What the Price Distribution is Saying

A correction to yesterday’s DR. The original idea that the U.S. Federal Reserve would prefer (and perhaps even engineer) a gruesome little stock market correction as the base from which to launch its next Quantitative Easing assault came from Slipstream Trader Murray Dawes over coffee last Monday.

Like all good ideas, we tried to take credit for it. After a few days our memory of it had morphed into a clear recollection that it really WAS our idea. But it wasn’t.

Murray sat down last Monday and showed us a chart of the trading range the Australian stock market is currently in. It’s near the top of what he calls a “price distribution.” If the market confirms to past charting patterns, then it will test the top of the distribution and break out (which may or may not be a “false break out”) or it will trend back towards the bottom of the range (where it may break below).

At least this is what we understood Murray to mean. Normally such conversations are held over beer and loud music. But our meetings with Murray are more like the old summits between Reagan and Gorbachev; but not because either of us are bald, or because we are bitter enemies who are gripped in an ideological death war.

In fact, they are not like those at all, now that we think about it. But they ARE summits. Why?

Your editor takes an orthodox, morally-driven view of markets (that honest money is backed by gold). Thus, all the daily moves in the markets are weighed and measured against some basic truths about what things ought to be worth, even if they aren’t at just that moment.

The traders and chartists, of whom Murray is a leading practitioner, don’t necessarily worship a different God. But they do speak a different language with a very precise, technical, somewhat obscure vocabulary. Communicating with them requires much patient effort, lots of pictures, and lots of questions. It feels like a summit.

It’s important to remember that most traders – or the good investors who know when they are investing and when they are trading – are basically amoral and market neutral with their trading portfolios. They are seeking to exploit short term technical trends in the market for profit. That is all.

As a caveat, some value investors may be traders too, trying to find securities the market has mispriced. But they are a rare breed, especially in a fiat money world where all securities float higher on a sea of money. We’d venture to say that what things should be worth or ARE worth (or whether they are really worth anything at all, intrinsically) is probably not a question a trader would bother with (or so we imagine).

But it is a perspective you can find quite useful from to time, even in managing your own long-term wealth. It is especially helpful when you’re trying to determine whether stocks you own are overbought or oversold. This has been the whole Slipstream Trader project from the very beginning – to see if a technical analyst with a proprietary method of analysing price action can spot and exploit tradeable moves in blue chip stocks.

That’s not to say Murray isn’t a bit of a fundamentalist himself. He’s the only real technical analyst we’ve ever met who also shares a basic understanding of the Austrian School of Economics. He shares our visceral dislike for the Federal Reserve and our visceral like for beer. But unlike your risk averse editor, Murray aims to profit from the Fed’s blunders in a precise way which is beyond our brain. But it may not be beyond yours. Have a look at my recent letter about the Slipstream Trader if any of this sounds intriguing.

Today Murray and your editor are probably asking the same question you are: is the QE planned by the Fed already fully priced into the market? Other questions include: will the American mortgage bomb cause a mini-asset price crash that gives the Fed a tailor-made reason to pump up the markets even more? And will that even work, or is QE already delivering diminishing marginal returns? And what about the future of the Mineral Resource Rent Tax (MRRT)?

We spent about an hour this morning trying to work out what’s going on with the MRRT. It’s easy to get lost in the details. But it looks something like this: in its rush to get a deal done before the election that neutralised the mining tax issue with voters, the government left some gaping holes in its language about whether future increases in state mining royalties would be credited against the Mineral Resource Rent Tax.

The miners now see their chance to back out of the plan. They are eyeing the door and judging how quickly they can dash for it. They probably have the PR firms that produced the ads against the mining tax on speed dial. But what legal issues are at stake?

Remember, under Australian Constitutional law (assuming we understand it correctly), only the States have the legal right to collect royalties on their own property. Minerals and commodities, those on-shore anyway, are clearly State property. Thus only the States can legally tax them or collect royalties on them. Conversely, the States cannot impose taxes on “Commonwealth Property.”

Blah blah blah. So what?

This feature of the law is why the Federal government can only tax profits and not the minerals directly. It’s also why the Gillard government had to agree to credit back State royalties against the Federal tax, so as not to double tax the miners. It now appears there’s a disagreement between the government and the miners over whether any FUTURE increases in State royalties can be credited against the Federal tax.

You can understand the government’s position easily enough. It wants every filthy penny it can get. It’s claiming that future State royalty increases are not going to be “paid” by the government in the form of a credit. Why? The States would keep the new royalty money but the Federal government would forego that payment because of the rebate to the miners.

This defeats the whole purpose of using super cycling mining industry profits to cover the structural whole blown in the government’s finances by the GFC and the stimulus plan, which blew the government surplus. Why would you rob a bank that had already been robbed?

You wonder why the States would ever give up the right to royalty revenues from their property. Or why they wouldn’t fight against Federal moves that would seem to infringe on that right. The only States that would agree to this are probably ones that don’t generate a lot of royalty revenue themselves, have large deficits and lots of public servants, but would love to share in the booty being generated by Queensland and Western Australia.

Ah…The joys of Federation.

But why would the miners have ever agreed to such an absurd tax plan at all when they probably had a legitimate legal challenge to the government’s authority to even impose such a plan? Maybe they are good corporate citizens. Maybe they were bullied. Or maybe they saw it as the path of least resistance toward an inevitable result.

Whatever the case, the agreement seems to be unravelling. For the stock market, this could be bullish if it means the end of the tax altogether. It could also be bullish if it means the unwinding of the mining tax means another Federal election is inevitable. Whether that election would deliver either party a majority – or Labor a big enough majority to pass the mining tax, is uncertain.

Markets, as you know, generally don’t like uncertainty. But this kind of uncertainty could go either way. An outcome where there is no tax because no one can govern seems like it’s positive.

But an outcome where no one knows if there will be a tax because no one is governing effectively, which might lead to a new government and a new tax…that’s less positive. Given all those legal, economic, and epistemological factors, why don’t we pare it down to just the charts and see what the market is telling us in its own terms. For that, over to Slipstream Trader Murray Dawes.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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“If The Economy Is Recovering, Why Is Not Energy Demand?”

So many empty houses?!~ :D

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