Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Dollar’s Drop is First Step to Changing Inflation Expectations

This was a wild week in terms of the market’s reaction to the news. Japan’s Nikkei continued to slide, though that index seems oversold in the short run. Shinzo Abe is now doing what all central bankers do when plans begin to fail – propose structural changes to the nation’s economy, part of which includes deregulating general business and health care systems in addition to redirecting government pension funds (of $1.1 trillion) out of Japanese government bonds and into stocks to help “bolster confidence.”

Mario Draghi also called for an EU recovery within the year, while reaffirming that “QE” prospects would remain “on the shelf” until further notice. We suspect Europe is still basking in the glow of Japanese funding, and is therefore feeling no pressure to act on its own quite yet. Draghi’s comments strengthened the euro and caused a sizeable retreat in the US dollar (more on this later).

6-7-13 Box ScoresAnd finally, to end the week, the US employment report was just what the doctor ordered. It beat expectations for May (175,000 non-farm payrolls vs. expectations of 163,000), though the quality of this report was dubious, as usual. A whopping 205,000 spurious birth/death-model jobs were thrown into the mix, distorting reality once again. Incidentally the ADP Research Institute report earlier in the week showed a gain of 135,000, failing to beat its expectations of 170,000.

Anyway, stocks overseas bucked Draghi’s optimism and weakened overall, while US markets managed to eke out small gains, aided by the hype in jobs and a technical bounce off the 50-day moving average. Bonds were slightly off worldwide – including Treasuries – as many yen carry-trade unwinds made their effects felt. All in all, there was a great deal of motion and commotion, but any winner in this week’s market action was hard to spot.

The most significant development – if any – was the action in the US dollar. An overambitious group of longs was caught off guard in the midst of Draghi’s ambitious endorsement of the eurozone. The USD dollar index made an unceremonious plunge toward its 200-day moving average of 81.04, touching just above that level, and finishing the week with a modest bounce (chart below).

Screen Shot 2013-06-07 at 3.00.39 PM
Gold initially responded to the dollar’s demise quite well, demonstrating an ability to break out, price-wise, on the charts. However, it fell back again in short order Friday following the hype surrounding the jobs report. Gold finished the week with minor losses. Of note, technicians point out that gold has been rising on lower volume of late. Though this may be true, it was not the case in the past few trading days. Thursday’s upside volume outpaced Friday’s downside volume as it pertained to trade in the ETFs. This is an extremely short-term observation, but one that is deserving of some attention.

That said, it’s hard to see gold continuing a downward trek given the unhinging of the US dollar now in progress. In that light, we still believe that $1350 for gold will prove a formidable downside hurdle. Instead, we believe we are witnessing a turn in perspective for the markets overall, with a base forming in the metals alongside a top in stocks. Devaluation of the dollar, if it holds, followed by corresponding hike in inflation, should go a long way toward locking these two trends in place.

Best regards,
David Burgess
VP Investment Management MWM LLLP