Anyone who drives is aware that oil and gas prices have been rising rapidly.  Less obvious to the public is the decline in the value of the U.S. dollar and the connection between the two. Below is a chart comparing the price of oil (USO) to the U.S. dollar (UUP) over the past year. As the chart shows, the two have a highly correlated inverse relationship. In other words, as long as the dollar is falling the price of oil will continue to rise.

Climbing oil prices are often attributed to problems with supply and in its latest statement about the economy on April 27, the Federal Reserve cited, “concerns about global supplies of crude oil” as a factor in rising inflation. While there is no doubt that the unrest in the Middle East is a concern, the reality is that there is currently no shortage in oil supplies. According to numbers from the U.S. Energy Information Administration (USEIA) as of April 21, the U.S. had 363.1 million barrels of available oil. That compared to 357.8 million barrels at the same time in 2010.

Keep in mind that a year ago, the U.S. was struggling with the aftermath of the Gulf oil spill. According to the USEIA the average cost of a gallon of regular gas on April 25, 2010 was $2.85. April 25, 2011 the price had risen to $3.88. That is an increase of $1.03 (36%) per gallon during a period when oil supplies have been stable and have actually seen a slight increase.

In its recent statement, the Federal Reserve made no mention of the declining value of the U.S. dollar, even though a falling dollar is synonymous with inflation. Oil is priced in dollars. When the value of the dollar falls, it takes more dollars to buy the same amount of oil.

Most consumers understand credit scores and the importance of having a good credit score. Think of the value of the U.S. dollar as a type of credit score for the country. A highly valued dollar equals a good credit score. A low-valued dollar is like a bad credit score. Rising U.S. debt means that its credit rating and the value of its currency are falling. Federal Reserve officials, many members of Congress, and the presidential administration are essentially ignoring the credit score and instead are focusing on the amount of money available on the credit line.

In an April 19 article on Bloomberg Businessweek, Ed Wallace wrote this about rising oil prices: “The problem starts with Ben Bernanke, no matter how many of his Fed presidents claim they are not to blame for the high price of oil. The fact is that when you flood the market with far too much liquidity at virtually no interest, funny things happen in commodities and equities. It was true in the 1920s, it was true in the last decade, and it’s still true today.”

David Stockman, a former member of Congress and of the Reagan administration recently wrote an article for Marketwatch called The Federal Reserve’s Path of Destruction. He wrote, “This destruction is namely, the exploitation of middle class savers; the current severe food and energy squeeze on lower income households; the illusion in Washington that Uncle Sam can comfortably manage $14 trillion in debt because the interest carry is close enough to zero for government purposes…”

There are experts who believe that a weak dollar can be a good thing for the U.S. economy because it lowers the trade deficit and makes U.S. goods and services more competitive in the global market. But obviously it is not a good thing when it means that middle class America must pay significantly higher prices for things like food and energy.  Ultimately, the strength of the U.S. economy is dependent on middle class consumerism.

Flint Stephens

This week gold climbed to a record high and broke an important psychological price barrier–$1,500 an ounce. Gold has been in a strong uptrend since autumn 2008, but the latest surge surprised some investors. Gold prices stalled in the last three months of 2010 and it appeared that a more significant decline was on the horizon. The reason for the new interest in gold is simple. Over the past three months, core inflation has risen at an annualized rate of more than 6%, as calculated in the Bureau of Labor Statistic’s Consumer Price Index (CPI).

Of course, core inflation isn’t even the whole story. The core CPI does not include food or fuel. Those two categories have risen dramatically in the past three months. Therefore, the actual inflation as felt by most U.S. families is probably much worse than then reported 6% annualized rate.

When paper money begins to lose value through inflation, people quickly adjust by moving assets to tangible commodities. Those include precious metals like gold, silver and copper, but they also include things like groceries. When prices for basic goods rise, people stock up to protect themselves against further increases.

Another factor fueling the rise in gold prices is global concern over U.S. government debt. Those worries increased Tuesday when Standard & Poors issued a credit warning because of the growing U.S. budget deficit. Although the presidential administration downplayed the warning, today there were reports from multiple news agencies that the U.S. Treasury Department met with official from Standard & Poors and tried to convince the agency that the U.S. government had a viable plan for dealing with the deficit so a credit devaluation was unnecessary.

The Obama administration, the Treasury Department and the Federal Reserve remain insistent that core inflation is under control. But consumers who are paying more for food, gas, and other items are unconvinced.

People have relied on gold as a protection against inflation for centuries. The web site www.seekingalpha.com noted that during the height of the Roman Empire, a consumer could buy a high-end suit of clothing for an ounce of gold. Today that same ounce of gold will still purchase a top-end outfit.

Gold has also been a popular choice for speculative investors—perhaps because of its volatility. Double-digit gains and losses in a single trading session have occurred in several instances. Those dramatic price fluctuations also make gold an unsuitable option for investors that are more conservative unless it is held in small proportions and carefully managed. Strategis Financial Group is currently holding gold position in some of its client accounts.

Right now is it difficult to forecast whether the rise in gold prices will continue for several months or whether gold prices could suffer a significant decline over the next few weeks. Investors who are currently holding gold should monitor their positions carefully and be prepared to exit if there is a significant price drop. For those who do not yet own gold, chasing profits by buying at these levels seems risky.
Flint Stephens

Chart watchers are undoubtedly looking at the recent price movements of the S&P 500 (like the chart below) and seeing a double top. For those who believe in such things, double tops are generally perceived as negative. My personal opinion is that stock patterns are similar in their predictive value to cloud formations: cumulus clouds might be indicative of rain, but spotting a formation in those clouds that looks like a bunny rabbit is meaningless.

Not all chart analysts would view the recent pattern of the S&P 500 as a true double top reversal. For example, here is some information about this type of pattern from www.stockcharts.com.

“While the Double Top Reversal formation may seem straightforward, technicians should take proper steps to avoid deceptive Double Top Reversals. The peaks should be separated by about a month. If the peaks are too close, they could just represent normal resistance rather than a lasting change in the supply/demand picture. Ensure that the low between the peaks declines at least 10%. Declines less than 10% may not be indicative of a significant increase in selling pressure.”

The current situation fits the criteria of peaks being about a month apart, but the decline in between was only about 5%. So according to the explanation above, the current pattern should not be classified as a double top reversal and therefore might not be negative at all.

In fact, other technical indicators indicate that an immediate upturn in the S&P 500 could occur. The bottom indicator on the chart above is a stochastic oscillator, which is used to determine turning points in an investment’s cyclical movements. In the past few sessions, this indicator fell to 20%–a level that is considered oversold and which often indicates an impending upward price move. The middle portion of the chart is a moving average convergence divergence (MACD) indicator. It turned downward in early April, but remained at a positive level. Now it already seems ready to begin moving upward again. Although it is not included on the chart, the relative strength index (RSI) for the S&P 500 is currently hovering right at the 50 level. Normally an investment with an RSI of 50 or more has the momentum and strength to maintain an advance.

Perhaps the best indicator of what an investment is likely to do is its recent long-term trend. The long-term trend for most major stock indices has been positive for many months and remains so, in spite of minor pullbacks in March and April. Changes in long-term trends are somewhat rare. The most recent example was in March 2009 when the bear market bottomed and stocks began moving up again. At present, there is certainly no proof that the bull market trend that began more than two years ago is at an end.

On the other hand, this could be the start of a corrective consolidation like the one that began at the end of April 2010. It persisted for four months. Because there is no way to be completely certain, it is prudent to be attentive and cautious right now, even though it seems likely that stocks will stage a rebound and resume their long-term rally..

Flint Stephens

The past six months have generally been good for investors. U.S. stocks, precious metals, real estate and international stocks all have positive gains. There have been losers, however, with long-term U.S. Treasury bonds among the leaders on the way down. The chart below illustrates how these positions fared during this period.

While the S&P 500 has posted the biggest gain among the positions shown, it fell victim to global worries in March and is just now recovering the ground that it lost during that time. One factor that should give strength to this index over the next few weeks is the announcement of first-quarter corporate earnings. The expectation is that many companies have done quite well and that has the potential to drive this index higher. International positions and real estate have shown a high correlation to major stock indices and they should likewise benefit from corporate strength.

In truth, it is difficult to forecast what the markets are likely to do over the next few months. Right now for every expert or analyst predicting impending hyperinflation there is another forecasting a deflationary economy. This lack of predictability and dissension is undoubtedly helping fuel the interest in gold and other precious metals positions. In the face of uncertainty, investors are looking for something that offer tangible value. Unfortunately even gold and silver offer no guarantees against loss or against investment risk. There are always experts willing to tout the positives of gold without mentioning that precious metals prices can be extremely volatile.

The summer months can end up being a weak period for stocks specifically and other investments generally. Such was the case in 2010. Stocks began a sharp slide in late April and the S&P 500 did not make it back to those spring level again until late in the year. Certainly, there is no way to know whether stocks will follow a similar pattern in 2011, but it is something that bears watching.

Currently, most technical and cyclical indicators for stocks are positive, but experience has proven that the situation can change quickly. The most important and reliable indicator might be the long-term trend and in spite of world uncertainty and a host of potential economic problems, stocks remain in a strong upward trend. As a result, for now the best course of action would seem to be to maintain existing long positions until there is a reason to do otherwise.

In the meantime, investors need to keep a close watch on their accounts because there are many forces that have the potential to derail this advance.