Seasonality Is Different In President’s Second Term

BOTTOM LINESeasonality is different in the 2nd year of a 2nd term president. Rather than peaking in May, as everyone thinks, the market typically peaks in early July, and this year seems to be true to form. Lookfor a drop to a bottom due July 21-23, and then another bottom July 29-30. Gold should have one more leg down, andshould take out the $1200/oz level before starting a robust new uptrend in August. T-Bond prices are still in an uptrend, andshould continue higher for at least the duration of the summer stock market correction.

The bullish message from the strong NYSE A-D numbers in 2014continues, but that does not preclude a normal seasonal correction this summer.Indeed, such a corrective phase would be a healthy action, and set up for more and better gains starting when the seasonal bullish period arrives this autumn. Many on Wall Street still believe inthe old axiom, “Sell in May and go away,” even though the average period of seasonal strength actually tops out in June. But it is harder to create a rhyming phrase with the word “June” in it, and people are funny in that they believe phrases more if they rhyme. Johnny Cochran famously made use of that point (“If the glove don’t fit, youmust acquit”).

Seasonality also works differently depending on what year of a presidential term we are in, and whether we have a 1st term or 2nd term president.The top chart here on page 1 makes that point by comparing the Presidential Cycle Patterns for each category.When a first term president is in

office, he generally spends a lot of time “discovering” that things are even worse than we all thought, and proclaimingthat the “only solution” is whatever package of legislation hewants to get pushed through. Investors tend to get discouraged by hearing that things are bad, and they push pricesdown. But that negative effect tends to end around the time when Congress takes its summer recess in the 2nd year.A second term president does not usually spend as much time telling us all how bad things are, and so the market typically rallies into July of a second year. That is where we find ourselves right now.The chart below features the same two plots as above, but zooms in closer on just the 1st two years to better allowus to see how the market is behaving relative to those models. It is pretty easy to see that the current market is correlating much better to the 2nd Term pattern, which is what we should expectto see happening.

And now, as the highway trust fund is going broke, and a flood of immigrants is coming in, and as the Affordable Care Act is seeing more court challenges, investors will have a chance to express their worries and doubts about the future for a couple of months, setting things up nicely for the 3rd year rally which typically starts inthe autumn of the 2nd year.Already we have a longer term overbought condition, as evidenced by the McClellan A-D Summation Index on page 3 getting up to a high level.

The McClellan A-D Summation Index peaked on March 7 at+4244.6 and just took out that high for 2 days, peaking on July 3 at +4286.5along with prices. The very bumpy structure of the move up to the July peak does not describe the kind of bullishstructures seen on the left of the chart where there are smooth upward Summation moves. This weak bumpy structure is indicative of a weaker price structure to come. Only the extremelyhigh Fed-induced liquidity was able to keep the Summation Index at such a high level for almost 4 months.

But we also have a big divergence evident in the chart here on page 2. This chart features an indicator that examines all 30 Dow stocks to see how many of them have a Price Oscillator which is above zero. It generally follows the dominant trend in the DJIA, and so watching how it behaves relative to its 15-day MA can be instructive. It has now gone below that moving average, and also made a divergentlower high compared to the DJIA itself. That is a condition which typically leads to more significant corrective moves.

Stock Market Bottom Line: Seasonality has finally turned against the market, and at a time when we have an overbought condition and divergences galore. A better time will come in several weeks, after the excesses have been corrected

Gold Starts Up Early, And FlawedWe have been watching and waiting for signs that the 13-1/2 month cycle bottom has arrived, and perhaps that the upturn from that bottom is starting. We have now seen an upturn, but it has bigproblems leading us to doubt its legitimacy. The top chart on page 4 shows gold prices compared to a representation of this cycle. The ideal bottom date for the cycle is in July, which is upon us now.The most recent price low was on June 2, which is technically within the normal tolerance window for when the actual bottom can arrive, but it was missing a major attribute. We have noted in past issues how the price top before the mid-cycle low this time was higher than the top which came after the mid-cycle low. This is a condition known among cycles analysts as “left translation”, and when it occurs in this 13-1/2 month gold cycle it always leads to a lower price low at themajor cycle low. Always, that is, up until now

The opposite condition of “right translation” is much more bullish, and says that we should not expect to see the price level of the mid-cycle low get exceeded at the major cycle low. But we do not have that condition this time. So we have an unmet requirement totake out the Dec. 2013 mid-cycle low, which was just below the $1200/oz level. So that remains on the agenda for gold prices, even as we are standing right at the moment when the cycle low is due. Actual price lows for this cycle can be early or late by about a month or so, and still be considered “on time”, so we figure that gold prices can still get the mission done without violating anything

The other reason for suspicion about an early start to the new 13-1/2 month cycle up phase is that it has been too eagerly embraced by the speculators. The COT Report data show that the“non-commercial” (large speculator) traders have made a huge jump in their net long position, and on just a small amount of upward price movement. The non-reportable (small speculator) traders have done the same (not shown), which the smart money commercials are taking the other side by ramping uptheir shorts.Bottom Line: Gold has had a “false start”, jumping the gun ahead of time. It is going to have to reset, and finish its task of making a lower low before the real upward phase can begin

Inflation Signals MixedIn MMR #460, we introduced a unique insight about how one canmodel the future for the CPI inflation rate, using global average temperatures as a guide. It is calling for rising rates of inflation into the end of 2014, and perhaps slightly into early 2015, after which inflation rates should start to abate again.Thus far the CPI is complying with that expectation by rising nowup above 2%, which is a level that the Fed says is their goal. It should be noted that the Fed now likes to follow the “PCE deflator” of GDP instead of the CPI, which was invented in 1913 the same year as the Fed.It is worth also noting that the CPI inflation numbers tend to lag a bitbehind changes on the raw commodities that drive consumer prices, and that is where we have an interesting topic for discussion. The chart above shows that copper prices have now broken outabove the upper boundary of a falling wedge structure. Copper prices have been weak thus far in 2014, on fears of an economic slowdown in China whichhas become a major consumer of thatindustrial metal

So a breakout move is news, saying that the economy in China and elsewhere may actually be starting to heat up. That chart also shows that the commercial traders of copper futures arestill net long, although they have pared their longs somewhat during the initial part of this new rally. That paring is normal, but the current level says that there is still room for copper prices torun higher before this particular rubber band gets too stretched. So the presumption of a continuing rise in copper is a bullish factor for higher inflation. Tempering that expectation is abearish contribution from falling grain prices. Both wheat and corn prices are down from earlier this year. Part of that may be from expectations of higher crop yields, but the chart below shows that wheat prices are actually just following in gold’s footsteps like they are supposed to.

The gold price plot is shifted forward by a year in this chart to reveal how wheat prices tend to trace out the same dance steps. So the decline we have been seeing in wheat futures pricessince 2012 is just an echo of the decline in gold prices that started from gold’s 2011 price top. Because gold bottomed (so far) in Dec. 2013, we should not expect the echo of that bottom to beseen in wheat prices until the end of 2014.That counteracts the inflationary forces we are seeing in rising copper prices, and suggests that even though inflationary worries are rising, they may not be ripe for turning into actual inflationfor quite a while longer.