Sunday, December 30, 2007

COT Review

Let's review the last four months in the S&P COT reports. In the first box we see the commercials at historic long positions. Apparently the smart money thinks rate cuts are coming and they are going to fix what ails the market. In the second box we get the rate cut and it's bigger than expected. The market rallies big. Oh but what happens? Half those commercials sneak out the back door on the big pop. Apparently there is some really smart money that was just waiting for this move to unload their longs. Boy did they. After the second rate cut the commercials again added to longs briefly hoping finally for the market to rally. When it didn't they again quickly started to cut long positions drastically even selling into weakness. Then along comes Abu Dhabi and throws 7 billion at Citi. The market rallies and again some of the commercials jump on the long side hoping for an end to this mess. It's not to be as the market sells off hard on the next rate cut. By the next week the commercial long position has evaporated as they sell at all costs into extreme weakness. Now comes the Santa Clause rally. Is it the start of some thing big? Well apparently the big boys don't think so as they use this strength to dump a bunch more longs taking their net position into the negative for the first time in 7 and a half months. Unless something momentous happens it appears the commercials have decided that nothing the Fed or sovereign wealth funds can do will save this market. Now that's not to say the market can't rally from here. If it does though I expect the smart money to be selling heavily into that rally. And as long as the big boys are exiting then the market is going to be on borrowed time.

Thursday, December 27, 2007

Is the S&P at the mercy of the piggies?

The S&P is consolidating in a triangle pattern. Also notice that resistance has again rejected the rally. The market looks headed for a test of the lower trend line. Whether it breaks that lower trend and heads down will probably depend on whether the BKX breaks down to new lows and another bear leg down.

Tuesday, December 25, 2007

More on the carry trade

I'm going to go over the carry trade a little more today. Notice in the first chart that no sooner did the yen start to strengthen than the Nikkei entered a bear market. Massive monetary inflation has been holding up the Japanese market just like it has the US markets. Once the BOJ took away the punch bowl things started to go sour.

Now let's take a look at the second chart. You can see for the last couple of years the US and Japan have been busy devaluing their respective currencies. We can see that in July that changed. The BOJ stopped running the printing presses. The US on the other hand turned on the presses full blast.

I think there are two reasons why this happened. The first one is shown in the bottom chart. Oil, good ole energy, the life's blood of any economy. What happened in July? Well oil priced in Yen was back nearing all time highs. Japan has the same problem we do. Liquidity is leaking into the commodity markets.

Japan's recovery from a decade and a half recession has been very fragile. What they don't need is escalating energy costs to force the economy back into recession. That's exactly what's been happening though as long as they have been following the Fed model of printing troubles away. Which actually just creates more and bigger troubles.

Now for the second reason that made this change in monetary policy possible. Japan held their elections in July and the ruling party was defeated. They lost the majority vote in the lower house. Now what do politicians do when they first come to office and don't have to worry about getting re-elected for a couple of years? They try and fix some of the problems of course. That's why the year after elections is often a year when the markets struggle. AKA 2001!

So now the new ruling party in Japan has 3 years before the next election. It's pretty obvious they are more concerned right now with keeping inflation from crushing their economy than trying to help US politicians get elected next year. I would look for the Yen to continue to strengthen and the carry trade to continue to unwind for a while.

Monday, December 24, 2007

Yen carry trade

Since June we've watched as the Yen carry trade has unwound. Also since that time the market has struggled matching the Yen tit for tat. As the yen sold off the market recovered if it strengthened the market waned. We are now at an interesting junction in not only the Yen but also the dollar. The Yen has now become oversold. In an up trending market oversold conditions should be bought. That would suggest that we are going to see the up trend resume soon. If the correlation holds then the market is probably going to fade again. Take special note that the week before last even though the Yen weakened the market still sold off hard. That would suggest to me that any strength in the Yen now is going to be deadly for the market. Now let's look at the dollar. The dollar is in a secular bear market no thanks to the Fed who seem to be determined to reduce our currency to the approximate value of a sea shell. Take note that the dollar is now overbought. Overbought conditions in a down trending market should be sold. On top of that looking at the weekly chart we see the dollar right up against the descending 20 week moving average that has tended to reject rallies this year.

It looks to me that conditions are ripe for a reversal of these two trades. The end result should again be pressure on the stock market and a boon to gold.

Saturday, December 22, 2007

Money flows

Thanks to Subscriber Robert L for pointing this out. The chart above shows the money flows selling into strength and buying into weakness. All data points are for significant inflows and out flows of the SPY ETF. A couple of things become apparent as you study the data. Assuming this is smart money selling into strength and buying weakness which I am going to do since retail investors do the opposite. Then it seems like the smart money can't pick tops any better than you or I but it does look like they recognize quickly when a top has been made and use any rallies to sell into. They also seem to spot bottoms as they are nearing and start buying into weakness. While this data probably won't help us time the markets it could potentially warn that a top has been put in especially when coupled with COT data. Vice Versa it might help us to buy closer to the bottom again combined with COT data. The take away from the last two days of heavy selling and the lack of buying last week or Monday would seem to be that this rally had more to do with options expiration and making sure everyone went into the final weekend shopping season in a good mood than an actual bottom to this decline. Couple this with the very large decrease in net longs in the COT this week and I'm not sure I want to be a big buyer of this market just yet. I would prefer to see the COT adding longs and smart money buying some of these down days first.

Wednesday, December 19, 2007

XAU line in the sand

Here's the other line in the sand I'm watching.

Tuesday, December 18, 2007

2b reversal in the BKX

I think we saw a very important event happen today in the form of a 2b reversal in the BKX. Very often these 2b reversals will signal the exact turning point of a trend change. If this holds then the selling pressure could be lifted from the market. Until the Nov. lows are broken or the COT turns short I'll have to go back to a bullish stance. This could be a very short bullish position if the BKX quickly breaks down again but for now bullish. While I'm not in any big hurry to buy the general market I think it's probably about time to get back on the precious metal bull. I'll elaborate in today's daily update.

Monday, December 17, 2007

Where's Joe Sixpack?

Somehow investors have gotten the impression that every bull market will continue higher until the public enters the market. I think this is a fallacy inspired by the recent bubbles in Tech and real estate. In the top chart we see the secular bull market that started in 82. I've marked the 4 year cycle lows. Note that only twice did we see the public come into the market. The first time was prior to 87 as the first phase of the secular bull was topping. Keep in mind this was nothing compared to what happened in 99 & 2000. The fifth year decline came along and wiped out Joe Sixpack. That cured him from wanting to invest in stocks for the next 10 years or so. It wasn't until after the 98 cycle low that the public had forgotten 87 and was ready to pile into a "sure thing". The public only piles into an asset class as it enters into the final bubble phase. I see the rational used that this market can't be topping because the public isn't in yet. I think it's way too late for us to expect the public to pile in. That happened in 2000. The market isn't in a bubble it's in a secular bear market. I have a feeling that to expect every bull move in the stock market to draw in the public is just ridiculous. History shows that it only happens rarely.

Now let's look at Gold. I think that the first phase of the secular bull ended in 06. The public was starting to take notice of gold as it made the parabolic rise into the May top. Unfortunately we then saw the fifth year decline and that cured the public of wanting to invest in Gold. Witness that Gold recently touched the $850 level and nobody is talking about buying Gold or Silver. If anything they think Gold is in a bubble. Hardly :) Gold will be in a bubble when everyone is buying it not when everyone thinks it's too expensive.

Sunday, December 16, 2007

The mess that Greenspan made

In 2001 Greenspan started slashing rates and began devaluing the dollar. This was done to try and sidestep the recession that should have followed the bursting of the tech bubble. Despite investors losing a large portion of their investments (which BTW adjusted for inflation they are still heavily underwater) the plan was semi successful. We had a mild recession in 2001. Unfortunately life isn't quite that easy. You can't just turn on the printing presses and escape the consequences of a bubble bursting. Japan tried this approach when their bubble burst in 90. It's now 17 years later and the Nikkei is still nowhere near all time highs. Japan also tried to prevent any pain in their banking sector just like the Fed is doing today. Just like Japan we are going to go through a long drawn out bear market unless the Fed allows the market to correct the imbalances. That is not a popular scenario unfortunately. So my guess is they will compound the problem again.
When Greenspan cut rates not only did he not stop the deflation in the stock market but in the process he created another bubble in real estate and credit. As we know bubbles are unsustainable and they will burst. In the first chart we can see the housing sector topped in the summer of 05. It has clearly been in a bear market since then. The housing bubble was in my opinion a large contributor to the incredible growth we've seen since 03. Unfortunately once that driver of growth failed we have seen a domino effect of failing sectors following housing down the bear path.
Out of the 06 bottom the Fed really started to pump the money supply to compensate for the deflating real estate market. From that point we can see the last major leg up in the stock market and what a leg up it was. Two runaway moves higher divided by one minor and short lived correction in Feb. and Mar. Sadly the cost of this borrowed prosperity was a devaluation of our currency to levels never seen before in history. Since this is also unsustainable it had to come to an end and it did come to an end in July of this year. At that point no more currency devaluation was going to lift the markets. The only thing it was now accomplishing was higher and higher inflation (the government finally this week published inflation numbers that vaguely represent what we have all known for sometime).
So now let's look at the progression of what's been taking place. First the housing bubble, the driver of this prosperity, collapses. Once the free money from refi's and home equity dries up and the devaluation of the dollar has run it's course we start to see the domino effect. Next go retail and of course if retail is declining the the transports are going to follow. That's exactly what has happened. The semi's also followed retail down. Even though the Nasdaq has held up better than the general market it is being held up only by a few large caps like AAPL and GOOG. The internals are actually much weaker in the Nasdaq than the general market. With the semi's in a bear market it won't be long before the last remaining large cap tech succumb to gravity.
Now for the sector that made the credit bubble possible, the banks. We see the rise as housing drove the economy into 05. We also see the banks start to falter right before the housing bubble burst. Then we see the meteoric run during the Fed's all out currency devaluation. Now we are seeing the result of the bursting of the credit bubble. The banks who failed to heed the warnings when greed was running rampant are now paying the price of that hubris.
The only question now is will the Fed let the market run it's course and clean out the excesses so we can start to rebuild or will they try and hold everything together like Japan did and draw this out for years to come. At the moment it looks like they are headed down the wrong path.

Thursday, December 13, 2007


All during the commodity bull platinum has been the strong sister in the precious metal sector. It has already broken out to new all time highs. Both Platinum and Gold are consolidating in triangle patterns after the powerful fall rally. The positive take away is that triangles usually break on the flat side. In the case of Platinum a break of the flat side would be up. If Platinum breaks up it will take the rest of the precious metals with it. At the moment silver is struggling but I have a feeling that some of this may have to do with the industrial component of silver and an economy that is slowing and may be heading into recession. If gold and Platinum move up though I expect silver to follow. I'll be watching Platinum in the coming days to get an idea what's going to happen to gold and silver.

Bull or Bear?

There's quite the debate right now going on as to whether we are starting a bear market or if the bull is still alive. This is probably one that will never be settled. Investors continued to hope all the way down from the top in Mar. 2000 till the bottom in Oct. of 02. However let me point something out. Without fail the market has seen a 4 year cycle low every 3-5 years for the last 100+ years. There have been no exceptions. For longer term traders I have to beg the question what's the point trying to catch the last little bit of profit in this bull? The odds are now very stretched against this bull lasting much longer. It's already tied for the longest trough to peak rise in history. Here's what is going to happen to investors who insist on trying to wring the last little bit of upside out of this bull. When this bull turns into a bear (and it already may have) these diehards are going to start taking losses on the long side. The longer you hold on to your bullish bias the more losses you are going to take. Eventually this cycle will bottom and when it does there are going to be incredible bargains to be had. However if you have been taking losses all the way down you will be gun shy and unable to pull the trigger when the time is right. You will miss those bargains. The next rally out of this low should be much more powerful than what we've seen in the past. Huge profits will be made in the commodity arena. Unfortunately you won't be able to make them if you've whittled away your capital trying to suck out the last dime of this bull. Patience to wait for that cycle to come is what is needed now. You don't have to be short and for most shorting is probably not a great option as the profits are limited. Simply go to cash and when the bottom comes you will be in a buying mood and ready to take advantage of Mr. Markets irrational move. I included a chart of the 98 cycle. Look at how much better entry one would have gotten just by being patient. This market gave a very clear entry at the exact bottom with a 2b reversal in Oct.

Tuesday, December 11, 2007

Failed support

With today's decline the S&P closed back below support in the 1490 area. Now this level again becomes resistance. The S&P also broke the intermediate term up trend line on today's decline. I mentioned before that V shaped rallies are prone to failure and it looks like the odds are good that this one is going to fail. Amazingly enough the VTO signal from from Oct. 19th would have closed profitable on Dec. 6th. Not by much but it was a profitable trade.

Let's just say I wouldn't be at all surprised if the Fed comes out and cuts another 1/4 point in the next week and the market trades back above resistance. Heck they can't seem to make up their mind what they are going to do from one week to the next. One week it's the economy is softening and they will need to cut aggressively. Then the next week they cut small and still seem worried about inflation (rightly so IMO. In the long term if they let inflation get out of control now it will do much more damage than the credit crunch) Keep in mind we still have positive seasonality through Dec. and many short term levels are already severely oversold. A bounce in the next day or two wouldn't be unexpected.

Sunday, December 9, 2007

Devaluing the currency and other Fed scams

Let's take a closer look at this supposed bull market from 02 till the present shall we. First off notice the strong dollar as the bear market commenced. It wasn't long after 911 that Greenspan realized that just cutting rates wasn't going to do the trick and the serious currency devaluation began. By this time the bear was firmly in place and it took over a year of massive currency debasement to halt the bloodletting in the stock market. In the bottom chart we can see that oil started to respond to the printing presses almost immediately. The smart money was already on board the commodity ship. As we progress through the cycles we see two times where the Fed tried to drain liquidity from the system and both times the markets stagnated. One of these was right before the 04 elections. Whew that was almost a major mistake. However we can see that Greenspan got with the program just in time to salvage the market and get Bush re-elected. Then in 05 we see another attempt to drain liquidity from the market and again stocks stagnated. Back to pumping again as this was about the time the public started to get fed up with the Iraq situation and Bush's ratings were in the dumps. Up goes the market except now we are starting to have a real problem with energy prices. As a matter of fact energy prices are starting to trump stock market gains. Something needs to be done before the mid term elections. Next we see a concentrated effort to move energy prices lower. The stock market suffers to some extent during this campaign even though the Fed never really drains liquidity from the system. Once the energy markets are brought back in check the Fed goes back to the printing presses just in time to levitate the market into elections. All's well. Well sort of. Right after the elections the pressure is released from the oil markets and wow look what happens. Like a spring that's been compressed and suddenly released the energy markets rocket upward gaining almost 100% in less than a year. All that liquidity that was being held in the paper markets drained right back into commodities. Now we come to July and Aug. Something big happened here IMO. The dollar was allowed to break through to new all time lows. Now the currency was in uncharted territory. There was no support under the dollar at all. Instead of the market continuing higher as its done for the last 5 years that the Fed has been busy devaluing the currency all of a sudden the market changed character. Volatility started to spike upwards and the markets are swinging wildly back and forth. In the meantime oil just kept climbing straight up. The massive amounts of devalued dollars the fed has been pumping into the markets is almost immediately draining off into commodities. We see the same picture in the gold market. A straight shot up from the Aug. lows. Now the Fed is again embarking on an even more massive liquidity pump. Not only are they printing money but they are lowering rates to make that money even cheaper to borrow. How will they ever keep all this liquidity out of the commodity markets? If they can't keep it out then what is going to happen to the price of oil, gas, gold, silver, natural gas, food, etc. in the coming months? Just what we need as the economy slows, skyrocketing prices for everything we need to live. Do us a favor Bernanke and raise 50 not cut 50.

50 points next Tuesday

Thanks to Doc for the chart. The spread between the 2 year note and Fed funds rate is as wide as it's been in 17 years right now. Contrary to popular belief the Fed doesn't lead the market. They follow as you can see from this chart. With a spread this wide I'd say it's a pretty good bet the Fed is going to lower 50 basis points on Tues. Lately they have been trying to talk short term rates up so they won't have to cut as much. I think they know these easy monetary policies are going to stoke inflation and weaken the dollar just like it's done since 01 but the market is demanding this action. At some point a Fed president is going to have to break this cycle like Volker did or we will just continue to watch the dollar drop and inflation rise. Rising inflation will eventually clamp down on the global economy.

Saturday, December 8, 2007

Agricultural sector

I'm going to show you another sector that I will be investing in when we get a pullback. That is of course agriculture. The powershares ETF DBA is one way to play this sector. Unfortunately there are only four components to this ETF, corn, wheat, soybeans and sugar. Other than sugar the other three are right near all time highs so I'm not keen to be jumping in at the moment but I will be when we get a pullback. Notice the recent weakness in the market had almost no effect on agricultural prices. When I see corn, wheat and soybeans pullback I will be looking to get into this ETF. Like precious metals agricultural prices have severely underperformed during the first phase of the commodities bull market. They will most likely outperform during the second. They already are :)

Friday, December 7, 2007

Gold & silver again

I think it's time to buy gold & silver again. Now I'll give you my reasoning. First off we all know the Fed is going to cut rates. Has anyone else noticed that after every rate cut they start talking about this being the last cut and inflation is a worry yada yada yada? Have you also noticed that right before the next meeting something pops up that necessitates another cut? Now maybe the rest of the world joins the party and starts cutting and the dollar stabilizes against other currencies and maybe it doesn't I don't know. I do know that won't change the fact that every country is running the printing presses. As long as everyone is devaluing their currency then it stands to reason that the price of Gold should go up in every currency. That's exactly whats been happening for the last several years. Now ask yourself what scenario would bring down the price of gold. The Fed tightening and draining liquidity from the system right or a huge gold discovery. Any one want to hazard a guess as to what the odds of either happening are? The other option the central banks have would be to try and control the commodity markets. Basically attempt to keep the liquidity in the paper markets. Well if that is their goal I'd have to say that with gold over $800 and oil at $90 they haven't been too successful.

Taking a look at the chart this just doesn't look like a major correction to me. Notice how gold typically just collapses after a powerful run? Silver BTW tends to fall apart even worse because it's an even thinner market. This looks more like a consolidation from the Sept. and Oct. rally to me. This also looks like we may be setting up for another rally of similar proportions. I'm really in no hurry to buy the general market but I will commit my capital to PM as they are in a secular bull market. If I'm wrong in the short term it doesn't matter as the bigger overall trend will eventually correct any short term timing mistakes.

Thursday, December 6, 2007

Are the precious metals ready to move again?

I like the action in GLD and SLV. GLD has held above the 50 DMA and it worked off the overbought condition from Sept./Oct. Last Tuesday GLD took in another 18 tons of gold. It has now surpassed the physical gold holdings of the central bank of China. Despite the strength in the dollar gold has not been able to break through support. The XAU is starting to look like it wants to break out of the consolidation to the upside. I have no desire to chase the market rally as I feel it's ultimately doomed to failure. I am willing to commit capital to a secular bull market that's pulled back and consolidated since the larger overall trend is in my favor. Stops are very close on this one. A close below support would probably signal the correction isn't done yet and one could exit with minimal losses.

Wednesday, December 5, 2007

Dollar rally Market rally

The market has been matching the dollar rally day for day. Tell me the market wasn't worried about a dollar collapse. I think the jobs report comes out strong and the Fed tries to get away with a 25 basis point cut or maybe even no cut. I'm wondering how the market would react to either one of those scenarios. If the ECU raises or stands pat tomorrow the dollar could start to weaken again. Either way the dollar needs to test the lows before a meaningful rally. If the Fed cuts 50 I suspect the dollar decline continues. Also note the RSI is approaching overbought. The pattern so far on rallies has been to touch the 70 level and then swoon back down to new lows.

Monday, December 3, 2007

S&P long term chart

Friday I posted that the S&P had bounced off resistance at the 90 DMA. So far this week that resistance is still holding.

I find it's often helpful to look at really long term charts and get away from the short term noise. We can see here that the last time the 90 DMA turned down sharply and moved under the 200 DMA was the fall of 2000 as the bubble was in the process of bursting. For the last several months we have been watching the bursting of another bubble. The credit bubble. The market may still bounce into the end of the year. The odds are still in favor of that scenario but I think the catalyst is now in place for the markets to move down into the 4 year cycle low.
This bull is now tied with the 82-87 4 year cycle for the longest trough to peak at 60 months. Once we get past this bounce/rally we should be setup for the final decline. History would suggest this decline has the possibility of being especially violent.

Saturday, December 1, 2007

COT warning signs

11/27/07---- 25.80
11/20/07---- 28.03
11/13/07 ---- 37.02
11/6//07 ---- 35.53
10/30/07 ---- 30.58
10/23/07---- 31.91
10/16/07---- 26.89
10/9/07 ---- 36.46
10/2/07---- 38.02
9/25/07---- 38.87
9/18/07---- 64.24

I'm going to try and explain what's happening in the COT's that has me concerned. Let's start on 9/18 we see a combined contract (S&P, Nasdaq, Dow & Russell large and e-mini) net long position of 64 billion dollars. The next week on 9/25 that position was almost cut in half. A move like this almost never happens in the COT. It's something that needs to be taken notice of. This happened as the market was rallying. It's not unusual for the commercials to add to hedges as the market rises. So the direction of the move wasn't surprising it was the one week rate of change that was unusual. The next big move came on 10/16 when the commercials dropped their long position by 26% from the prior week. As you can see on the chart this corresponded very closely to the market turning down. Last week they dropped another 24%. Now the first two reductions in longs make sense to me. The commercials usually sell into strength so they were just doing what they do, hedging their longs as the market rallied. The last one is very strange. They dropped a huge amount of longs as the market was going down. Now let's look at the data from 10/16 to 11/27 a little closer. Granted they did increase longs a bit as the market declined but notice they aren't anywhere close to the 64 billion that they had on 9/18. Does anyone remember what happened on 9/18? That's right the Fed cut interest rates. The very next week (correction: the chart has the week of 9/18 marked and it should be the next week)all those longs that had been building up for months got basically cut in half. Hmm??? They then increased longs slightly as it became apparent the Fed would cut again. This time however the increase never came close to the 64 billion we saw before the first cut. Now it's widely believed the Fed is going to cut again but instead of building long positions the commercials are drastically trimming longs and they are doing it as the market has moved down. This is completely out of character with what the smart money normally does. Hopefully this clarifies what I mean when I say the COT has been giving warning signs for a while now.