Red Flags Update And More Solar Research

First, the flags:

1. China repo rate has escalated sharply today suggesting another cash crunch may be at hand:

20ja1Source: Chinamoney

2. Insider selling in the US is now historically high, a further sell signal for equities:

20ja2Source: Barrons

3. Comex gold stocks that are eligible for delivery versus open interest has risen to a historic extreme of 112:1. This means that the gold owners will demand higher prices to put their gold up for delivery and is bullish for gold prices.

20ja3Source: Jesse / goldchartsrus

Now to the solar findings.

Below is a chart showing the last 4 solar cycles. In the last 4 decades there have been 3 major real estate peaks in the US and UK: 1979, 1989 and 2006/7. There has been one in Japan: 1991. In the last 4 decades there have been 2 secular peaks in the CCI commodities index: 1980 and 2011 (which exceeded the 2008 high). In the same period we saw one major secular equities peak in Japan in 1989 and two major global equities peaks in 2000 and 2007. All are annotated below.

SCsThe theme of major market peaks falling at solar maxima is again revealed, but two recent anomalies stand out: the equities and real estate peak of 2007 falling at a solar minimum, rather than a solar maximum; and the commodities speculative peak of 2011 falling on the rise towards SC24 maximum.

Tackling the first, that 2007 peak gave way to the 2008 financial crisis, in which we saw crashes in real estate, equities and crude oil prices. This is in keeping with other crashes and crises that have historically occurred around solar minima. 1987’s historic crash in equities took place near a solar minimum. 1994 delivered a treasury bond market crash. 1997 saw the Asian financial crisis and a crash in equities. 2008 the aforementioned multi-asset crashes and financial crisis, and 2010 the flash crash in global stocks. All saw significant price rises into the crashes/crises. Central bank policies of this last decade were particularly friendly to asset bubbles, hence a suitably large boom and bust.

Turning to the second anomaly, one possibility is that commodities have not yet peaked and go on to make a higher high than 2011 in a late and swift cyclical charge as equities top out.

20ja4Source: MCRI

If they have already made their highs, then one explanation for their early peak on the SC24 maximum could be that China’s demographics topped out around 2010, and as the main driver of commodities demand the speculative finale had an earlier bias. China’s demographic trending to peak is perhaps better reflected in the bull market in commodities from 2000 than in their brief stock market mania around 2007.

But there is something else. Solar cycles average 11 years 1 month, but there have been outliers as short as 9 years and as long as almost 14 years. Here are the smoothed solar maxima of the last 100 years:

Aug 1917 (+11y6m after the previous solar maximum)

Apr 1928 (+10y8m)

Apr 1937 (+11y)

May 1947 (+10y1m)

Mar 1958 (+10y8m)

Nov 1968 (+10y8m)

Dec 1979 (+11y1m)

Jul 1989 (+9y7m)

Mar 2000 (+10y9m)

Dec 2013 ? (+13y9m)

Most aren’t far from average cycle lengths, but May 1947 was a year shorter, July 1989 shorter still, and if this smoothed solar maximum turns out to be around December 2013, that will be a much longer one than any of the others. Even if the smoothed maximum turns out to be Feb 2012 (the smoothed max to date) it will still be an outlier on the long side.

If lunar phasing still works despite artificial lighting and is to some degree ‘hard coded’ in human evolution, could sunspot cycles be too? Do we see evidence of human excitement through speculative peaks occurring around 11 years 1 month after the last solar maximum on those occasions where solar maxima occur significantly earlier or later?

The last smoothed solar maximum was March 2000. Add 11 years 1 month and we get April 2011, which is where we saw speculative peaks in silver, cotton, coffee, rare earths and others. However, we also see evidence of a speculative peak occurring now, at the likely smoothed solar maximum, as evidenced in many indicators and measures of equities.

July 1989 was an early outlier. 11 years 1 month from the previous peak would have been January 1991. Close to that, Japanese real estate peaked June 1991 and crude oil peaked in October 1990 in a war-associated major spike. However, we also saw US and UK real estate and Japanese equities peaking close to the actual solar maximum of July 1989.

May 1947 was an early outlier. Had it been a more regular May 1948, then we saw wholesale prices and crude oil peaking out around 1948. Yet commodities such as wheat, corn and oats peaked close to the 1947 actual smoothed maximum.

That may suggest there is some degree of hard coding of rhythm in human excitement, as well as some degree of variance in speculative peaks according to when actual solar maxima fall. However, when we look at the solar cycle progression charts,  we find that the tops of the solar maxima stretched across 1989-1991 and 1947-1948, which suggests there was no anomaly: speculative peaks were in line with actual solar maxima. But this is not really the case for the 2011 speculative peaks which fell on the rise into SC24 maximum. Therefore, we need to wait to see if commodities do make a late charge to a high exceeding 2011, wait to see if the solar maximum is falling and completing now, and also to wait to see if equities top out here and deliver a peak aligned with that potential solar maximum, before we can judge this further.

Cyclical stocks bull top?

Weighing up whether the equities bull market that began in 2009 is topping out here, we can look to fairly reliable historical topping signals, and I can summarise as follows:

1. A topping process, normally months, with reversals of reversals of reversals in a range – yes, up and down legs since May within overall range

2. Evidence of overbought and overbullish extremes (such as RSI and sentiment surveys) – I found this not to be too reliable as an indicator once the topping process has begun, but nonetheless, investors intelligence bears would be one such current reading – click here for link

3. Breadth divergence – yes, advance-declines or Mclellan summation index would be two

4. Cyclical sectors topping out before the index top and money flow into defensives – nope, not happened meaningfully yet

5. Major distribution days near the highs – we have had some 90% down days since May

6. Yield curve flat or negative – since the debt impasse began, treasury yields at the shorter end of the spectrum have indeed inverted, the longer end remains healthy

7. Tightening of rates through rising yields – we have seen a doubling in treasury yields over the last 6 months

8. Excessive inflation – nope, we are seeing global disinflation

9. Rolling over of leading indicators and recession model alerts being produced – combining OECD, Conference Board, ECRI, narrow money and Recession Alert, we don’t yet see this in any meaningful way

10. Market valuation excessive – measures such as the Q ratio and cyclical p/e show the US to be currently overvalued, whilst globally speaking valuations are within normal historic range (however, by my work this is relative to demographics and as such USA and Europe should get cheaper)

In summary, we see some warning signs of a top in progress, but not yet a full set.

To be clear, not all cyclical tops are a process. Some are parabolic manias that end in a spike, with a similar crash down the other side. Examples link here.

However, we don’t see parabolic rises in equities in global stock indices currently, and if this is a top being formed currently, then it is of the topping process type. The 2000 and 2007 tops were topping processes, as were the multiple tops around the 1970s.

What I have found about the topping processes is that when the topping range began, there were precious few topping signals present – as if the stock market were as competent a leading indicator as any other. But when the topping range ended – the last push up – the majority of signals were clearly present. I have highlighted the 2000 (Mar-Aug) and 2007 (July-Oct) topping ranges on the charts below to show this.

First, OECD leading indicators – downtrends in evidence by the end of the topping ranges

14oct20131

Second, ECRI leading indicators – by the end of the topping range had fallen through zero
14oct20133

 

Third, treasury yields – rising prior to the topping range, then falling once topping range in progress
14oct20134

Next we see the topping ranges on the SP500, which if you zoom in, had different shapes in 2000 and 2007 but in both cases there was a last push up to the highs, with many topping signals present, before the bear began. I show here what happened with commodities – both times topping after the stock market. In 2007 commodities only took off once the equities topping process had begun, so there is the potential for that to occur now, but it has to happen without delay if this is a top.14oct20135

Fifthly I show US housing, declining into the market tops. The recent drops in new home sales, related to the increasing mortgage rates, could be similar if it continues.14oct20136

Sixth, US GDP – again clearly in a downtrend by the end of the topping ranges, so should look for the same this time14oct20137 Seventh, margin debt. We see a similar overthrow rally in margin debt recently as per the 2000 and 2007 tops, and again margin debt was in a clear downtrend by the end of the topping ranges so should look for the same to occur
14oct20139 In short my message is this. If this is a topping process in equities, then we should see a further leg up ahead where the bulk of these indicators have moved into clear downtrends. We have certain topping signals already in place, but the rest should fall into place ahead if this is a topping range. It means a golden opportunity to go short would be following a further leg up in stocks against the backdrop of these remaining indicators having turned. If this is not a top in equities, but a consolidation before further gains, then we should break free from the range, and the topping indicators in place one-by-one cease to be.

I want to end by commenting on the global disinflation in place currently. This to me is consistent with demographic trends, and is the threat to a commodities rally coming to pass. If commodities can’t rally as per historic topping order norms, then I would point to the unprecedented collective demographic deflationary trends in place now.

As inflation levels drop in the major indebted economies, the danger is that inflation drops below yields making the massive debt effectively grow bigger. Central banks would then need to intervene further to suppress rates or initiate inflation, perhaps by increasing QE. If, on the other hand, commodities become a speculative rally target here, then inflation will increase but the move would have detrimental impacts on the economy. Central banks would again be bringing out the toolkit. It’s the trap that I referred to before. Can instead the goldilocks scenario continue, of low growth, low inflation and equities rising, with the Fed able to slowly ease out of QE? I personally can’t see it, because it is such a fragile position. Rallying yields or rallying commodities or government pullback on stimulus/spending would likely tip the fragile economy over, and I believe one or more of those will happen in due course. It would take stronger growth to prevent this, and I don’t see it can occur against the demographics.

 

Roundup

This is the latest geomagnetism forecast versus the SP500. The forecast extends to the beginning of September and as can be seen has further transformed from a downtrend to a sideways/up trend.

5aug1The SP500 notably diverged from the model throughout July, more so than other indices which have more closely tracked the model. The outperformance of the US stock indices has meant p/e valuation has now increased to make the US amongst the world’s more expensive:

5aug4Source: FT

Is this justified? Not by demographics. Here once again is my real US equities plus real US house prices model versus 3 demographic ratios for the US:

X1That model has edged further up now in mid-2013 as real equities are back at 2007 levels and real house prices have edged up a little more (though are still a long way from the real 2007 peak). Yet the 3 demographic trends call for the model to collapse once again, as in 2001 and 2008. What makes demographics more potent this time around is that China has joined Europe and the USA in an unprecedented collective downward demographic pressure.

If we take the best of the three demographic measures, middle to young, only, then this is how it looks:

5aug5Source: PFS Group

Is it possible that the 2014-15 bottom is near enough and that stocks have taken off already? Well that p/e10 now stands at around 25, having bottomed in early 2009. That would mean p/es bottomed out around 5-6 years before the M/Y ratio, whereas in 2000 and 1982 the two peaked and troughed at very similar times. In the  1960s there was more of a gap, with demographics topping out a few years before p/es, but note it was demographics rather than p/es first, and this is echoed in my demographic work on Japan and UK, namely that if there is any lag it is demographics changing course first. In short, another cyclical bear in US stocks still looks the most likely course to me, and this is further cemented when we draw in all demographics measures, demographic pressures in China and Europe, and other US market valuations such as the Q ratio.

However, current leading indicator data is still largely positive for the USA at the moment (e.g. latest Markit PMI), and Europe is showing renewed strength (Markit PMIs, Conference Board). In fact it is the demographic-positive markets such as Brazil which are showing particular weakness. So what’s going on? I suggest commodities have played a key role in this. Lower input prices have boosted the developed economies and stocks. Commodity-economies such as Brazil have suffered. If commodities can rally again and make a historically-normal late-cyclical peak after stocks have peaked then I suggest the demographically-challenged major economies won’t be able to handle the renewed input price pressure. I believe the weak global recovery will topple over if commodities, particularly oil, rise in a meaningful way again.

Here is 30 year treasury yields with CCI comodities index, world equities index and Euro-USD. Euro-USD and commodities could be in a new uptrend that began in early July, IF they can make a higher low here.

5aug6Source: Bloomberg

But too early to say anything more. For me, it remains a game of patience, waiting to see if commodities can start to outperform here. Gold and silver had a very up-and-down week last week. Oil has maintained its breakout but appears to be stalling.

I believe the solar cycle still has a key role to play in the fortunes of commodities. Here is the latest SIDC update which continues to show two possibilities. If the solar max was Feb 2012 then I suggest commodities peaked out in 2011. If this were the case then I don’t believe a new secular bull market in stocks is underway because as per my work secular actually is demographic and the major economy demographics don’t support a new secular bull. I rather expect a deflationary recession to come to pass in due course. If the solar max is ahead as per the second SIDC option then I believe we will see the historically normal late outperformance of commodities from here into 2014 and that will tip the world into recession.

5aug3

Source: SIDC

In the near term, I am looking at the window from tomorrow’s new moon through to Friday’s end-of-lunar-positive period to take profits on some equities longs and potentially add more short equities. I would like to see stocks advance further this week to do so.

State Of The Markets

No collapse in the stock market, which makes the case stronger for a more regular multi-month topping process. It would be historically normal for equities to retest their May highs and even make a marginally new high, then complete a volatile trading range by around September time before falling in earnest.

Also historically normal would be if commodities outperform from here, with bonds having topped first, then stocks topping, and eventually commodities topping out, likely in 2014. The continued falls in bonds – and rise in yields – adds weight to bonds having topped – and yields bottomed – in 2012. Now are world equities in the process of making their top?:

7jul4Source: Bloomberg

The strong advance in crude oil of late has added more weight to commodities going on to outperform here, rather than the historically abnormal but deflationary case of commodities sinking. The combination of protest and unrest in Egypt together with speculation in crude oil are both historically normal for a solar maximum, so I am encouraged. Nonetheless, crude oil has yet to truly break out and some geopolitical dampening could pull it back:

7jul1Source: Stockcharts

If crude does continue to rise, then commodities as a whole should catch a bid, due to high historic correlation, with oil a a key input in the agri process and a key inflationary force, which brings us to gold. Gold has dropped around 30% from its 2011 high, which is similar to the percentage drop made in 2008. It has the potential to be making a bottom here with a higher low than in late June, and the longstanding overdue bounce based on extreme bearishness, but only if it can rise this coming week, which brings back to oil’s performance, plus also the US dollar.

The recent strength in the USD has taken the currency to back up to a key level. Below is the long term view and the potential for an important breakout:

7jul6Source: Rambus / Stockcharts

However, as per my demographic work, I believe leading indicators will weaken and gold will re-assert itself, and US stocks will top out here reducing demand for the dollar. Here is some evidence to support that view.

The latest global PMI combined services and manufacturing dropped to 51.4 from 52.9 and continues the overall weakening trend over the last few years. This is as I would expect under the combined deflationary demographics of USA, China and Europe since around 2010.

7jul7Source: Markit

The performance in corporate bonds suggests US housing may be about to turn down again also:

7jul5Source: Martin Pring

And margin debt continues to look an important pointer for the stock market. See below how a sharp run up in margin debt, a final parabolic rise, precedes the 2000 and 2007 tops in the SP500 by several months. We have seen a similar parabolic rise since mid-2012 to now and there is the possibility that margin debt peaked out in April which would suggest stocks should indeed be in a topping process now and over the next couple of months:

7jul8Source: Dshort

If stocks are topping out then normal clues would be found in negative divergences in stock market internals and leading indicators. For the former, we should look for breadth divergence once we see a retest of the highs. For the latter, we have the potential in the global PMI above, but also in this leading indicator of leading indicators, by RecessionAlert:

7jul2

Source: RecessionAlert

I have enquired with them what this MBS indicator is, but have no reply. If anyone knows, please share. But it would fit with my demographic-deflationary expectations.

We also see a potential divergence in geomagnetism, if equities can now rally again to a retest of the highs:

7jul9

The ideal combination by my work and research is for commodities to outperform again now into next year, and make a speculative peak near to the solar peak (the timing of the solar peak remains unknown, with the experts still diverging. Sunspots are currently back up over 100, which adds to the muddy trend), then deflationary demographics to mean the global economy fairly quickly tips into recession under that commodity price pressure, and then we should see the steep falls in nominal stocks. My alternative scenario is that the deflationary forces are too great and commodities in general sink with just gold, as the anti-demographic, eventually coming again alone.

In support of my primary scenario, the action in live cattle has been very much aligned with solar history, with what looks like a peak earlier this year:

7jul10Source: Tarassov

7jul11Source: TradingCharts

Now we need to see other commodities make a fresh rally to new highs, assuming a solar peak is still ahead.

This week we have the new moon on Monday and the end of the lunar positive period by Thursday. So I am ideally looking for equities to rise further in the next couple of days and make that retest of the highs or marginally higher high, then retracing again in the negative lunar period ahead, to further the technical look of a topping process. If we get that retest of the highs then I will be looking to sell equities longs and add short. But for further support I would like to see oil break out, commodities to rise en masse and the US dollar to be turned down with gold catching a bid at last. Let’s see how the action unfolds.

Macro And Markets

The Fed announced tapering of QE as of 2014, subject to developments of course. It will first need to taper out its QE to zero before rates can rise from ZIRP. Rates will then likely be raised slowly as in the 1950s due to high government debt. Together this means easy monetary conditions will persist until US demographics bottom out 2014-2019.  I suggest that is broadly necessary to counter the demographic downtrend and could mean that we see continued low growth with more asset bubbles appearing and then popping.

What would change this course of action? If inflation became problematic and yields rose too far too fast. Currently inflation is benign as global growth remains fairly soft. History reveals that a  low growth low inflation low rates environment is good for equities. It took the last 12 months for investors to really gain confidence in economic growth persisting (if soft) and with a gradual bottoming in government bond yields:

21jun1

Source: Bloomberg

At those record low yields, investors were making a guaranteed real loss, yet money flows were still attracted into government bonds – with the assistance of QE in USA, UK and Japan – due to fear of greater losses in other asset classes. Recently that has changed, and it is because low economic growth has persisted long enough with some of the main worries (e.g. Euro debt, sovereign default) deflated. That does not preclude new crises emerging, but there has been a gradual process of repair since 2008, and I suspect we have seen the bottom in bond yields.

Because we are currently in demographic downtrends for the USA, China and Europe, I suggest it makes sense that only low growth is the current norm and that easy monetary conditions are likely to be maintained until a collective demographic improvement as of around 2020. Gains in real estate and equities should be capped by the demographic downtrends, but supported by the easy money conditions. Commodities have historically performed well during demographic downtrends, but could struggle to make large gains if soft growth holds down demand. Money should continue to flow out of government bonds, with any of those three classes the recipient, unless real yields rise too high for bonds to become attractive again. Yields cannot be allowed to rise too high because of high debt servicing and negative economic impacts. Combined, that makes for a fine balancing act between all four asset classes.

Japan is one economic giant that is in a demographic uptrend and I believe the recent surge in equities there is a belated catch up to that trend.

X2

I believe Japan was ripe to bottom around 2002, along with demographics, but was then pulled back down again with the global crisis in 2007/8. The H1 2013 Nikkei rally was stopped at the long term declining resistance, but I think this time it will burst through it successfully, in due course:

21jun2

The Japanese government has declared it will do whatever it takes to re-inflate the economy and assets including buying equities. The question is how long it will take to break through. If US equities are beginning a topping process then it would seem unlikely that Japanese equities break out at this point. If emerging markets are heading into a crisis, as Russel Napier believes, then a global sell-off would likely take place again.

There are 3 possibilities here for US equities. One is that they have run up in an eiffel tower parabolic formation and will collapse now down the other side. Two is that they have begun a topping process whereby we should see an overall sideways volatile range over several months whilst negative divergences appear. Three is that they are consolidating before further gains.

Because of the sharp run up and the demographic headwinds, I have my doubts about option three. However, cyclical stocks bulls usually end with commodities and inflation rising to become problematic and helping tip the economy into recession. Inflation rises, yields rise and the higher input costs and higher rates squeeze the economy. Bonds top first, then equities, then commodities. At this point we appear to have seen a top in bonds, but do not yet see commodities or inflation rising. Therefore we don’t see the usual historic pressures to pull down equities. Low growth, low inflation, low rates: good for equities.

For option 1, a harsh collapse, some analysts are referring to a 1987 overlay, predicting a crash. I can’t rule it out, I can just refer to that current environment again – it differs significantly from 1987 where yields and rates were much higher. We know that flash crashes can happen, where automated selling begets automated selling, but I suspect we’d need a swift change of status quo to bring it about. Something like the possible emerging markets crisis.

For option 2, a topping process, we would have time. There is no rush to short until we need more technical evidence of a topping range and negative divergences in breadth and leading indicators begin to appear.

In the short term, I believe we could be reaching a point this weekend whereby equities rally up again. Passing through the full moon together with a possible bottoming out in geomagnetic disturbance – the Singapore STI shown here mapping very closely to the model:

21jun3

Plus, low Nymo and bullish percent / call put readings in US equities suggest a bounce imminently.

If equities do bounce then crude oil has a chance of holding its breakout, which it is currently backtesting. If crude cannot, and falls back into the triangle, then the textbook action to follow would be a breakdown out of the bottom of the triangle, which would likely spell prolonged doom for the commodities complex.

So will commodities come again? I believe they will. Nothing goes up or down in a straight line. Mean reversions eventually occur, if not something more juicy. What could give them momentum? A top in equities or concerns about the economy functioning without QE could spur money into precious metals as safety again, with a short squeeze possible on record short interest. Geopolitical developments can affect oil prices and in turn wider commodities and protests/wars are common at solar maxima. Global warming and global wierding remain risks to agricultural commodities, with May having come in at the 3rd hottest on record globally and Jan-May the 8th hottest on record. Global temperatures have historically peaked around solar maxima.

The latest on solar peak prediction is that NASA believe a summer peak in 2013 is likely, NOAA a Nov/Dec 2013 peak, and SIDC running with two options as shown:

21jun4Source: SIDC

Averaging, we could look to a late 2013 smoothed maximum. Historically, secular asset peaks have been made close to solar maxima, along with inflation peaks. We should allow around 12 months for commodities to rise up and make a ‘secular’ peak and an associated inflationary peak if it is to happen along with this solar maximum, so it should be the theme from here into 2014 if it is to occur. With bonds having likely topped and equities having rallied hard, we are also ripe for outperformance to emerge in commodities. However, economic data out of China, increasing inventories, depressed sentiment in the class, and strength in the USD are some reasons why this is not occurring. Until this collective picture changes in some way, I have to remain open to the possibility that commodities will underperform through the solar maximum, and  this could mean a different asset class is bid up to a speculative peak if the solar maximum is still ahead.

From my recent Dow-gold ratio analysis, I suggested two likely bottoms in the ratio: 2014 or 2025 (approx). Either a swift run up to a speculative peak in gold into next year, or a mid-point currently on the way to a bigger gold peak a decade away at the next solar max. From the same analysis, demographics in the main nations no longer offer clear support for either equities or gold going forward, which I suggest means we are likely to see less wild swings between the two, and alternating shorter bulls. So I remain happy to average down in gold and other commodities, particularly with my new cash injection, and await either a mean reversion rally or a possible momentum move into commodities once a trigger emerges. I also would add to long Japan equities on any further drops. I am tempted by the weakness in positive-demographic Brazil and India to build more of a long positive there, but each are currently experiencing their own economic or social problems which could yet worsen so I am going to hold off. I would look to add short equities if a topping process becomes clearer with negative divergences. I remain short treasuries.

I believe the greatest risk currently to my portfolio is some kind of sharp global sell-off, a collapse in US equities infecting all pro-risk. However, I really can’t call a winner from the three options I outlined above for US equities at the moment, so await further flags and developments. If pushed, I still place greatest likelihood by a historically normal unfolding of events, namely that bonds have topped and we will see equities top as commodities outperform, with commodities topping last, helping tip the world into recession and end the equities bull; that the solar maximum will inspire speculative peak and that peak will be in commodities (or precious metals at least) due to the collective demographic downtrends aside Japan. However, I am nowadays ultimately of the view that there is complex interaction between demographics, solar cycles, fundamentals, government intervention and more, that make it a difficult calculation. I believe anomalies can occur if several of these factors conspire together to produce one, which is why there is no holy grail. However, I expect clearer ‘probabilities’ to emerge from here, one step and development at a time.

What Really Moves The Markets

The evidence has led me to a ‘dumb’ model of the markets, whereby humans are more subjects and less intelligent creatures of free will. It’s up to you to decide whether I have simply found what suits me and filtered out the rest, i.e. dumb seeks dumb. If we remove all the noise by looking long term, I suggest sunspots and geomagnetism are two big (but very subtle) drivers of human behaviour towards risk assets, with demographics (which are influenced by solar cycles) simply providing bulges in demand to produce long term bull markets in stocks and housing.

I suggest the solar phenomena are influencing human behaviour in the economy and financial markets alike, and that is why we find treasury yields, interest rates, money velocity, inflation and commodities largely correlated together. Optimism, excitement and positive sentiment driving all up, or pessimism, fear and negative sentiment driving all down. Just waves of sentiment supplied by nature. Plus, when increasing numbers join the investor age bracket of the population versus old and young over a period then enduring bull markets in stocks and housing can occur simply due to the growing demand the demographic trend provides. No complex interaction of fundamentals, just more people investing for retirement.

So I figured the next step was to produce a composite model of sunspots, geomagnetism and demographics for the USA over the last century to see to what degree this correlates with the long term US risk asset composite that I charted earlier in the week: namely real stocks and commodities, real house prices and treasury yields. To do make the triple ‘agent’, I used annual mean sunspots, annual average geomagnetism (inverted, because low geomagnetism is pro-risk, high geomagnetism anti-risk) and for the demographics the middle-young ratio up to 1950, then a composite of middle-young, middle-old and percentage of net investors from 1950 to current. To make the quadruple ‘subject’ I used real SP500 annual values, the Schiller real house price index, the commodities index and 10 year treasury yields.

This chart shows how geomagnetism relates to sunspot cycles over the long term:

17may20131Source: NASA

Peaks in geomagnetism occur typically 1-3 years after sunspot peaks, averaging 2 years later. This fits with recessions and unemployment peaks usually occurring within a couple of years after the solar peak, as peak geomagnetism escalates pessimism and fear. The strength in a geomagnetic peak is also a reasonable predictor of the strength of the next solar cycle.

Once I had worked back half a century, compiling the data, this is what popped out (click to view charts larger):

Z16

The model didn’t work out so well in the periods around 2006, 1974 and 1951. I then discovered what united the three: real interest rates were negative:

Z15

Inbetween, the model worked very well. When real interest rates were negative, risk assets (particularly commodities) got an uplift, regardless of sunspots, geomagnetism and demographics. This is because this type of inverted evironment discourages cash and savings, and encourages borrowing and speculation. People are not being compensated by leaving their money at the bank to offset the gradual erosion of purchasing power, so they seek hard assets and risk investments instead.

So I added negative real interest rates to the model (netting them from the composite where they occurred in the last century) and completed the history, and this is the result:

Z17

Overall a very close match with the moves into and out of stocks, commodities, housing and t-yields over 100 years.

Therefore, I am suggesting there are 4 main agents in moving financial risk asset markets: sunspots, geomagnetism, demographics and negative real interest rates. On a yearly basis, they collectively mapped the bull and bear waves up and down, with little missing.

I then attempted to project the model into the future for the next 20 years.

Demographic projections to this end are fairly reliable as those entering the key age groups over the next 20 years are largely already alive so we have a good idea of numbers moving through. I therefore used all three measures again – middle / old, middle / young and net investors – and combined into a composite.

For sunspots, there is a historic rhyme with a past period of solar cycles as shown:

17may20132Source: WattsUpWithThat

So I projected sunspots forward based on solar cycles 5 and 6. Then, using the link between a geomagnetic peak with the next solar peak, as referenced further up the page, and its typically peaking 2 years after a solar peak as well as general relations with the sunspot cycling, I constructed a geomagnetism model for the next 20 years.

Lastly, for negative real interest rates, I used the late 1940s and 1950s as a guide due to its historical mirror, with high government debt meaning rates had to be kept low, whilst modelling inflation based on its correlation with solar maxima.

The result:

Z18

Clearly, there are assumptions and a reasonable tolerance allowance in my 20-year forecasts for the three datasets that make up the model other than demographics. One assumption is that the solar maximum is ahead this year. If that proves correct then there is a fairly potent combination of a sunspot peak with negative real interest rates, which contribute to the 2014 spike, before dwindling sunspots and peak geomagnetism arrive along with fading demographics. From 2022 to 2027 a bull market in stocks and housing should be enabled by an upturn in demographics and the next solar maximum. Overall, however, the future model is downward sloping, as demographics are poor relative to a golden period like 1980-2000, and the sun potentially enters a new ‘minima’ period as shown in the SC5 and SC6 historic rhyme above.  This is also despite the built-in expectation that real interest rates may oscillate in the negative for some time yet, as the Fed only slowly and gingerly moves up rates, balancing servicing high debt with keeping inflation in check.

As time progresses, the assumptions in the projections can be confirmed or denied and the forecasts within it refined. As this is a long term model, forward validation is going to take some time. Nonetheless, the backwards validation that came out of the data confirmed the validity of what I believed mainly moves the markets over time, with negative real interest rates added to the three that I set out to test. I am well aware that this is not the mainstream view and would be a hard sell to investors: that the four agents of risk asset markets over the long term are sunspots, geomagnetism, demographics and negative real interest rates. However, drawing those together into a composite appears to account for all the major bulls and bears that we have seen in equities, bonds, real estate and commodities over the last century.

I am still formulating my thoughts on the findings of this last week, but here’s one to end the post: maybe the Fed isn’t as foolish as many make out. The reason the Fed intervenes at all in periods of ‘bust’ or cleansing is to prevent a depression, which would be much harsher on the population and likely bring about social conflict. By pushing down interest rates into the real negative, it can induce risk-asset rallies, which make the people feel better if their investments are rising, and housing rising. The problem is this action typically produces commodity inflation, which is bad for the people. Now there is a large block correlation between official interest rates, t-yields, money velocity, real commodities and inflation, and then recession and unemployment. The first five typically rise together and then produce the latter two. By acting on t-yields through QE, rather than just acting on official rates, might the Fed be able to keep the 5-correlated from rising, and thus also prevent the recession and unemployment that follows too? It would seem worth a try. If that worked, they would perhaps be able to maintain an environment of negative real rates with the beneficiaries stocks and housing, whilst preventing the undesirable trio of commodities inflation, recession and unemployment from rising until they end QE. Right now, that overall scenario seems to be what’s in play in the markets, doesn’t it? However! I am doubtful this actually works. Commodities staged a big rally in 2011 despite QE2. I believe they will do so again and normal correlations will apply.

Update: 

One additional chart to ponder – is global temperature correlated too? It’s tempting to shift this along and see how it matches up, but I’d need a good reason to apply a lag. Any ideas folks?:

Z19

USA Financial Markets Economic Correlations

Correlations between real stocks, real commodities, real house prices and treasury yields, together with inflation, interest rates, recessions, unemployment, demographics and sunspots. A more detailed, step by step study of the correlations, using correlation coefficients, whereby +1 means a perfect lockstep relationship between two things and -1 means a perfect inverse relationship, whilst zero would mean no relationship. A reading over +0.5 is considered a strong positive correlation. Note some of the data has been scaled to share the same chart (indicated by, for example, /10 or *3). Also note for US inflation I have used an average of Shadowstats and official CPI since the 1980s, and official CPI before that. You can click on any of the charts to view larger.

Let’s start with a couple of the highest correlations:

Z1

Z2Combining the two, 10 year treasury yields, official US interest rates and MZM money velocity all move in almost perfect lockstep. They are currently all together at record lows. If one begins to rally, we should expect all to rally – with implications for the Fed.

Now let’s look at another closely correlated pair:

Z3Real commodity prices and inflation show a strong correlation. There is a feedback looping between the two as rising commodity prices cause price inflation but price inflation spurs money into commodities (hard assets) as an inflation hedge. There was a lot of debate around the 2008 and 2011 commodity spikes as to whether speculators were to blame. The trading of commodity futures has been around for 150 years in the US, and price spikes are more speculator-heavy because of the feedback looping. Regardless of which kicks off the process, the two occur together.

The next chart shows the relationship between US official interest rates and inflation. Most of the time there is a strong correlation, and as the Fed is the sole agent in rate-setting, we can say that the Fed move rates up and down either in response to or in anticipation of inflation, but largely in line with. However the late 1940s and the current period don’t match up as well as the rest.

Z4

The picture becomes clearer when we look at real interest rates (net of inflation), and extend further back in time:

Z5

We see three clear periods of negative real interest rates – which notably coincided with secular commodities bull markets. Inflation was higher during these periods. If you subscribe to the Shadowstats calculation of inflation (that official inflation stats have been significantly doctored over the last 3 decades) then the purple and red lines would be somewhat higher and lower respectively than shown at the current time. If you take the official CPI data as true, then annual inflation would be currently running around 1.5% which would still maintain the real rates line in the negative. I suggest true inflation is likely somewhere between the two, and thus as shown. As things stand currently, therefore, the environment for the secular commodities bull is still in tact.

Here is another correlation with inflation. US unemployment brought forward two years has a correlation over +0.5 with US inflation:

Z8

This is because recessions occur following inflation spikes:

Z7So we see inflation spikes bringing about recessions which bring about peaks in unemployment around 2 years after the inflation spike (due to unemployment being a lagging economic indicator).

Now let’s draw together unemployment (brought forward 2 years) and inflation, and bring solar sunspot cycles into the picture:

Z9Sunspot solar peaks correlate with inflation peaks, and unemployment brought forward 2 years. This is not a lockstep relationship – it is a correlation specifically related to the solar maxima – and the reasoning for that is the ‘excitement’ that Aleksandr Tchijevsky discovered around solar peaks in human history which is backed up by more recent research revealing bilogical changes in humans at sunspot peaks. If this ‘excitement’ translates into buying and speculation at solar peaks then we can justify spikes in inflation (with subsequent recessions and unemployment spikes).

If it is true that humans are biologically disposed to buying and speculation at solar maxima then a composite of risk assets, namely real stocks, commodities, real estate and treasury yields, should spike up at each solar maximum. Here it is:

Z10The composite uses Schiller real house price data and real SP500 index annual values. Each solar peak is accompanied by a spike in what can be termed risk appetite. There are other spikes inbetween the maxima, but what is key here is whether solar maxima reliably bring about spikes in risk assets, given that we are likely in the year of a solar maximum in 2013.

Within the risk asset composite, there are broadly speaking two pairs:

Z12

10 year treasury yields have a distinct relationship with real commodities, whilst real equities and real house prices correlate very positively together:

Z11

Yet commodities and stocks display an inverse relationship over time of around -0.5, with the result that the two above pairs are often going separate ways. Indeed, thus far in 2013 we have seen US equities and real estate rallying whilst commodities and treasury yields have been languishing. Is it time for a reversal?

If we bring in demographics at this point, and combine stocks and real estate into a composite, this is what we see:

Z13

All three demographic measures – middle to old ratio, middle to young ratio and percentage net investors – are all pointing down for the next couple of years. The stocks and real estate composite has historic correlations with the three measures ranging from +0.54 to +0.7, so all strong positive. It would therefore seem more likely that there is another leg down for real equities and real housing into circa 2015, rather than secular bull upwards action from here. Another leg down in real terms would also help satisfy secular p/e, Q ratio and regression to trend measures for equities, which all call for further washout.

Drawing all the above together, along with my previous analysis, I suggest it remains the most likely scenario that we see an inflationary peak to coincide with the solar maximum (allowing for a reasonable time window), within which commodities and treasury yields rise and stocks and real estate decline in real terms, but due to significant inflation hold up in nominal terms. A recession and peak in unemployment should then follow the inflationary peak. As of around mid-decade demographics improve sufficiently to remove the headwinds for equities and housing, which could enable a new stocks bull, with real interest rates turning positive again.

Once again, your observations and suggestions are welcome, as I believe there is more to be teased out.

Solar Cycles, Demographics and Equities

A long post coming up, but I found this to be outlook-changing research.

Firstly, the Japanese stock index long term chart, with solar cycle maximums marked as black lines (C for commodity secular peaks):

22apr20131Underlying source: Wikipedia

A fairly simple 100 year history: a long secular bear followed by a long secular bull followed by a long secular bear that potentially just ended at the turn of 2012 into 2013. The secular turns fell very close to solar maxima.

Secondly, the US Dow stock index long term, with solar maximums again marked in black.

22apr20132

Underlying source: Stockcharts

Alternating secular bulls and bears. I argue the mid 20s to mid 30s episode was outsized greed and fear events that cancelled each other out on the way to the true secular peak in 1937. The secular turns fell very close to solar maxima.

Thirdly, the commodities index long term, with solar maxima marked. Again, alternating secular bulls and bears, and again secular turns falling very close to solar maxima.

22apr20133Source: Nowandfutures

Fourthly, 10 year treasury yields long term chart, with every third solar maximum marked.

22apr201317Underlying source: Multpl

A longer term cycling of secular bulls and bears, but again the secular turns falling close to solar maxima.

Here is real estate, but only half as much history available as a global index (hat tip Rob):

22apr201316

Underlying Source: P Loungani

There is a tentative cycle here, with the peaks alternating on solar maxima and solar minima. Furthermore, there is the main (circadecadal) solar cycle averaging 10.66 years, and a lesser (circahemidecadal) solar cycle averaging 5.75 years. They fit rather well with the two cycle parts noted above. But a little more history going forward is required to judge this model’s validity.

Moving on, the next chart is US unemployment versus solar cycling.

22apr201318Source: Gorbanev / Ktwop

Rises in unemployment just after the solar peaks. The chart fits well with my own chart, showing recessions occurring after each solar peak (which correlates with geomagnetism peaks lagging sunspot peaks).

recessions

And also this chart, which shows inflation spikes occurring at each solar peak.

17sep18

Below we see money velocity rising into solar maxima and peaking before or at the subsequent recessions:

22apr201314And the next chart shows the treasury spread (10 year treasury yields minus 3 month treasury yields) widens to a peak leading into a recession:

22apr201315

Source: New York Fed

Let me draw all that together. At each solar maximum, we see a particular risk asset or assets making a secular peak, whether this be equities, commodities, real estate or bond yields. I argue this is sunspot-driven biological human excitement that translates as a speculative mania in the popular asset class of the time. We also see inflation and money velocity spikes at each solar maximum, which I argue is also behavioural effects in the economy of the same excitement phenomenon. After each solar maximum we see peaks in the yield spread and unemployment and recessions. Market history dictates that bull market cycles end with inflation rising, yields rising and overtightening, so this fits with the picture being revealed. Excessive and unsustainable speculation and buying in the markets leads to excessive inflation and tightening and tips the world into recession – economists would relate to that phenomenon as a regular cycle of greed and fear, boom and bust. But add in solar theory, and sunspot maxima biologically help inspire the greed/boom part, whilst geomagnetism maxima (lagging sunspot peaks) depress sentiment to assist in delivering the fear/bust part.

So by this modelling, we should be seeing a secular peak in commodities and a secular bottom in treasury yields around the current solar maximum, which should fall either Feb 2012 (past) or ahead in Fall 2013.  Both commodities and treasuries have fulfilled secular bulls through to 2012/13, regardless of what happens next. The difficult part is in timing the turns when you are close in on the action, as we are as traders here in 2013. What is clear is that money velocity has not yet picked up and inflation has not peaked (making its high thus far in 2008). US jobs and yields spreads do not indicate a recession, and geomagnetism is currently benign. Jobs are in fact predicted to grow ino the Fall:

22apr201329

Source: PFS Group

Historically, recessions have begun an average 14 months after solar peaks, so we might expect to see leading indicators for jobs falling by now if the solar peak passed in feb 2012.

Collectively, these suggest the solar peak is more likely ahead in Fall 2013 than behind us in February 2012. I previously showed that world bond yield and money velocity charts could be bottoming out based on technical action thus far in 2012-2013, and in which case an escalation from here through the solar peak (assuming Fall 2013) would fit well with history. That would also suggest an inflation peak, and a secular commodities peak, lies ahead.

We can now cross-reference this solar picture with demographic models.

The next chart is a 100 year chart of the US Dow p/e ratio together with the trend in US demographics as measured by the middle-aged to young-aged ratio:

22apr201319Source: CXOAdvisory

This chart is the same demographics trend shown against the inflation-adjusted Dow.

22apr201320Source: CMG Wealth

Both the p/e and ‘real’ Dow do the same job of removing inflation from the picture. There is a clear correlation between equities and demographics.

Chart 14 shows the SP500 netted of inflation versus the same demographic trend, and I have added in the solar maxima (black lines) again.

22apr20134Underlying source: Chris Puplava

Now things get interesting, because there appears to be a three-way relationship between solar maxima, demographics and equities, with peaks and troughs in all three lining up. In my Trading The Sun PDF I noted there was some research identifying solar cycling as influential in population and demographics in other species, as well as research attempting to correlate solar cycles with longevity and mortality in humans. But I have now additionally found a research paper by Walter Randall (1991) that identifies an 11-year cycle in human births, and here is the chart showing that dominant cycle in the US:

22apr201349

Source: W Randall

Randall also found variation in human conceptions relate to sunshine levels and geomagnetism.

I have added the solar maxima to the US births per year chart below. We see births have typically spiked up a little at the solar peaks.

22apr201350

Underlying Source: CalculatedRisk

And here are UK births, with solar maxima overlaid:

22apr201352

Some clear peaks and troughs aligning with solar maxima.

So, we have solar-inspired waves in demographics which provides a reasoning for a correlation between the two.

We can also explain the demographics correlation to the stock market. There are young borrowers/spenders, middle-aged investors (partially investing for retirement) and old-ages disinvestors. If the middle group is growing relative to the others, then we have a growing demand for the stock market. Similarly, the old and the young don’t typically buy houses, so a swelling middle-aged group relative to the others is an environment for a housing boom, and vice versa.

So there we have our three way correlation between sunspots, demographics and equities (and housing too). Because of the solar cycle related births swells, we will find certain demographic groups peaking in numbers and relative numbers around solar peaks. That provides peak demand or supply (e.g. a peak in retirees disinvesting), and together with the sun-driven biological changes in human excitement at the peaks, we have a recipe for asset invesment and speculation peaks at solar maxima.

In the US demographic chart above we can see that the steepness of the secular bull from 1980 to 2000 appears related to the steep demographic uptrend of that period. Now here is the same demographic model for Japan:

22apr20135

Underlying source: Chris Puplava

Again, peaks and troughs in stocks, solar and demographics line up. The steep secular bull up until 1989 again appears related to the steep demographic uptrend of that period. The reversal in demographic trend as of 1989 appears to explain why Japanese equities topped out at that solar maximum and did not keep going until the 2000 solar maximum, whereas US demographics did.

Looking forward, we can see that the US demographic model reveals a new uptrend from this solar maximum (circa 2013) to the next (estimated mid 2020s), which is supportive of a secular bull, albeit a relatively shallow one in real terms. Meanwhile, the Japanese model is already in an uptrend and is good until around 2020. Japanese stocks are currently in a sharp upswing, belatedly catching up the demographics and suggestive of a new secular bull.

We have looked at middle-young demographics, so let’s now draw in middle-old demographics. The chart below shows the picture for the US:

22apr201324

Source: BusinessSpectator

The US faces a demographic headwind looking out to 2020 in this regard, unlike its middle-young asset. Using the m/o ratio only we see a prediction for the p/e ratio to drop to just 2-3 by 2020. This should be offset to some degree by the improvement in the m/y ratio. Nonetheless, there is something notable here, which is that p/e ratios for country stock indices appear to largely reflect demographics. In other words, a country stock index with a cheap p/e is only a good buy if the demographic trend forecast reveals an uptrend ahead. Some of the most ‘expensive’ stock indices around the world right now by p/e valuation are Indonesia, Mexico and Philippines, all of which have very favourable demographic trends looking forward compard to most of the world. Rather than shying away from these indices because they appear overvalued compared to historical averages, it might instead pay to invest there, as they should get more ‘expensive’ going forward. This also explains why the Nikkei around 1982 maintained a p/e of around 20 whilst other stock indices were making single digit secular bottoms, because it was in the midst of a positive demographic trend looking out to 1989. Note this relationship is longer term and does not preclude shorter term p/e oscillations. P/e valuations will overshoot and undershoot the demographic trend but mean revert to it over time.

The next chart shows the middle/old trend for Japan, which is a tailwind out to 2020, like the middle/young for this country.

22apr201322Source: Zerohedge

Two more demographic measures for the US. The first chart points to a bottoming out by around 2020, followed by an upswing into 2036, which is supportive for a secular bull market.

22apr201323

Source: HS Dent

And this chart shows an enduring trend in nominal labour force expansion in the US into mid-century, standing out from the other developed countries shown.

22apr201325Source: SeekingAlpha

So combining all four demographic measures for the US, we have strong odds of a secular bull from around 2020 to 2030. Prior to 2020 it may struggle to gain traction, and  need a deeper washout in p/e. Let’s not forget that we are dealing with ‘real’ Dow/SP500 and p/es, so inflation matters. A sharp rise in inflation could drive down p/es whilst the index goes sideways. A lack of inflation could mean the index falls nominally before embarking on a momentum secular bull run from 2020-2030. Either way, because this demographic uptrend from 2020-2030 is ahead, we might not expect a major washout in p/e in the US. The SP500 and Dow are amongst the more expensive indices by p/e around the world but this could reflect the positive demographics ahead.

Let’s now look at dependency ratios (proportion of retired and young to the working population) demographics globally. Trends in the developed world contrast starkly with trends in emerging countries, as shown here:

22apr20136

Chart 23 reveals the bad situation kicking in as of now in developed countries:

22apr20138

Whilst the next chart shows a particularly positive outlook for Philippines, Malaysia and India:

22apr201327And the next chart provides another comparison:

22apr201328Brazil looks good. The USA improves looking out to mid-century. And the worst: Japan. So let’s return to Japan, which we can also model using the dependency ratio as below:

22apr201332

Japan is understood to have battled with asset deflation for 2 decades. However, we see that demographics were responsible for a p/e or real downtrend in Japanese equities from 1989 to around 2000. Then the m/o and m/y demographic trends picked up again, and we can see in the chart below that the Nikkei effectively tracked sideways since then.

22apr201330

We might therefore take a fresh look at it and consider the Nikkei was in a downtrend for a decade (or one solar cycle) and then turned sideways as the demographic trends in m/o and m/y changed upwards. The massive spurt since October 2012 therefore looks reasonable, as a belated catch up to trend. However, not all is well for Japan. The dependency demographic trend is the worst around the world in that it is likely to become devastating by mid-century. It also has the largest debt-to-GDP ratio in the world, over 230%. Interest rates are effectively zero, and cannot be allowed to rise much because of the servicing of the debt. There is little hope of major GDP growth in the years ahead because of the dependency trends and the debt. Despite this, Japan is going hell for leather in a bid to restart the economy and ignite inflation, now doubling money supply from 29pc of GDP to 56pc of GDP by 2014. The first result of this ultra-aggressive policy has been a swift 20% drop in the yen. As Japan is an energy importer, this has immediately produced a big uplift in energy price inflation. If I am correct in predicting a pick up in money velocity here, and also correct in a commodities/inflation peak ahead relating to the solar maximum, then I suggest there is the potential for Japanese inflation to quickly become problematic. As the government cannot combat with rate rises because of the debt servicing, the risk then would be hyperinflation. I know hyperinflation is overhyped, but I just wonder whether it is worth an outside bet here.

Hyperinflation has historically been initiated by either rapid increases in either money supply or money velocity, then the other one has joined in to complete the feedback looping. Japan is obviously at full acceleration on the former. Under hyperinflation, stock markets have historically gone wild in nominal terms, but the cost of living has gone even wilder. In Zimbabwe, the stock market went up 47,000% in a year, but the cost of living rose even faster. So a Japan hyperinflation trade could be achieved either by a spreadbet on the nominal index or a long Japan fund whilst short the yen. This is how I see it: Japanese stocks should rise on the belated catch up to m/o and m/y demographic trends, regardless of the Japanese government’s policy actions, but those actions have the potential to produce wild inflation which would then take Japanese stocks in nominal terms much higher.

Back to demographics. The headwinds facing many developed countries in dependency trends are problematic. Here is real estate modelled against dependency for six developed nations:

22apr201331Source: Business Insider

If we refer back to the global house index chart further up the page, that cyclical model projected no real take-off in global house prices until 2019. These dependency charts suggest headwinds that further cement the likelihood that housing won’t offer a great return for the next few years in the developed world, applying equally to most other European countries, New Zealand and Canada. China and Korea also faces the same dependency trend issues starting around now.

The countries with the best demographic trends looking forward include India, Brazil, Mexico, Indonesia and Philippines. South Asia, ASEAN and South America look particularly fruitful regions going forward, and Sub-Saharan Africa too. If this is a global transition into a K-Spring, then investments in equities and real estate (K-Spring’s champions) might do best in these countries and areas. The USA should perform well too, from 2020 to 2030, but the period before 2020 is less certain.

Brazil and Mexico have good prospects until around 2025 but India and Philippines extend until 2040. Contrast this with China, which is just hitting trend reversal point into a negative trend, and we can see the likelihood of China stepping back from being the world’s leading growth engine, and in doing so maybe provide a backdrop to a secular commodities bear (as it is the world’s largest commodity consumer).

22apr201334

Source: DarwinsMoney

Dependency ratio trends and projections for select nations:

22apr201335

Source: John Eyers

Maybe the investment star of the next two decades will be India, which could feasibly rise for multiple solar cycles in a powerful secular bull that resembles the Nikkei into 1989 or the Nasdaq into 2000. With its 1.2 billion inhabitants it has the potential to mobilise something significant. But India, just like Brazil or Philippines or Mexico or Indonesia is an emerging country, with emerging risks. Let’s say the demographic outlook provides potential for great returns in these countries, but the structure to achieve it is less reliable than in the developed nations. The developed nations conversely have the track record but now the demographic headwinds.

To draw back together demographic trends, solar cycling and equities, we might expect that the positive demographic trends that have been in place in some of these emerging countries to have provided a secular bull over the last solar cycle, much like the Nikkei powered its way through 4 solar cycles in a secular bull set against a positive demographic backdrop. This is indeed what we see:

22apr201340

22apr201341

22apr201343

22apr201345

Source: Yahoo Finance

Over the last solar cycle, from 2000 until now, all the four country indices shown have made secular bull markets, not secular bears, in line with the demographic trends. They are all also amongst the most ‘expensive’ countries in the current p/e spectrum in the world, again in line with the demographic trend. I suggest that the ‘expensiveness’ of a country’s p/e rather has to be measured in terms of its relativity to its demographic trends. I also suggest that due to the demographic trends in all four remaining positive for another solar cycle, they should go on to continue their secular bull over the next solar cycle. I suggest that may be at a steeper rate, because it will be against the backdrop of a global K-spring, an up-cycle. As a reference point, see how the Nikkei secular bull (first chart in the article) that lasted for 4 solar cycles was at its steepest in the solar cycles of 1947-1958 and 1980-1989, both of which were global upcycles, a K-spring and a K-Autumn.

To conclude, these are the opportunities that I see (for myself of course… I am not an advisor).

1. Long Japan, due to m/y and m/o demographic uptrends until 2020, and an outside bet for hyperinflation. Averaging into any falls. We can see Japan’s little window of positivity here, in the upturn in the green line between 2005 and 2020:

22apr201346

2. Long USA, but more compelling as of 2020. At risk of a p/e washout before then. These two charts show head and tail winds respectively for the US market from now until 2020:

22apr201347

22apr201351

Source: Informed Broker

3. Long a basket of emerging markets with the best demographic outlooks: choosing from India, Philippines, Indonesia, Brazil, Mexico and potentially sub-Saharan Africa. Averaging into any falls.

Here is the very long term look at dependency ratios to end:

22apr201348Source: Appliedmythology

If these projections hold true, then the four lowest listed regions should offer the best opportunities over the next solar cycle. The following solar cycle the USA stands to fare well (where the blue line flattens). And later his century Russia and Eastern Europe may get their shot at being investment gold.

Additional chart: prospects for specific sub-Saharan African countries: positive demographic trends for the next solar cycle for Algeria, Ghana, Nigeria, Cameroon, Ivory Coast and South Africa:

22apr201360

In The Balance

Time for an updated look at the big picture: is a secular commodities peak ahead or behind us?

Here is the equally weighted commodities index. It remains in the nose of a large triangle. A decisive break down through the twin supports will add weight to a secular commodities peak having already occurred in 2011, whereas an upwards break beyond down sloping resistance will add weight to a secular bull still in tact.

4apr20131Source: MCRI

By solar/secular history, a secular commodities peak normally occurs around or closely following a solar maximum. However, that too remains in the balance as shown by the alternate predictions in the SIDC chart below – either a solar peak occurred at the turn of 2012 or a solar peak is ahead later this year.

4apr201317Source: SIDC

The most common consensus remains that the solar peak is rather ahead than behind us, with the median forecast for Autumn/Fall 2013. Planetary models predict a spike in sunspot action around Sept/Oct 2013 and some physicists also predict a burst in activity later this year, which would fulfil the NOAA red line prediction below:

4apr201311

However, until such a flurry is seen, it remains unresolved.

Danny challenged the 33 year secular commodities peak and solar peak correlation with this chart:

4apr20132It is an ultra long term modelling of commodity prices, to which I have added the markers to show when the industrial revolution began and when the gold standard was abolished. It can be seen that the correlation in solar peaks and commodities peaks largely failed prior to the industrial revolution. Understand that prior to this time there were only localised markets for commodities, little storage, and almost nothing in the way of demand and supply matching. Farmers tended to grow their usual crop, bring it to market, get the best price they could for it, and anything unsold went to waste. For a natural cycle that influences collective human behaviour to manifest itself, I suggest optimum conditions are instant, globalised, free markets, like we have in the current day and age. In pre-revolution conditions, it would have been impossible to draw out real cycles from slow, localised, restricted and fragmented markets. I don’t see that part of the chart as valid therefore. See also below how the solar/secular oscillation in the Dow-gold ratio became pronounced after the freeing of gold and paper:

4apr20135

Source: Sharelynx

So, returning to the ultra long term commodities price chart above, we see an broken success rate (as shown by the circles) in the fiat era and between the industrial revolution and fiat era two successes and a potential inversion or double failure. However we classify that anomaly, such a failure could potentially reoccur in the future – unless it was the result of a non-free, slow, localised era. But a failure amongst a majority of successes would be in line with all other ‘real’ trading disciplines, i.e. there is no holy grail, nothing that works all the time, just things that work most of the time. To sum up, the solar peak is probably ahead, and the secular commodities peak is probably ahead in line with that.

Turning to climate and agricultural commodities, are we going to see another year of extreme temperatures and natural disasters, which would drive up commodity prices? The next chart reveals that the last two years have not been as severe as a cluster before that. However, they were both La Nina years, which has a cooling effect.

4apr201312

Source: NOAA

This year, a largely neutral year is expected (no dominance of La Nina – or El Nino either) so there is the potential for a bigger bar – unless the long term trend is now reversing.

Global warming is one factor, global wierding (rate of natural disasters) another, and in the US, drought conditions at the start of 2013 are displaying patterns that could unfold into the equivalent of the worst drought years in history. Grains took a big hit in price this last week due to higher than expected plantings and stockpiles, but there remains the potential that climate developments could drive agricultural commodities higher again in the remainder of the year.

Rising commodity prices and inflation together make a mutually reinforcing feedback loop. Escalating commodity prices drive up inflation and escalating inflation attracts money into commodities as an inflation hedge. So how do inflation expectations look, aside any climate developments? The next chart shows expectations have been on the rise since Q3 2012, with a divergence in gold that we might expect will be rectified:

4apr20139Source: M Boesler

If gold is not to make up that ground, then we might expect inflation expectations to fall instead – i.e. a period of deflation would be ahead.

Turning to valuations, gold is historically expensive here versus stocks and real estate, but could yet become more extreme expensive before reversing.

4apr20133

Source: Fred4apr20136

Source: Approximity

4apr20137All 3 charts reveal gold’s meteoric relative rise in price to stocks and real estate since 2000. The question is, does it have a parabolic finale yet to come in which it reaches the obvious zones, or is going to stop short and is already in relative decline?

If gold has already made its secular top (in 2011), then we would expect stocks to be now in a new secular bull. So did stocks wash out sufficiently, in terms of price/earnings and price/book valuations, to make it likely the secular bear is over? So far in the secular bear, the FTSE reached a p/e of 7, the Dax 9, the Hang Seng 8, the SP500 and Dow 9. The Nikkei only reached 13, but it made a p/b ratio of under 1. Broadly speaking, they are all low enough to satisfy secular bear cleansing, and we can add to that the extreme low p/es reached in the PIIGS at the height of the Eurozone crisis. If we look at other valuation measures in relation to the SP500 then we get a different picture:

4apr20138Source: Dshort

These four valuations combined suggest the secular bear has not washed through sufficiently, and that current valuations are closer to a top than a bottom. However, we ought to note the much higher top in 2000 and question whether central bank policies of unprecedented easing and stimulus have dragged all these measures permanently higher.

US indices aside, we have reasonable evidence from around the world that secular cleansing could be largely complete in terms of valuations reached at the bottom of the falls in 2011. Plus this year we have what appears to be a new secular bull break out in the Japanese indices.

What about treasuries? This secular transition should also be accompanied by a secular transition in treasuries from a long term bull market to a new long term bear. Did treauries top – and yields bottom – in 2012? It remains to be seen as it is currently too technically ambiguous to say with confidence.

4apr201313Source: Stockcharts

Using history as our guide, if a secular commodities peak is ahead later this year (and potentially into H1 2014), then we should see a topping process in equities by around mid-year whilst commodities take over as the outperforming class. A feedback looping between inflation and commodities should occur, until too expensive commodity prices and tightening yields help push the economy into recession. That recession should be fairly mild, with stocks making a shallow bear market, whilst commodities plunge harder, in the mirror of their preceding parabolic escalation. The bottom of that shallow stocks bear would be the momentum ‘go’ point for the new secular stocks bull.

Alternatively, if a secular commodities peak already occurred in 2011, then secular bull momentum in stocks should already be underway, and we might point to action in the Nikkei or SP500 in 2013 as supporting evidence. The recession that should follow the secular commodities peak occurred then in 2011-12, with the Eurozone and the UK two notable areas that experienced this. It was not a world recession however, and we did not see typical cyclical stocks bull topping bells ringing preceding it. If we look at an overlay of the CCI commodities index on the MSCI World stock index, we can see that they topped together in April/May 2011:

4apr201314Source: Bloomberg

We did see outperformance in commodities, but not to the degree of 2008, or the last secular commodities bull peak of 1980. But silver did make a suitable parabolic blow-off in price.

To sum up, a case can be made for both competing scenarios: a secular commodities peak ahead or behind us in 2011. It remains in the balance, but not indefinitely. The CCI commodities index will break one way or the other. Gold will catch up to inflation expectations, or inflation expectations will fall. Sunspot evidence will come in more definitely in favour of a solar peak ahead or behind. Climate evidence as 2013 unfolds will drive agricultural commodities to escalating or plummeting prices. Equities will maintain secular bull momentum and outperformance of equities, or they will begin to make a topping process whilst commodities outperform.

What about a third scenario: both equities and commodities drop here into a bear market, with treasuries the beneficiary? For that to occur, we should still need to see a topping process in stocks whilst leading indicators and internals deteriorate. Currently, we do not see major warning flags in either, with leading indicators and breadth supportive. However, we have lately seen changes in trend in economic surprises, both in the US and Europe:

4apr201315

4apr201316This coincides with the change in geomagnetism trend, and perhaps provides fuel for a pullback. I do not believe, however, that we have evidence for more than a swing pullback at this point, but it could become part of a more significant topping process that lasts several months.

If we pull back and look at the wider environment for assets, we largely/generally have ultra low rates, central bank support, money supply growth, cash and bonds paying negligible or negative real returns, stock yields exceeding bond yields, low/spotty economic growth and not excessive inflation, and historically below average valuations for stocks and real estate. This is a fairly positive environment in which equities and housing can attract money flows, and that is what we are seeing. It would take another sharp slowdown in the world or another debt-related crisis coming to the fore somewhere, for this to change. The question is whether we have seen a sufficient cycle of cleansing since 2000 and sufficient foot-on-the-accelerator central bank action to now sustain growth. If growth can stick and even accelerate, then we have better chances of reaching growthlationary froth and the commodities/inflation feedback loop, as all the inflationary stimulus and easing could quickly become problematic, with faster money flows out of bonds.

Finally, a few more potential clues as to the likely winner in the scenarios. Crude oil inventories are approaching a record, which has the potential to pull the rug from under crude prices if growth stumbles. Inflation should make a bigger peak 5 years after 2008, which would be this year, based on secular/solar history. Emerging markets manufacturing surveys (a leading indicator) picked up to 52.6 in March (over 50 is growth), of which China is the biggest commodity consumer. Commodities generally move opposite to the US dollar, as they are priced in US dollars, and the US dollar could be ripe for a sustained decline as speculator positions hit a record and this has previously led a swing top.

In conclusion, there remains no clear winner, with good evidence supporting a secular commodities peak ahead, or that it occurred already in 2011 and a new secular stocks bull is in progress. I maintain that the balance of probability lies with the secular commodities peak being ahead in H2 2013 – H1 2014, which should mean a cyclical stocks bull top occurring by mid-year 2013. However, if that is the case, then it should only give rise to a shallow stocks bear before new secular bull momentum. I am positioned for a secular commodities bull finale ahead, with significant exposure to precious metals, energy and agricultural commodities. I have only a position in Russia by way of equities exposure. So there is my concern: if the alternative scenario is the correct one, then my current portfolio will perform badly. However, if commodities did top in 2011, there should be an ‘echo’ bounce around 3-4 years later in line with history (as the commodities supply-demand story is not resolved overnight), which would be a belated opportunity to make some profits on those positions, with correct timing. In the meantime, evidence would increase in favour of a new secular stocks bull being underway and I would add trades there.

I will continue to weigh this up as developments come to light. Your views and any additional evidence very welcome. I have personally found that we have reached a period of time in the markets, and perhaps in my progress, where I don’t really feel there are any ‘experts’ out there I can rely on. I believe this is the difficulty of trying to navigate a secular transition, which in effect takes several years.