Urge to speculate not as rampant as it seems

The recovery of the US stock indexes and big new highs in the Russell 2000 and Nasdaq seem to have convinced a lot of people that we are either entering the next phase of a sustainable bull market, or about to at least crawl up another 10% before finally exhausting. I don’t see it that way. This feels to me like October 2007, when the market had smartly recovered from a hard break on the leadership of the secondaries, but the trend had been broken and stocks were strenuously overbought on extreme complacency.

This rally has mostly been a small-cap, tech stock and speculative affair. Larger stocks are not getting the same kind of bid, nor are commodities.

I have turned very short-term bearish this week on the extreme low in the equity put:call ratio. You can see here that the 10-day moving average is lower than at any point in the last three years, which at 0.51 might actually be the lowest ever (since this includes the Goldilocks spring of 2007):

Indexindicators.com

How could you possibly be long given a reading like this?

Before concluding that we are blasting off here, take a look at oil, which has gone nowhere for five months, with each advancing impulse weaker than the last, and the latest looking particularly anemic:

Stockcharts.com

Even gold and silver, which have dependably found a strong bid whenever stocks have rallied and even when they have not, have stalled out well under their fall highs:

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Silver is weaker than gold, and this measure of risk appetite (silver:gold ratio) peaked all the way back in September:

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Perhaps the greatest beneficiary of the risk impulse has been the junk credit market, which by one measure is actually showing the narrowest spreads in history over quality. This is absolutely astounding given the economic conditions, and only explainable by the notion that the investing public, twice burned by stocks in the last decade, has decided that bonds are safe, without making any distinctions among them. You can see this trend here in the ratio of the price of JNK (junk bond ETF) to LQD (investment grade bond ETF), though this chart appears to show waning momentum:

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I’m not calling for an immediate crash, but certainly at least for a smart set-back, which may in retrospect turn out to be the start of a decline to new secular bear market lows. With the credit system still clogged with bad debt at the personal, corporate and state level, the economy simply has no ground from which to launch a new phase of business growth. What we have seen for the last year is simply unsustainable government spending and an overeager investing public that still trusts Keynesian economists and bogus statistics like GDP.

We are not out of the woods. We are entering a long phase of write-downs, defaults, bankruptcies and generaly frugality. We are not going to get away this time without our Schumpeterian event.

Commodities running out of steam.

The trend was smartly broken back in January, and now this bounce looks like it’s exhausting right about where the old support line would be. These are the various popular commodity indexes, from Bloomberg:

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You can see this loss of momentum in the former leaders: gold, silver, oil, copper, sugar and cocoa have all failed to make new highs as stocks have surged over the last month.

This is a strong sign that the urge to speculate is fading. Without that, there is nothing to keep prices up, since demand is very low for everything from oil to wheels of parmesian cheese (remember the cheese bailout in Italy?) compared to the 2008 commodity peak. When commodities fall, they often drop straight down. No class of assets declines faster. See this weekly chart of sugar for a case in point:

futures-tradingcharts.com

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If you are looking for short ideas among commodity stocks, this is a neat tool: miningalmanac.com (I think so anyway, but then I’m part of the team that’s building it).

Select the exchanges you trade on, then look for stocks without a lot of “burn time,” in other words those that may be running out of money. Or look at the “financial strength” tab to see who has too much debt and too little cash. Right now this beta version has mostly Canadian companies, but it’ll have almost every mining stock in the US, Canada and Australia before long.

Loaded for bear

Graphite here.

Although it’s easy for this kind of contrarianism to turn into unhelpful navel gazing, on Friday the level of despondency seemed to hit a new high (or is it low?) on the bear blogs. Posts and message boards are chock full of buzz about perpetual asset inflation powered by the Fed’s magical money machine and an ample supply of that tricky thing called “liquidity.” Visions of the 1990s and 2000s are offered as proof that the market can disconnect itself from any fundamental or technical backdrop and power to endless new highs. The January highs are trotted out as “points of no return” for the bears, as though the market is guaranteed to launch higher if it manages to cross that threshold. And with the market seeming to shrug off every negative news item from sovereign defaults to bank failures to continued hemorrhaging of jobs in the U.S., traders are unable to conceive of a “trigger” that could send stocks lower.

Meanwhile, take a step back and look at the technical picture the market is presenting at the moment. After a several-week buying frenzy in stocks, we have new highs in the high-beta Nasdaq and Russell indices, unconfirmed (so far) by the Dow and S&P. Friday’s 5:1 NYSE a/d ratio was cause for concern, but hardly a match for the 35:1 down day seen in the February selloff. The 17 handle on the VIX shows complacency in the option market. Bonds and the dollar remain very well bid, despite the imminent end to Fed purchases and the best efforts of politicians to dismiss the euro’s and pound’s woes as the unnecessary manipulation of nefarious speculators. After a period of sideways movement the currency DSI sentiment has backed off somewhat from its recent extremes. Sterling in particular seems to have taken over whipping boy duties from the euro for the moment, and may have just finished a failed breakout from a channel on the 1-month chart. I have entered a short position with a stop above the upper channel line:

Source: Interactive Brokers

If it tops here, crude oil will have put in a right shoulder on a ponderous 6-month H&S formation. A close today below 81.79 in the April contract would also create a bearish outside reversal bar (not shown):

Source: Interactive Brokers

Over the weekend Marketwatch ran a segment prominently touting “The Year of the Bull,” complete with an upward sloping line starting from March 1, 2009.

If immediate new highs are in store for the major indices I would expect them to be muted at best, following Friday’s buying frenzy and the outpouring of bullish sentiment and resignation from the bears. If all the indices turn and fail right here I would think we will put in a stronger, swifter leg to the downside than we saw in January. And with entries in various markets offering tight, well-defined stops at multi-week highs, risk/reward favors the battered bears for now.

Commodities roundup

Hi all. Sorry for the long span between posts. I’m going to try to be a bit more diligent about daily postings, as I was in the earlier days of this blog, even though things aren’t as exciting as they were the second half of last year. After all, there is always market action somewhere, and government is an endless fount of stupidity.

The currency, cocoa, sugar, natural gas, and of course gold markets have been of interest lately.

Let’s start with King Dollar, sprung from the grave. This of course is a warning to all stock and commodity bulls to keep an eye on the exit. My target here is over 90, maybe even 110 (meaning the euro could fall under parity).

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Here is a 25-year chart of cocoa, which clocked an all-time high this past week at nearly $3500 per metric ton (1000 kg):

Source: Indexmundi.com (a wonderful compendium of long-term charts and all sorts of data)

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I’ve got a short position in cocoa from 3406. Friday was a big down day, with a drop of as much as $130 per ton off of Wednesday’s record in the high 3400s). This is a very thin market, in which it’s impossible to finesse positions, so I’m just shorting and holding. Cocoa tends to move with the broader commodity complex, last having topped in mid-08 with the rest of the bunch. For its own reasons it has outpaced everything this year but our next feature, sugar:

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In this 2-year daily chart from stockcharts.com, you can see a classic 4th wave triangle consolidation over the last few months:

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As prices drifted slightly lower in an ever smaller range, DSI bullishness declined to about 20%, meaning that most traders believed that the highs were in. After all, sugar hadn’t been above 20 cents per pound since the 1970s, when it had gone from under a penny to 60 cents! Here’s a chart from 1961-2006 in which you can see those monster spikes (the 1974 peak would equal about $2.50 in today’s prices):

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Now, I’d stay out of the way of this blast-off (and maybe even participate if we get a pullback with a clean stop), but when it exhausts there will be nothing but air under this market.

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On to oil… I think $70 a barrel is nuts in this economy, and that this year’s rally is just the natural reaction to the $100 decline off the July 2008 peak.

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That doesn’t mean we can’t vault higher still, but even considering that global production is likely peaking, the price just doesn’t reflect the drop in demand. Don’t tell me about China — China is still due a major set-back to liquidate its own bubble. I highly recommend the preceding link to Mish’s site. Few understand the extent of debt-driven malinvestment in the People’s Republic.

Here’s a 1-year view of West Texas Intermediate crude. Note how it violated support last week, indicating flagging momentum. Once this bounce exhausts, there could be a very nice short set-up:

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Here’s a 25-year view of natural gas:

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What’s remarkable about this fuel is that because storage capabilities are so limited, and because of the nature of its use as a heating fuel and for electricity generation (gas plants are the most expensive to run, so many are only turned on during peak demand days), it is prone to tremendous spikes and deep valleys.

What the above chart makes clear is that 5-6 dollar winter gas is on the cheap side of things for this decade, so even if demand is soft (and it is), a spike is possible. That said, I don’t think it’s likely, because we’re not quite due for one yet. Gas has only been of interest to me lately because it formed a nice slope into a bottom this summer, then ramped up in September and re-tested the bottom this month. The re-test was a nice long entry, and I rode the futures from $4.50 to a shade over $5.00 (silly of me to tighten the stop too much and miss the last $0.80).

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I’d look to get back in here on a pull-back with a neat stop (tough to get in this volatile market), since there seems to be plenty of momentum left.

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Now onto everyone’s favorite commodity lately, gold. Here’s a chart from 1974 to present from kitco:

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You all know my opinion. I think this bull market has started a major set-back, similar to the ones that started in April 2006 and March 2008, the peaks of previous parabolic runs that ended after weeks of extreme bullish sentiment. I’m going to continue to trade the short side off of rallies. I covered my short from $1215 at $1150 last week, then traded a small bounce, and have since attempted a couple of long positions only to have them taken out. In past months, we would have had a nice snap-back rally by now, but like the euro and carry-trade currencies, this market is looking very weak. Note how it has now broken its 50-day moving average:

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For now though, I do like the long side of gold and hope that we get our corrective rally soon, firstly because I’d like to play it, but more importantly because it would provide such a nice short entry. Downside momentum seems to be stalling around the $1100 level, even as the dollar has chugged ever higher.

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RSI seems to be rounding out, and the $1095 is a pretty clear stop, so the short-term odds seem to favor a long position. Who knows, maybe the big rally isn’t dead yet. We still haven’t busted cleanly through the 50-day average, though with the dollar having turned with such gusto much of the impetus for the rally is gone.

Choppy & toppy

Here’s a 6-month shot of the S&P500 futures:

Source: Interactive Brokers

Looks like another good short set-up here, using a couple of points over today’s high as a stop and 1055 as a target (with much greater bearish potential of course). Like many bears, I’ve been expecting the 2009 rally to peter out since summertime, and I’ve been continually surprised by the stock-buying public’s recklessness, delusion and plain stupidity as evidenced by a PE ratio well over 100 in the face of 10%+ unemployment, shrinking credit, and accelerating foreclosures and bank failures.

That said, the market since summer has given us a series of fairly clear short-term sell signals and has obeyed them with a series of 4-6% declines. Unlike previous rallies that powered through resistance into solid new highs, the rally since the latest interim bottom (November 1-2) has stalled out well within the price range of the previous top (mid-October). Not only that, but the distribution (choppy) pattern within this three-week plateau has exhibited a much wider range than previous ones. Might this instability indicate a pending phase shift, such as when a top gets wobbly before toppling over?

Oil

I want to show some basic charting here with crude, which is supposedly falling because of the supply report today, an explanation that I consider hogwash. Rather, the chart offers some examples of a very simple sell signal: the broken trendline. Yesterday’s signal was classic: it broke a very clear uptrend at a couple of different degrees, attempted a re-test, then fell hard.

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Here in the 2-day view you can see the smaller trend and how its break lead to the break of the larger one:

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This reminds me of last week’s mini stock panic, which was supposedly because of Dubai World. Funny thing is, as EWI noted, stock futures made their high a few hours after Dubai made its announcement.

Distribution time

Markets have rebounded feebly from their early November bottom, with speculative interest focused in fewer sectors than in earlier risk binges. The hot money is now concentrated in big-cap US stocks over small-caps, and in gold over silver, reflecting a shift in preference for quality over junk.

With upside momentum taking a breather, we’re in another distribution zone, where assets move from early buyers to late comers. The put:call ratio, my favorite indicator of complacency, has backed off its recent highs and could approach the extreme lows we’ve seen recently if stocks remain at these levels for a few more sessions. That would be another excellent short-entry signal.

Souce: indexindicators.com

Here’s the last month of trading in the December S&P 500 futures contract:

Source: Interactive Brokers

If precedent holds, we could chop around up here for another week or so and test the highs a couple more times before rolling over. What’s important is that we have made no net progress for three trading days, and that we have a clear stop for a short position.

The moonshot in the Dow has not been confirmed by any other indexes, though a few of them have made minor new highs. The Russell 2000 remains the laggard, remaining well under the October and September highs. The Nikkei is similarly weak, and crude oil has just been working its way down a channel:

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I also suspect that gold’s run is over or nearly so. I’ve never heard so much talk of gold on the financial news and in other contexts. 19 traders are bullish for every bear. This is about as lopsided as it gets, and we’ve had a huge parabolic rise. It is hard to nail down where these ramps will end, but like oil in 2008, when their momentum stalls, they can fall extremely fast.

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For another take on things, here’s the ratio of gold to the US dollar index:

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Clearly the above trajectory is unsustainable. This is the kind of market action that draws everyone in and forces most shorts to cover. When that process is over, an asset can fall under its own weight. Conversely, the most fear and despised currency appears due for another bull run in 2010, in large part because of all the new debt that has piled up this year in the corporate bond frenzy and renewed carry-trade (borrow dollars and buy anything).

That said, gold should continue to outperform most every other asset class for years, since as professor Roy Jastram showed, its purchasing power increases in deflation when there is a gold-standard and when there is not (it is money, after all).

Trading notes

I thought I’d make a quick post here to update some of my thoughts on the markets. Here’s the S&P 500:

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Most major world markets and US indexes look more or less like the above. Every one has rolled over since mid-October, and some made their highs several weeks before that. Based on measures of breadth and volume, this has been a strong and broad decline over the last two weeks. Fear has returned in pretty good measure, as witnessed by a 50% jump in the VIX and a breakout from its downward trend. Oil and precious metals fell, and the dollar broke its own downtrend, though it still needs another boost to confirm the move.

I was positioned very short equities, oil, metals and long the dollar, but over the last couple of days I’ve been tightening stops, closing positions and hedging the remainder. I believe we’ve seen the start of a major trend change, but for the next few days I would not be surprised by a minor stock rally. If one develops, I’d expect weak breadth and plenty of divergences if the primary uptrend has indeed been broken. That could be an excellent entry for short positions.

Tops are generally rounded affairs, though occassionaly declines from peaks will morph into waterfalls just when you’d expect them to ease up. We definitely have that potential here, and I will be expecting some fireworks on the other side of any little rally. It is entirely possible that the March lows could be revisited early in the new year, if a decline matches the aftermath of the 1930 and 1937 rallies.

Some crude charting

Here’s a 1-month view of the Nymex December light sweet crude contact:

Source: Interactive Brokers

Watch for a break of that trendline. With bullishness running at 95% (and 97% on gasoline and heating oil), this rally must be getting long in the tooth. Also note that the rally has stalled against a longer-term channel trendline (see 1-year chart below). This week’s highs could make for a nice stop for a short position.

Source: Interactive Brokers

Don’t underestimate crude’s ability to levitate even if stocks begin to fall. This is just what happened in 2008 of course. Oil and other commodities charged ahead even as demand fell apart and deflation (a contraction of money + credit) took hold.

Also watch copper, which has been tracking oil pretty closely lately. Bullish readings aren’t as high here, so it may have even further to run:

Source: Interactive Brokers

The target here would be about $3.35-3.40 if copper hits the upper trendline. Given modest bullishness readings, there are enough traders to convert to the bull side for this to happen. Of course, a strong turn down in equities and move up in the dollar, should they come to pass, would be a headwind for all commodities.

Bubblicious

The Indian stock market since 1990:

Source: http://www.nseindia.com/

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I suspect that this market will end up back at 2002-2003 levels. Manias like this tend to be completely retraced, like the oil bubble from ’04 to ’08, which sports a similar chart to the above, complete with a big B-wave bounce that should be peaking soon, though by looking at this chart alone I wouldn’t rule out $80:

Source: http://futures.tradingcharts.com

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Thought I’d take a look at some other wild markets:

Russia’s RTS:

Source: http://www.rts.ru

Russia hasn’t made much of a retracement, only about 25%, but if the US markets fall from here you can bet it will join them.

Shanghai is ready to rumble (about a Fibonacci 38% retracement, just like the S&P 500):

Yahoo! Finance

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Brazil’s Bovespa – about a Fibonacci 62% bounce:

Bloomberg.com

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Why not check out the Swiss? Ok, they’re not so wild — just a 33% retracement here, but a remarkably similar pattern to the S&P 500. Also, it is worth noting that the Franc went from roughly $0.83 to $0.93 over this period, so this was a much larger rally when priced in dollars, like many of the other foreign markets.

Bloomberg.com

WIth foreign markets sporting high valuations and high exchange rates, it looks to me like the US dollar is going to be where it’s at going forward. Shorts that capture the exchange rate movement along with stock moves would be attractive.

Reflation fade vindicated

Today’s action (equity and commodity sell-offs through key levels, major bond and dollar rallies) confirms once again that the dollar is still king and that deflation is the name of the game.

The action since March can be summed up as (1) a dead-cat bounce from oversold conditions in equities, (2) a replay of early 2008’s speculative rally in commodities, and (3) premature fears of the dollar’s demise.

The charts below show how things have played out since I noted the following on June 5:

Well, the reflation trade has managed to hold on for a few more days and even reached new heights, but the case for a pullback is looking that much better. Precious metals, non-dollar and non-yen currencies, oil and treasury yields have all benefited from what looks like a fairly extreme fear of inflation. …

From this juncture, I am still more enthusiastic about the prospects for the dollar, bonds and related commodity shorts than I am about stock market shorts, since the sentiment in the later has not reached the same levels of broad consensus. That said, it would be surprising if we don’t at least stop making new highs for a few weeks, if not fall well under 900 in the S&P.

This trade has gone well so far, but a bit over a week ago I had very large shorts (with futures) on the euro, pound, franc and oil, in addition to my large equity, copper and gold shorts, but the former made a little pop to new highs that stopped me out. I put on some more pound and franc shorts, and retained some puts on oil, but I’m kicking myself for being such a wimp with tight stop prices. My excuse for not re-shorting in bulk is that I was about to move for the summer and wouldn’t have much screen time again for a while.

I am also guilty of getting cute and taking profits on my silver futures short (from 15.75) at 13.92 and not re-shorting at 14.40 when I had the chance, though I have thought all along we are going well under $10. Nonetheless, today was a good day, and squiggles notwithstanding, I think we have turned the corner here.

Here are a few three-month charts from Yahoo! to show how things have gone so far (the little dots are placed on June 5 (actually I first said to fade the reflation trade on May 28):

S&P500:

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The dollar vs. the euro (not much action so far, but certainly no dollar flameout):

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USO (United States Oil Fund):

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Precious metals complex (GLD, SLV and GDX):

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30-year Treasury bond yield:

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Even grains have sold off hard (DBA agriculture fund):

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Now, we’ll see if this is just a setback from premature extremes or if we’re headed for new deflationary lows in a hurry. I think the reflation trade has topped, but that doesn’t mean equities can’t make a last ditch effort to stop out the shorts with new highs. That said, I’m sitting on a big load of index puts.