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.

Gold stocks

Nice entry with a clear stop for a short on GDX. Might have a channel forming off the highs:

Prophet.net

Gold:Silver ratio keeps on trucking

This classic risk ratio is in its own bull market. Look at the spike last week, which may kick off another monster rally in 2010. Interesting also how it turned up all the way back in September.

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Checking the archives, I see that I charted this bottom as it happened.

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Silver did make a peak just then as I’d anticipated, but then it charged ahead with gold to briefly trade over $19. The deflation trade should not be kind to it in 2010.

Another move up?

Maybe today’s the day that tips the balance from confident bears to confident bulls. It’s what we need to reset the pendullum to get on with this drop. I was short from 1098 last night to 1089 this morning, where I reversed the position (which makes me flat, on account of a healthy long-term put portfolio):

Source: Interactive Brokers

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I also went LONG some silver this AM, since it’s tested and held at the $16 level. Would be nice to see some risk appetite come back to gold and silver and to see some more decline in the dollar. I’m the biggest dollar bull anywhere, but a continued ascent from here without more of a set-back just feels too easy.

The precious metals

In this 1-week chart, from top to bottom as of today’s highs, they are: palladium, platinum, gold and (the all-of-a-sudden quite unpopular) silver.

Source: Interactive Brokers

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I have no position in gold or silver futures at the moment, but am shorting the other white metals. Platinum and palladium broke parabolic runs last month and fell very hard. They’ve now rebounded more than enough to restore bullishness to where they can resume their decline if they so choose.

PS – For curiousity’s sake, I wonder what they are saying out there to explain the drop in silver from $19.50 going on $30 to a shade over $16. Rumors of better mine supply? Stories of Grandma cashing in her serving platter? Mexicans shelving their (excellent) idea for a new Peso de plata? I have no clue, since it doesn’t matter a whit.

Deflation trade returning?

While Americans were on holiday, the last couple of days have seen some exciting market action. Stock indexes around the world declined roughly 3-8%, “safe” US and German government bonds rallied, and the dollar plunged to a new low then rebounded very strongly. Gold made a new all-time dollar high at $1196 as the dollar made its low, but when the buck turned yesterday gold plunged to $1130 as US stocks futures (which traded round-the-clock through the holiday) wiped out two weeks of gains in about 24 hours. Higher yield currencies such as the Aussie, Kiwi and South African Rand fell 3-4%, oil extended its decline to under $75, and copper got smacked $0.20 off its new high. One spot of green was natural gas, which extended its bounce to 14% off an area of strong technical support.

Gold showed us what can happen to a levered market after a parabolic move breaks its uptrend. In the wee hours today, it fell $55 in just two hours before rebounding right to resistance (the previous support at $1180, which when broken, precipitated the crash). Here’s a chart of the last two days:

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Commentators blame the Dubai default for this week’s gut-check, and the event may have acted as a catalyst, but the fact is that the risk/reflation trade had reached new heights over the last couple of weeks on a wave of complacency. Early this week the VIX nearly hit the teens and the daily put:call ratio put in a super-low print, while the Nikkei, Treasuries and yen offered warnings that all was not well. Browsing through the world index charts on Bloomberg, it is striking how few other markets have followed the Dow to new highs this month. The troops have been losing heart since summer as the generals kept charging ahead, a classic case of inter-market non-confirmation, which can also be seen in the weak action in small-caps and sector indexes like the transports, financials and utilities.

In last few trading hours of the week (this morning), many markets staged a very sharp recovery, as you can see here in this 1-month view of S&P futures:

Source: Interactive Brokers

Today’s pattern played out in nearly identical fashion in oil, gold, silver and other stock indexes. The stall point offered a clean spot for initiating or adding shorts, and those who did so were rewarded nicely in the last 30 minutes of trading as everything sold off quickly.

Next week should be very interesting. The risk trade plateaued for the last two weeks and went through the usual distributive action, so I have been expecting a down leg of some magnitude. Wouldn’t it be nice if this were the one to finally put a nail in the reflation coffin? I am sick of this market, as would be anyone who understands how far out of line these prices are with value or economic reality.

As Dubai’s default reminds us, this credit bust is far from over. There are still trillions and trillions in bad debt out there, and nearly every major bank in the world is still bankrupt and contracting lending (down another 3% in the US in Q3). We have all the hotels, condos and strip malls we’ll need for ages, and the consumer culture of the late 20th and early 21st century is just an unfortunate historical blip. Don’t tell that to Wall Street equity analysts, though — they still think the S&P will earn over $60 next year, just like in boom-time 2005.

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PS — check out Dave Rosenberg’s latest essay for a good commentary on the week’s action. You have to sign up, but it’s free.  Click here.

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.

She’ll be comin’ round the corner when she comes…

Here’s a roundup of the usual markets, plus a look at grains. This topping process is frustrating, but the action remains encouraging for those waiting to profit from a resumption of the deflation trade. Even as some stock indexes make new highs, they have been revealing their weakness with low volume and advance/decline ratios. The currency and metals markets are signaling exhaustion, and Treasuries have refused to participate in this summer’s nonsense. To the charts:

The dollar to stock inverse relationship is still strong:

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With only a few % of traders (DSI) bullish on the dollar and about 90% bearish on stocks last week, and respective 20-day averages similarly extreme, a big reversal is imminent. We first entered this condition in early August, and we have not had a significant correction to relieve it, but it has grown even more extreme, so when the break comes it is likely to be very large. My theory is that the more extreme sentiment gets, the sharper the reversal, and the longer extremes are maintained, the larger the degree of that move.

From a trading perspective, I prefer dollar longs (via euro, pound, CAD and AUD shorts) and gold and silver shorts as optimal short-term plays right now. This is where the single-digit DSI readings and exhaustive spikes are to be found. Short entries from this level allow for tight and well-defined stops.

Risk appetite remains very robust across the board, with investment-grade corporate bonds back to the kinds of yields we saw near the peak of the credit bubble. Here is the LQD ETF:

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The above is sure to end very badly, since corporate revenues are off a whopping 25% since last year.  Treasury traders are holding up a big red flag and are not participating in this summer’s risk binge, but keeping a steady bid under the entire yield curve. Bonds made their bottom in June (TLT and IEF here — 30 and 10 year proxies, respectively).

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I almost never mention the agriculture markets, but I have been watching them all summer, and I think there may be an opportunity coming up for a short-term play on the long side of grains. Wheat, corn and oats have been in a downtrend for much of the last two years, and their slides may be approaching termination as DSI readings enter the 7-18% range. This is similar, though not yet as extreme as what occurred in the natural gas and hogs markets recently, and those went on to violently reverse to the upside. The grain charts are not yet as pretty as those, and sentiment has some room to allow for an exhaustive plunge, but if it happens that would be a very nice buying opportunity, especially if we get a few consecutive days of single-digit readings. Here’s a weekly chart of wheat, my favorite:

source: http://futures.tradingcharts.com/chart/ZW/W

Corn here:

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That about wraps it up. In summary, I’m feeling good about my long-term equity puts, but even more excited about the set-up in the currency and precious metals markets. I always like to able to go long something relatively uncorrelated, so it’s nice when a random commodities like grains provide such an opportunity.

Still rolling over?

At the moment, everything is still up in the air, so to speak. The rollover into the sub-950 range is still on the table, since a bounce like the last 24 hours on weak internals (such as an advance:decline ratio of well under 2:1) should surprise no one. Despite the lack of oomph here, it is still possible we drift to new highs. I’m sticking with a bearish stance until we see some more strength and breadth on the upside. A sharp drop to fresh lows in late US trading today or tomorrow would not surprise me, and this chart provides a nice stop in case that does not pan out:

Interactive Brokers

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Meanwhile, the zig-zag action in the dollar since Monday looks corrective, maybe a wave 2. Sentiment remains highly bearish on the dollar in the face of a pretty sharp rally. Silver completed a brutal $1.70 drop over 5 days, but everyone still loves it. Oil is conspicuously not making new highs here with that storm out there. Nice short set-up there, since you’ve got a ready-made stop just above these levels.

Copper also seems to be losing its mojo, and is potentially on the verge of a very sharp fall after this sideways correction. Also a nice stop there. Did you read about how pig farmers and other Chinese are taking out bank loans to stockpile tons of the stuff? Now if that isn’t a productive use of credit, I don’t know what is.

Credit spreads (junk vs. quality and corporate vs. Treasury) continued to widen yesterday, further undercutting the integrity of the bounce in equities.

What should worry the bears a bit is the oversold condition in Chinese equities, down 20% from their peak a few weeks ago. But then India’s bubble is just as big and they’ve not dropped nearly as much.

Safest route here is to short with a tight stop or sit in cash. Longs are just tempting fate.

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.