34 year cycle projects the next crisis near 2030. What does this mean? This means that there is more upside on Gold to come on one side and second a majority as usual will get trapped buying Gold near 2012-2015 highs. This is how long term cycles work.
They originate from the time necessary in order that one generation has time to forget the faults of a previous one. And even if neural prosthesis embeds a memory chip in our brain, one really needs to be a good student of econohistory to understand that cycles exist not just in gold, but in interest rates, inflations, inventories, sectors, stocks and above than they are all linked.

The linkage part of cycles between assets is also a loosely knit subject and needs sizeable research inputs. Tom McClellan talked about liquidity waves in his book “Predicting the future”, where he mentioned about money flowing from gold to stocks and vice versa. Though written less than a decade back, the gold connection with stocks is not much talked about. We briefly touched the subject of metals predicting recession in our article Metals Maze (April 14), when we said Gold and other metals are strong forecasting tools for economic cycle upmoves and down moves. We even said that anticipating a recession (February 4) might be an illusion as metals do not suggest that the crisis is yet here. We explained our case using the gold-silver ratio. To strengthen our case we talked about the direction Gold should take in the coming months. In Fools gold (April 28) we said, “Gold is not just a metal, but a predictor of recession. And the anticipated fall of the precious metal can surprise most recession watchers. Gold is ready to come down sub-$800.” On 15th August, Gold touched a low of $773, a drop of 16 per cent from the intermediate negative trend highlighted on April 14.

Gold touched a multi year primary low in August 1999 at $251 and moved sideways till April 2001 at $254. And since then it has nearly quadrupled to $1,030 without a primary fall (more than nine to twelve months). Even the current fall lacks in retracement. Now what we are discussing here is a case for further fall on Gold at least till $700 levels and potentially lower. Intermarket cycles suggest that if the 30 year commodity cycles have to push up till 2015 (fooled by simplicity, May 26), we need more than a few months of fall for commodities to regroup. So a growth and decay progression is what commodities should experience. We wrote about this impending move down in commodities of markets and about a multi month pause in commodities and about the oil rocket (May 12) and its fateful journey lower. We have covered some ground in terms of CRB commodity index down 19 per cent since July and Oil making lows near $109, falling near 25 per cent from the $145 high registered in July. What happens now till first or second quarter 2009 is the key part.

Gold is a commodity leader more important than oil, as oil cannot replace money but gold can. Jack Sauers, Gold cyclist wrote about Gold linkage with market sectors and inflation in 1977. From the investor point of view, gold and gold stocks are looked at as being counter cyclical. That is why when the stock market peaks out and reverses trend, there is usually a rush to buy gold and gold stocks with investor funds obtained when industrial stocks are sold off as Dow Jones drops. There is thus a strong tendency to drive gold prices and gold stocks even higher. After the low of business cycles is reached and recovery starts again, gold and gold stocks are sold off and funds reinvested. Jack also explained why gold sometimes ignore the inflation trend of other commodities on the rising portion of business cycle. As far as the average business cycle of 41 months is concerned, copper and silver rise as the cycle increases due to industrial demand and gold decreases. Only when inflation rate is terribly high, or too apparent to the average consumer, do all metals rise simultaneously as investors lose confidence in paper money.

So the question one should ask is how terrible is this inflation? And does inflation lead commodities or vice versa. If it is a commodity linked inflation, a pause in commodity will also see a pause in inflation for a few months while the long term cycles exert themselves. The equity v/s gold cycles for Nikkei, Dow and Sensex also suggest that we are heading for seasonally positive time for equities compared to Gold. This means that a multi month pause in equity market fall, a bear market rally beginning from cycle lows in October 2008 might be in. We mentioned about the late economic cycle and how it is linked to the 41 month Kitchen cycle. Sensex fall for the last 8 months also pushes us towards completion of the first leg down in the late economic cycle. Every cycle has three legs and the current late economic cycle should complete sometime in 2011-2012.

From a market sentiment point of view, confidence crisis are also of various degrees. First is the crisis linked with earning expectations; second is a political crisis (like we are witnessing in Pakistan); third is a regional or local currency crisis; fourth is a global financial crisis (subprime). Only after this the economy faces a cash crisis when there is a flight of money from paper to hard assets like gold and metals. Markets don’t just bounce from one crisis of lower degree to a larger one immediately. Though this can happen, easing commodity prices belie that fear. We have been crying recession for almost a year now and the DOW remains unflappable near 12,000 (barely 15 per cent down). In conclusion, the current negativity on Gold prices should push prices lower for more than a few months. This should accompany the other commodities, including oil. The countercyclical effect of this should be seen in equities around the world with markets rising for more than a few quarters around the world. And when complacency will return that recession has been averted, the next leg up on Gold, up till 2015 should begin. Global recession does not come just because we are waiting, it will come in due time, when Gold cycles and other intermarket cycles signal.


The Google Story

- CORPORATE HISTORY - Authors - David A. Vise and Mark Malseed.

Google holds an insurmountable reputation in the search engine industry. Google is an American firm based out of Mountain View in California. Google’s founders are two intellectuals of Stanford University who started up this project in January 1996.Their mission to organize world’s information. Larry Page and Sergey Brin started this company on 7 September 1998 at the Silicon Valley boom time for startup companies.

Their business model was quite simple. They hypothesized that a search engine that analyzed the relationships between websites would produce better results than existing techniques, which ranked results according to the number of times the search term appeared on a page. Initially they used the local domain at Stanford University. Later they incorporated Google Inc. at a friend’s garage in Menlo Park, California. Later Andy Bechtolsheim one of the founders of Sun Microsystems helped with initial investment that amounted to dollar 1.1 million and after meeting the Google guys he was so impressed that he simply wrote them a cheque of dollar 100,000.

Innovation at Google comes from its people. Google has a policy to allow its people 20 percent of their time to pursue their independent projects. These independent projects which harnesses employees passion and drive leads to 2.5 x greater productivity. Page and Brin insist that all engineers in the company have one day a week to work on their own pet projects. An ideas mailing list is open to anyone at Google who wants to post a proposal. Orkut is an outcome of one of such big ideas.

Google’s café famously known as “Charlie’s Place”- Charlie Ayers was Google’s executive chef. He joined Google in 1999. He cooked exotic gourmet meal for all the Google employees. Vegan and vegetarian fare is an important part of the menu mix at Google. Dishes like- abbouleh, Baba Ganjou, Hummus, Dolmas (stuffed grape leaves), Tsatsiki Sauce, Stuffed Squash Blossoms, Spinach-Lentil Dahl, Khombi Tartare, Curried Chick-peas and Stuffed Vidalia Onions. It’s a mouth watering experience every time for an employee who is allowed to even carry food home to their spouses or get their families to the café. For all Google employees the company has an in house hair stylist and they have dental van service too.

Google’s Library Project is another innovation. When you click on a search result of a book, you can view snippets, few sentences or key words that show the search term in context. If the book is out of copyright, one may be able to download an entire book or there are links that can take you directly to the libraries or bookstores from where one may purchase these books. Google did face lot of resistance from Author’s guild on violation of copyright’s. But Google’s mission on the ‘library project’ or ‘partner project’ is to organize hard to find information and making it ‘universally accessible and useful’. Publishers do have an opt out option by just sending Google a message.

Click Fraud is a type of internet crime that occurs in pay per click online advertising. This fraud happens when a person, automated script, or computer program imitates a legitimate user of a web browser clicks on an ad, for the purpose of generating a charge per click without having actual interest in the target of the ad’s link. Google paid dollar 90 Million to affected advertisers in attorney’s fees and credit as part of the settlement. The lead plaintiff was Lane’s gift and collectibles which sells items such as dolls, figurines and teddy bears online, over the phone and by mail.

Google Vs Booble was also another hurdle which the company faced. In early 2004 Google Inc. claimed website Booble infringed on their trademark name and logo. They distinctively duplicate the look and overall feel of website. Google asked the web site to disable the website and to disable the domain name. The Google version on ‘I am feeling lucky’ was changed to ‘I am feeling confused’. The logo was also similar to the white screen and colored alphabets. To this date, Booble fought back stating that theirs is a competitor website for an adult search engine. They claimed their site as a parody site and said it’s not confusing at all.

Google’s language toll covers 104 languages, which offers a personalized version to 115 countries. Two types of interface are possible in this tool, by country and by languages.

Google has indeed become a phenomenon, a part of society’s social expression. Google also entered the Oxford dictionary as a verb in Jun 2006.


SURABHI SOOD


Relative Valuations - A Critique

Valuation, though a subjective matter, has many elements of objectivity. In the year 1934 Benjamin Graham and David L. Dodd published their book on Security Analysis that was precursor to many work in this field of finance. This was followed by ‘The Theory of Investment Value’ in the year 1938 by John Burr Williams. While William stressed on the value of a stock being equal to the present value of all future dividends, the duo of Graham and Dodd emphasized on what we call earning multiple or relative valuation.

Which mode of valuation is better? And why? Can any investment professional answer this question without annoying coterie of analysts and fund managers? In the tech boom of 2000-01 in the Wall Street the average P/E of stocks had risen to as high as 228 . Will anyone buy a stock, today, at or near that level? The answer is no as you know, when you can get all the stocks at around P/E of 11 why would you buy so high. This is why subjectivity in the valuation becomes important. One more question, given the current scenario in the global market, will you buy a stock tomorrow at a P/E of 200? If you said, no, you better watch out!

Given a stock, in how many ways can it be valued? And whether all such methods will lead to the same value? Market analysts value common stocks based on the following methods:

• Discounted cash flow(DCF) method
• Relative Valuation method
• Residual Income method

Each of the methods stated above carries some degree of bias. In the DCF based valuation companies are assumed to be going concern, however, given the nature of many firms in the market no one can guarantee the continuity of a firm. Having decided to use DCF, still the task is a little complicated when it comes to valuing emerging market stocks. The Analyst has to choose between adjusting the discount rate or the cash flow when it comes to emerging market stock in an inflationary scenario. Adjustment of cash flow is preferred over the discount rate as the emerging market risk is diversifiable. Normally, future dividends, cash flow to firm or cash flow to equity may be used as an input to valuation in DCF approach. The point to note, however, is all the methods should ideally give approximately the same result. If not, then, the analyst has to change his assumptions. In the dividends discounted valuation approach, the perspective is that of a minority shareholder who owns the stock to reap the benefits in terms of dividends. Stocks in the Mature Industries can be valued with this approach. For a majority shareholder, however, the perspective is that of control and hence the relevant cash flow is free cash flow to firm (FCF) or free cash flow to equity (FCFE).

Having chosen the relevant cash flow to discount, the most important thing that remains is the growth trajectory. This is where the subjectivity takes the centre-stage. A growth stock may grow in future till a few years and then may return to the industry’s normal growth rate. The same stock may grow at a very high (read abnormal) growth rate for few years, then to decelerated growth and to finally the industry’s normal growth rate. It is up to the analyst to forecast the growth duration. Again the classification of industry is very important, viz. the industry may be a pioneer, in growth, or achieving maturity or may have reached the decline. Each of the above categories will have different growth rates. The reason why stocks value don’t always equal to the one projected by analysts is because of various assumptions used in the analysis. During the period of extreme optimism stocks prices rise much above what is predicted by analysts and during the period of extreme pessimism stocks fall much below their intrinsic value. You may call this irrational exuberance in the words of former Fed Chairman, Mr. Alan Greenspan. Since this has happened in past, history will be repeated again.

Relative valuation is easier to work out compared to absolute valuation –as in the case of all DCF based valuations. This is based on law of one price. In reality, however, not all stocks in the same industry are priced at the same level. The range of P/E in one industry may not vary much but there always is premium for a brand. The reasons why companies in the similar industries are priced at different multiples compared to their peers is because of the growth estimates, management’s reputation (read corporate governance) and the model of business, patents, industry structure among others.

The industry leaders always command high price, hence their earning multiple is higher than their peers. Even if a stock is valued in terms of its cash flow to be received in future, the estimate of its future P/E is required to arrive at its terminal value. How do you justify a stock paying dividend yield of 1.5 %? If this stock is kept for five years the cumulative yield is 7.5%, assuming no price change. Definitely, then, any one having the stock would like to sell this for a better investment. In other words, people buying dividend stocks also have some expectations of price appreciation or the future P/E. In the earning multiple (P/E) based valuation the following multiples are used by the analysts, the price of the stock remaining the same.

• Price to Earnings (P/E) ratio
• Price to Book Value(P/B)
• Price to Sales(P/S)
• Price to Cash flow(P/CF)
• Enterprise value (EV) to Earnings before Interest Taxes and depreciation (EBITDA).

The problem in these earning multiples is all the stocks do not and can not be a candidate for one of the above ways of valuations. A software solution(ITeS) company, for example, has its little assets in real estate, stationeries, computers, furniture and mostly in the human resources. The P/B of a this tech stock will be much higher than that of a finance (banking) stock. As will be clear later in this essay, these tech companies are expected to have very high residual income or income above their cost of equity. A bank stock has most of its asset in liquid form; hence they trade very close to their book value. Compare this with a tech company that trades at over 8 times its book value. Two frontline stocks in IT and Banking listed on BSE and part of benchmark index Sensex, Infosys Technologies Ltd. and ICICI Bank Ltd. are trading at P/B of 7.3 and 1.62 respectively as on August 20, 2008. Similarly stocks in pharmaceutical industry trade at a very high P/E ratio.

The market always expects them to come out with one great discovery! The problem with P/E based valuation is they can not be used in case of capital intensive company or companies in the beginning of their life- company in a pioneer stage and requiring huge capital expenditure. Companies whose stocks give negative earnings can be valued based on Price to Sales (P/S) or Price to Cash Flow (P/CF). The advantage of using P/S is sales are not as easy to manipulate as the earnings, though companies can always do it. Cash flow in that sense is very hard to manipulate, but as stated above, some companies generate negative free cash flow in the early years of their operation and in such cases the best candidate is sales. An analyst often has to run a regression equation with top down approach. If the GDP grows by a certain percent, industry picks up some fraction out of it. Within an industry, a company may have a particular share that may remain constant or may grow at certain percentage. Sales can then be estimated based on the regression equation. EV to EBITDA based valuation is used when a company spends a lot on machinery or capital goods and hence their depreciation is very high. All this effort ultimately has to be compared with values obtained in case of various companies.

Compared to individual stocks, indices trade within a particular multiple. Hence, comparison can always be made as to whether the basket is trading at historical high earning multiple. The table below shows the highs and lows of P/E, P/B and Dividend yield of S&P CNX Nifty for the period 1999-2008(July).

As stated, the P/E of the S&P CNX Nifty is more volatile compared to its P/B, as the standard deviation of the P/E (3.65) is much higher than P/B (1.06). This proves what we stated that earning based measures are more volatile than book value based measures.

The Residual Income approach uses concepts like Economic Value Added (EVA), which is based on the premise that there is a cost to equity which is not charged in case of the accounting based earnings. The cost of equity is charged to Net Operating Profit adjusted for taxes (NOPAT) and the income so obtained is called the residual income. If the company is growing and is likely to grow further then its residual income is also adjusted upward for growth. The analyst has to again use his judgment about the time when the residual earning drops and the company earns just normal earning. What is relevant in the EVA based valuation is book value is used in the valuation equation and present value of the residual income is discounted. Many analysts, therefore, feel that this is a better way of valuing a stock as the major part of the Valuation equation is known in advance, i.e. the book value.

Which method is the best?

In global scenario assets are being bought and sold based on different perspective in mind. Real estates are mostly valued on the basis of income method, however, on many occasions their market value is far above their intrinsic value. In India, almost all research reports are being prepared based on relative valuation. Probably the market does not want to be wrong in forecasting cash flow beyond a horizon. In a study of research reports published by broking firms in India, ICRA, a credit research agency, found that stocks perform well just after the report is made public, however, in the long run no such evidence was found. Even between the sell side and the buy side report there are differences in the way the report is being presented . Illiquid stocks trade at a discount to their fair price. The value of an illiquid asset is generally lower than the value of a similar asset that is readily marketable . The difference in the earning multiples of various stocks may be justified today if tomorrow can be seen today! While analysts will always remain busy in their valuation, market will keep moving in its random walk only to remind that valuation is never a constant!

Jainendra Shandilya

The author works as Assistant General Manager at Securities and Exchange Board of India, Mumbai, India. The views expressed are personal and does not belong to the organisation.


RSI - DIVERGENCES

Divergences are also an extension of the Dow Theory rule of non confirmation between indices. DOW Theory looks for non confirmation between two indices. While divergence looks for non confirmation between price and its RSI. Unlike failure swings, divergences are a bit loosely defined. There are simple and complex divergences. There are also divergence failures and divergence loops. As a basic guideline, whether divergences are able to create a trend reversal or not they do create some weakness in the ongoing trend. Fig 1. illustrates a bearish divergence and Fig 2. illustrates a bullish divergence.

The next issue of Interpreting RSI we will speak about the following aspects.

4. Price Patterns on RSI
5. Trendline on RSI
6. Reversal Techniques on RSI
7. Channeling on RSI
8. The 40 and the 60 line on RSI
9. Moving average on RSI
10. Changing RSI default values from 14

RSI calculation

For each day an upward change or downward change amount is calculated. On an up day, i.e. today’s close higher than yesterday’s:

Upward change = close today − close yesterday
Downward change = 0
Or conversely on a down day (Downward change is a positive number),
Upward change = 0
Downward change = close yesterday − close today

If today’s close is the same as yesterday’s close, both Upward change and Downward change are zero. An average of Upward change is calculated with an exponential moving average using a given N-days smoothing factor, and likewise for Downward change. The ratio of those averages is the Relative Strength,
RS = Exponential MA of Upward change / Exponential MA of Downward change

The index is then formed by using the formula:

RSI = 100 - ((100/1+RS))

The RSI fluctuates within a band of 0 to 100. Oversold and overbought lines are traditionally drawn at 30 and 70 levels. Wilder originally used a 14 day period for smoothing, but 7 and 9 days are commonly used to trade the short cycle and 21 or 25 days for the intermediate cycle. Cycle interpretation helps to decide the period for RSI. The RSI should confirm price movement; therefore, if the stock price is moving up, the RSI should be moving up as well.

If prices make new highs and also the RSI indicator makes new peaks then there is no technical weakness. But if prices make new highs and RSI indicator fails to confirm this, i.e. make lower highs, a negative divergence is given indicating the weakening of the technical structure. A bullish divergence is given when prices make lower lows and RSI indicator make higher lows. A bullish divergence failure can be extremely negative and vice versa.

Ashish Kyal, is a Bachelor of Engineering (B.E.) and MBA. He is pursuing the Chartered Market Technician program and is an associate member of the MTA (Market Technicians Association, USA). Ashish has also worked in the Risk Management area for a leading commodity exchange in India. He supports his investment decisions using technical tools and is passionate about Investment psychology.


MOMENTUM - INTERPRETING RSI - I

Linearity or trend in a price does not depict the strength and weakness cycles in a price very well. Momentum is a popular secondary indicator after price because it de trends the price and elucidates when the trend in a price strengthens and weakens. Why is this important? A stock or asset bought in a weakening or falling cycle may fail to move up despite all positive news behind it and vice versa. When a stock fails to behave as expected, the investor loses patience and conviction regarding his investment and throws in the towel. After which (to the investors consternation) the stock proceeds as expected. The only way to overcome this unfortunate feeling is by understanding cycles or simply putting market momentum.

The relative strength index (RSI) was developed by Wells Wilder. It is one of the post popular momentum indicator or oscillator that measures the relative strength of the price of a stock or market. How strong or how weak is the price? When is the cycle of strength higher and when does the price trend exhaust and fall?

Momentum falls in two broad categories, banded and non banded. Banded ones move in a fixed range, 0-100 for RSI and non banded move around a mean or equilibrium or zero line like ROC and MACD. Banded indicators are easier to interpret as they swing in a range and move from one extreme to other exhibiting a consistent periodicity.

RSI Interpretation

Before we talk about the various ways to interpret RSI, one should understand that like every interpretation, momentum or RSI interpretation has a convention and unconventional usage. Therefore the trader should not only understand the conventional usage of indicators but also know how to use them unconventionally. Since indicator failure is a reality, a conventional interpretation has a high chance of failure. Some of the principal methods used to interpret the RSI are as follows.

1.Extreme Readings

When RSI moves above the 70 level it can be considered as an overbought level or when it moves below the 30 level it can considered as an oversold level. These levels again depend on time frame under consideration and also on whether the market is trending or ranging. Overbought or oversold reading does not indicate a clear sell or buy signal but it only indicates some action in opposite direction is pending as market has a tendency to return to the mean in long run. Though we at Orpheus use the 30-70 default, traders also talk about stretching the limits to 20-80. Sometime extreme readings can also be established in terms of historical levels e.g. when was the last time RSI hit 90 on weekly basis or say 15 on a multiyear basis.

2.Concept of failure swings

Failure swings, in overbought or oversold territory, signal that a trend is weakening and likely to reverse. A trough below the oversold level, followed by an intervening peak that does not reach the overbought level, then a higher second trough and to complete the failure swing the indicator must then rise above the intervening peak. The similar concept can be applied for movement from the overbought level to give a good sell signal. This the classic DOW Theory rules of lower highs and lower lows applied to the momentum indicator instead of the price. We have not seen failure swings as a commonly appearing phenomenon. They are a bit rare, hence more effective. Failure swings are defined above 70 and below 30 levels not between the 30-70 bands.


MOMENTUM - INTERPRETING RSI - I

Linearity or trend in a price does not depict the strength and weakness cycles in a price very well. Momentum is a popular secondary indicator after price because it de trends the price and elucidates when the trend in a price strengthens and weakens. Why is this important? A stock or asset bought in a weakening or falling cycle may fail to move up despite all positive news behind it and vice versa. When a stock fails to behave as expected, the investor loses patience and conviction regarding his investment and throws in the towel. After which (to the investors consternation) the stock proceeds as expected. The only way to overcome this unfortunate feeling is by understanding cycles or simply putting market momentum.

The relative strength index (RSI) was developed by Wells Wilder. It is one of the post popular momentum indicator or oscillator that measures the relative strength of the price of a stock or market. How strong or how weak is the price? When is the cycle of strength higher and when does the price trend exhaust and fall?

Momentum falls in two broad categories, banded and non banded. Banded ones move in a fixed range, 0-100 for RSI and non banded move around a mean or equilibrium or zero line like ROC and MACD. Banded indicators are easier to interpret as they swing in a range and move from one extreme to other exhibiting a consistent periodicity.

[bold]RSI Interpretation[/bold]

Before we talk about the various ways to interpret RSI, one should understand that like every interpretation, momentum or RSI interpretation has a convention and unconventional usage. Therefore the trader should not only understand the conventional usage of indicators but also know how to use them unconventionally. Since indicator failure is a reality, a conventional interpretation has a high chance of failure. Some of the principal methods used to interpret the RSI are as follows.

[bold]1.Extreme Readings[/bold]

When RSI moves above the 70 level it can be considered as an overbought level or when it moves below the 30 level it can considered as an oversold level. These levels again depend on time frame under consideration and also on whether the market is trending or ranging. Overbought or oversold reading does not indicate a clear sell or buy signal but it only indicates some action in opposite direction is pending as market has a tendency to return to the mean in long run. Though we at Orpheus use the 30-70 default, traders also talk about stretching the limits to 20-80. Sometime extreme readings can also be established in terms of historical levels e.g. when was the last time RSI hit 90 on weekly basis or say 15 on a multiyear basis.

[bold]2.Concept of failure swings[/bold]

Failure swings, in overbought or oversold territory, signal that a trend is weakening and likely to reverse. A trough below the oversold level, followed by an intervening peak that does not reach the overbought level, then a higher second trough and to complete the failure swing the indicator must then rise above the intervening peak. The similar concept can be applied for movement from the overbought level to give a good sell signal. This the classic DOW Theory rules of lower highs and lower lows applied to the momentum indicator instead of the price. We have not seen failure swings as a commonly appearing phenomenon. They are a bit rare, hence more effective. Failure swings are defined above 70 and below 30 levels not between the 30-70 bands.

Mukul Pal
Orpheus Capitals, Global Alternative Research


RSI - DIVERGENCES

Divergences are also an extension of the Dow Theory rule of non confirmation between indices. DOW Theory looks for non confirmation between two indices. While divergence looks for non confirmation between price and its RSI. Unlike failure swings, divergences are a bit loosely defined. There are simple and complex divergences. There are also divergence failures and divergence loops. As a basic guideline, whether divergences are able to create a trend reversal or not they do create some weakness in the ongoing trend. Fig 1. illustrates a bearish divergence and Fig 2. illustrates a bullish divergence.

The next issue of Interpreting RSI we will speak about the following aspects.

4. Price Patterns on RSI
5. Trendline on RSI
6. Reversal Techniques on RSI
7. Channeling on RSI
8. The 40 and the 60 line on RSI
9. Moving average on RSI
10. Changing RSI default values from 14

[bold]RSI calculation[/bold]

For each day an upward change or downward change amount is calculated. On an up day, i.e. today’s close higher than yesterday’s:

Upward change = close today − close yesterday
Downward change = 0
Or conversely on a down day (Downward change is a positive number),
Upward change = 0
Downward change = close yesterday − close today

If today’s close is the same as yesterday’s close, both Upward change and Downward change are zero. An average of Upward change is calculated with an exponential moving average using a given N-days smoothing factor, and likewise for Downward change. The ratio of those averages is the Relative Strength,
RS = Exponential MA of Upward change / Exponential MA of Downward change

The index is then formed by using the formula:

RSI = 100 - ((100/1+RS))

The RSI fluctuates within a band of 0 to 100. Oversold and overbought lines are traditionally drawn at 30 and 70 levels. Wilder originally used a 14 day period for smoothing, but 7 and 9 days are commonly used to trade the short cycle and 21 or 25 days for the intermediate cycle. Cycle interpretation helps to decide the period for RSI. The RSI should confirm price movement; therefore, if the stock price is moving up, the RSI should be moving up as well.

If prices make new highs and also the RSI indicator makes new peaks then there is no technical weakness. But if prices make new highs and RSI indicator fails to confirm this, i.e. make lower highs, a negative divergence is given indicating the weakening of the technical structure. A bullish divergence is given when prices make lower lows and RSI indicator make higher lows. A bullish divergence failure can be extremely negative and vice versa.

[bold]Ashish Kyal[/bold], is a Bachelor of Engineering (B.E.) and MBA. He is pursuing the Chartered Market Technician program and is an associate member of the MTA (Market Technicians Association, USA). Ashish has also worked in the Risk Management area for a leading commodity exchange in India. He supports his investment decisions using technical tools and is passionate about Investment psychology.

Mukul Pal
Orpheus Capitals, Global Alternative Research


OIL 2012 - The real hijack

MOVING SUB 100, PREPARING FOR 300

A recent conversation with an old friend on 11 July, went like this.

MP: How are things at your end? You ready to retire after making your billion? RL: Well I have not yet reached the billion dollar value, still struggling to hit that number and then quit.  Meanwhile oil has hijacked the gains so retirement has become doubtful.

The timing of this conversation was perfect. 30 Jun OIL hit  dollar 150 and 11 July it was still retesting the previous highs. Now prices have fallen till 112. Blaming Oil was easy. But whom will we blame when it moves to dollar 300. These high targets did not seem improbable at dollar 150 and will look incredulous sub 100, but then sentiment extremes are not always easy to visualize.

The right form of OIL illustrated on the right suggests a completed 3 circle primary wave to us with 4 and 5 primary circle still to come. This means we are indeed heading for a 2015 retirement hijacking. Both Oil and markets give a second chance.

The 3 circle primary took 6 years. It took about a year each for wave 1 and 2 circle primary. This makes it an 8 year bull. From a decade cycle the bull is definitely exhausted. But from the 30 year commodity cycle the energy asset can easily extend till 2012. And if you take cycle translation into view prices could continue to push higher beyond 2015.

What does this mean? This means that after 4 circle primary wave pause, the final up leg higher should begin. This could take oil till dollar 300 and maybe higher.  Now the interesting question is the kind of formation the 4 primary leg would take. The classic extended one, or the sharp down. Elliott Alternation rule is in for a sideways action till Q1-Q2 2009. This could probably keep OIL in the primary log channel illustrated here. But in any case previous 3-4 intermediate supports easily point to a sub 100 target.

The timing for OIL fall could not have been better. Now with all the recession worries here and OIL inspired news on a new high, the commodity decides to surprise. But then that’s what market is all about, surprises. A potential fall till dollar 70 is another preposterous target that could happen sub 100.  Read THE OIL ROCKET published in May 2008 when we said the ROCKET up is unsustainable. Sub 100 would mean a drop of 50% from the historical top. This should be some reason for a red signal for OIL BULLS and green for Equity Bulls (WAVES.GLOBAL).

Enjoy the latest WAVES.OIL


Recession proof stockpicking

Attractive valuations should lead to price performance. This statement may be partially true in secular bull markets. But when markets fall for more than a year, we need more than attractive valuations to recession proof our investments. As good valuations necessarily don’t outperform and even if they do, there is no fast retribution. Things take more time in slowdowns. So how to pick stocks that can deliver in tough times?

In XTR INDICES, we lay down a complete step by step process to pick up the top picks. First and foremost, if a stock figures in the XTR 21, it has gone through a serious filtering on statistical, fundamental and sectoral aspects. If a stock is there, it has already been filtered once. Second, if the same stock figures in the free float index XTR 30, it passes through the tough tradability criterion. Third, we give you the late economic filter. Any stock from the materials, energy, staples, utilities, chemicals and Pharma suggest more insulation to tougher times. And even if globally we are witnessing pauses in the OIL upmove ( read the latest WAVES.OIL), the energy boom is far from over and Energy and Metals still have a few years of upside left. Fourth, if you still want to filter your stock shortlist a bit more, run the classic price and fundamental screens and you can rest assured that your final results will definitely conserve capital, if not make you rich. And the way we see markets evolving over the next two quarters, we see more of a profitable than a mere capital conservation strategy here.

We ran the steps for you and came with the following stocks AMO, AZO, VRANCART, ALU, PTR. If you add to them the Energy Major SNP and utility majors TGN and TEL, you have an eight stock portfolio that should weather all your recession storms for the next two quarters. If you take out TEL, all the rest have an average P/E multiple of around 12. All the respective stocks are from Late Economic Sector and are present in XTR 21. And half of them also pass the tough free float criterion of the XTR 30 Index. Now what’s left is conviction that such extreme filtering has more chances of success than failure.

The last week’s XTR INDICES performance highlights the XTR recession filtering yet again. XTR 21 was top Mid Cap performer at 10%. XTR 30 components topped the Small Cap category. On a month over month basis XTR 21 shined again with a 12% relative performance over the universe components. Our flagship Index XTR 21 is back near neutral territory for the year with relative gains of more than 50% above BETFI (the financial sector Index). COMI, TEL and COS breached the 10% performance screen for XTR 21. TEL also figured in the utility sector screen along with COVG and SCTO utility components. ATPA topped the discretionary sector. ATB topped Pharma sector screen. CEON, COS and AMO topped the materials screen. ARS, COMI, COBS and EPT topped the Industrials. PRAE was the staple outperformer. Another interesting and profitable week for recession proof stocks.

Enjoy the latest XTR INDICES

ORPHEUS ROMANIA RESEARCH

XTR.INDICES is our analytics product, which creates and manages Romanian market indices like XTR 21, XTR 100 and XTR 30 (Free Float). We also run models based on breadth indicators (Advance Decline ratio) and statistical parameters (correlations, betas, volatilities, top price changes, 200 day moving average etc.) XTR 21 - THE BLUE CHIP INDEX. REUTERS RICS COVERED.TRPS.BX, VNCA.BX, AMSL.BX, PEXI.BX, BATR.BX, ARTM.BX, COMI.BX, PTRI.BX, BRDX.BX, BRKU.BX, ARTM.BX, SNOS.BX, ARSB.BX, ALRO.BX, AZOM.BX, OTSP.BX, ALUM.BX, MOPN.BX, TSEL.BX, TGNM.BX XTR 100 - BROAD MARKET INDEX. XTR 30 - FREE FLOAT INDEX. XTR – EE (XTR EARLY ECONOMIC INDEX), XTR – ME (MID ECONOMIC SECTOR), XTR – LE (LATE ECONOMIC SECTOR)

ORPHEUS RESEARCH AT REUTERS - UNITED KINGDOM

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The Cycle Blindness

Start of August is the celebration of the richness of harvest. It is a time for festivals. People step out and celebrate. This is seasonally a good time for food and beverage companies. It was during these weekend jaunts out of Cluj, back at the farm house about 80 kms away, we started picking plums and enjoying the natural inspiring beauty of corn fields and farm lands around us.

Did our city life really isolate us from the underlying agricultural economy? Did the harvest cycle stop affecting us? Or are the agricultural, climate, commodity, social behaviour and economic cycles somewhere connected? A common theme runs through all these cycles. They are all linked and have a distinct periodicity. The long term and short term climate cycles establish what we harvest and eat and what we eat is linked to our social, economic growth and expression. And a crisis or a down cycle on any one of these cycles affects all the rest. Though the modern economies are no more agrarian, the current food crisis is increasing inflation and pushing commodity prices higher. The unison of up and down cycles are changing how we celebrate (behave) and remain happy (prosper). Jacob J Van Duijn, talks about how a classified or phased approach to economic development is important to realise that human behaviour as producers, consumers, and investors create cycles. But still a majority of us are unaware of the economic consequences of this behaviour. For example, every generation comes with capital investment ideas and allocation as the previous capital investments become technologically obsolete. This leads to the repetitive investment cycle. But little is learnt from the past.

This creates a gap between our understanding of the economic future and the current socio economic perception. This is one of the reasons humans are generally under prepared for the future. We can’t understand how policy induces monetary cycles or how oil prices or shock induced boom bust cycles and over investment, under consumption, demographics and mass psychology driven cycles can influence and change a growth period into recession or vice versa. There is one more reason why we are cyclically blind. We relate or register more to short cycles. The fluctuations caused by Kitchen cycles (3-4 years) very much determine people’s mood and expectations regarding the short term outlook of the world economy. Because, in the short run it produces the dominant cyclical pattern, most observers tend to overlook the longer term developments which lie underneath. Needless to say, this form of myopia may cause rather wild swings of over optimism and over pessimism. This is why euphoria and pessimism repeat with such regularity.

As we move from short term to long term cycles the cycle applicability and debate intensifies. More so because what affects us in the long term is still unclear. In 1991, Richard Mogey, Cycle Guru said, “Many have been expecting a Kondrateiff wave (the long term 60-year cycle) to top for nearly twenty years, but it has yet to unfold.” This long-term cycle has been hotly debated and a few cyclists like Tony Plummer, Author and cyclist, suggest the Berry cycle (25-30 years) and Strauss and Howe cycle (90-99 years) as a more valid case over Kondrateiff cycle. Plummer’s case becomes more relevant if you connect power law relationship between Kitchen, Juglar, Berry and Strauss. All are linked with a factor of 3. Three Kitchen cycles make a Juglar cycle, three Juglars make a Berry cycle, three Berry cycles make a Strauss crisis cycle.

Small fluctuations caused by the Kitchen cycle sometimes go unnoticed by the masses. But it is the large Juglar, which registers in the long term memory. Average length of little less than a decade appear to be in conformity with the way people think of time spans, the swinging 60′s, the 90′s etc. Hence Juglar recessions have a deeper impact on mass psychology. Juglar recessions are also deeper than Kitchen recession just like Juglar upswings more sustained than Kitchen upswings.

Juglars are also considered as the most long standing, dominant and periodic. This cycle was identified by Clement Juglar, a French economist in the mid 1800′s. Juglar began his work with cyclical studies in French marriage, birth and death rates. These observations led to similar cyclical behaviour conclusions in interest rate, credit contractions and commercial crisis. His studies concluded that credit contractions and crisis occurred with an average periodicity of 9-10 years. Juglar cycle is also referred to as the pendulum swing of prosperities and liquidations.

A similar 9-12 year cycle is also witnessed in agriculture, social trend and is informally also labelled as the business cycle by economists. There is another business or trade cycle namely the 7-11 year investment cycle also known as the cast iron cycle, which existed 250 years ago and still exists today. Cyclists have discovered more clusters of 10 year cycles. The most reliable is the sunspot cycle of 11.2 years. Sunspot cycles are also known as prosperity cycles. Research by Garcia Mata and Shaffner suggested that low sunspots actually work on the human psyche to influence confidence. Kitchen and Juglar cycles have been known to work on yields also. And of the many other running cycles, Juglar and Kitchen cycles work best for stock markets.

For example, historic lows are generally made in the second year of the decade. 2002 was a historic low worldwide, be it Nikkei, Dow, Sensex, Brazilian BVSP, Russian IRTS, it was everywhere. Juglar slowdowns have also known to degenerate into real crisis and depressions. The Juglar recession cyclicality has been observed since 1721.

But recession is not a singular event. It is linked with both short term and long term cycles. And since excesses happen in stages, correction of market imbalances also does not get over just by price retracement. Hence real recessions generally take time to balance and get into the human psyche. This is why recessions are also about market mood and not just about prices. Prices are just one way to express it. Simply speaking Juglars are real recessions. Historically we have not seen a bigger than a Juglar recession globally. The great depression (1929-1937), the Japanese depression (1990-2002), the American bear market (1965-1975), the Sensex sideways action of the 90’s (1990-2002) were all of Juglar time frames. Shorter recessions are labelled as Kitchen recession. Some European countries experienced a Kitchen recession in 1987, when industrial production came to a standstill. Though irregular, only Kitchen and Juglar could explain the global recession of the 1970′s.

There are other inter-market aspects linked with Juglar cycles. The bond markets generally hit a low on every Juglar low. The bond market rise from 1921-1932 in America is a classic example that can explain how interest rates should behave. American bond markets also hit a low in 1990-1991, ushering in another decade of prosperity. If we consider the Sensex in a Juglar up starting 2002, the cycle should complete anytime between 2011-2013.

This means interests and inflationary conditions should continue to rise for the next 3-5 years. This observation is in sync with the other commodity cycles, which we see peaking around 2012-2015. This also means that what we just saw from January 2008 was a Kitchen or growth recession, the real bust or Juglar recession should start at least a year from now.

The cycle truth is hard to accept. Like technical analysis is a foot note in Elliott, both Elliott and economics is a foot note in cycles. They are larger than life, above any mathematics and fractal science. And this more than 200 years of observed cyclicality can’t be wished away, just because it does not fit our conventional beliefs.

Accepting that we are cycle blind is a step forward to understanding economic uncertainties that surround us. Just like it takes 10 years to become a glassmith, for a global analyst, it takes 10 years to witness the Juglar recession and cycle truth.