Tonight I received an e-mail from Ameritrade informing me that they now have pattern recognition software for retail traders. As soon as I saw this I got to wondering if trading patterns has become too popular.
Almost every night on Fast Money they have a chartist on the show. When they started the show the only one using charts to any extent was Eric Bolling. The other traders would basically roll their eyes when he pulled up charts during the show. Not so anymore. Almost every blog I visit is loaded with charts full of patterns, trend lines, support and resistance, etc. etc. Mine included.
While I was reluctant to come around to trading patterns I have to admit that they often worked probably more than 50% of the time. More than 50% defines an edge. If you have an edge you can probably make money in the market.
Now one thing I can tell you is that when something works for very long the market will eventually discount it and your edge will disappear. The three charts are examples of widely recognised patterns that did not "work" as expected.
Somebody once said that speculating in the market comes down to anticipating the anticipators.
When I received tonights update it started to dawn on me that the smart money is probably starting to anticipate the pattern traders. I expect the more obvious patterns are going to work out less and less frequently.
As always when the markets get confusing I go to the weekly charts to get a better idea of what's really happening. Yesterday I noted that the S&P had broken the trend line from the Mar. lows. By looking at the weekly charts it becomes apparent that the market rallied back to the 75 week moving average that acted as support during the bull market. As of last week it is now acting as resistance.
The Transports have been much stronger than the rest of the market despite high oil prices but looking at a weekly chart (or daily for that matter) the 2b reversal becomes very apparent.
I know the argument that if oil backs off it will rescue the market and the economy. I'm just not sure I buy it. The damage has already been done. Oil will back off during a recession because demand will drop. I think the Fed's liquidity pump over the last 5 months just made sure oil went to $135 instead of $100.
Economies don't turn on a dime. Just because oil is backing off it doesn't mean the economy is all of a sudden going to rebound strongly. As the economy continues to sink from the duel effect of the real estate bubble bursting and energy spiking the stock market will likely again try to price in the recession. I still don't buy the whole market discounting theory. The market wasn't discounting anything over the last two months other than the fact that the Fed created a lot of paper. At some point the market will wake up to the fact that the economy is faltering and there likely won't be a quick rebound no matter how much money the Fed throws at it.
When it does I fully expect Bernanke to again turn on the money spigots. If he does he may keep the market from falling below the Mar. lows but he will also just continue to stoke the fires of inflation.
I'll be watching oil closely during this period. If it bottoms around $100/$110 and then heads north again I think 09 could be a very rough year.
I wanted to add this link for what to look for at bear market bottoms. As I've said repeatedly we are in a long term secular bear market.
I've noted in the daily updates for a while the build in negative sentiment levels and now the S&P has broken the uptrend line. It has also tested the consolidation zone from the T1 move and failed. I think the odds are now in favor of a continuation of the bear market. I do think the market is going to bounce into the end of the month but I suspect that is just going to allow the shorts in at a better level. I also have a feeling that when and if the market approaches the Mar. lows Bernanke is going to flood the market with even more liquidity and put a floor under the market.
The massive amount of liquidity the Fed has created as they try to prevent a recession before elections has now created a runaway move in the energy markets. So far each correction in oil has been slight, in the range of $11 to $7. Make no mistake when this parabolic move collapses it's going to be spectacular.
That being said no one in their right mind should be shorting this thing yet. A good rule of thumb is to be on the look out for a correction that exceeds the previous corrections by 20% before trying to call the top. That would work out to be roughly $13.50. Once oil corrects by at least that amount then we might be looking at the end of this move. Until that happens your odds of trying to pick the top of this move are not good.
I've also included the charts of gold and silver. The Fed has flooded the world with so much liquidity that for the first time in this bull market a D wave decline was unable to push gold or silver back to the 200 DMA.
A month ago I was under the impression that the dollar was ready for the next counter trend rally in the ongoing bear market. It's definitely time. It's been over two years since the peak of the last rally. In that time the Fed has cost us 23% off the value of the dollar peak to trough.
Unfortunately the dollar is starting to look like it's ready to roll over again. It seems the Fed is still hard at work devaluing our currency. The actions of this Fed are really starting to worry me. They apparently have no concern for inflation.
Obviously all that matters is to rescue the financial system no matter what the cost to the rest of us. If the dollar breaks to new lows I hate to think what commodity prices are going to do, especially oil and gasoline.
I've mentioned in the past that I think the fun part of the Fed's monetary inflation is now over. The US is entering the time when the Fed's loose monetary policies are going to start causing pain. Probably a lot of pain.
We've hit the point in the road where the fundamentals are going to take over and move markets where they must go.
Over the last two months we've been privileged to be schooled by countless anonymous posters who are sure that gold and commodities in general are going to collapse. They've repeatedly pointed to the bear market of the 80's and 90's as proof that this is so. Most think commodities are in a bubble. I guess after watching the last three bubbles the Fed has created it's understandable. However just because prices are rising doesn't imply a bubble. For a bubble to form you must have oversupply.
I've occasionally tried to explain that markets work in cycles and that commodities, because of supply and demand fundamentals, are no longer in a long term bear market with as you might guess little success.
Now I think there's a very good chance that Gold's A wave has started. Look at the chart and you will get a picture of the last complete cycle in gold. A waves rarely take gold to new highs. So I expect gold to test the lows again later in the summer. That will be the next great buying opportunity in the PM.
A waves can be explosive but investors probably shouldn't get married to the idea that gold is going straight to $1500.
As I write this gold is up another $14 and oil is up $3. Many technicians will of course tell us the fundamentals don't matter. Personally I pay attention to both the fundamentals and the charts. In the short term fundamentals aren't going to influence day to day movements. The fundamentals however over the longer term are going to move the market in the direction it has to go. Case in point the commodity bull market since 2001. Fundamentals are more like a rising tide. You can swim against it for a while but you can't prevent it from coming in.
My theory is that this rally is nothing more than a blizzard of paper being created by the Fed to keep the markets levitated until the elections, which seems to be working BTW.
Unfortunately this is also preventing over stretched commodity markets from correcting.
I'm watching the dollar closely now. We are in the window of time when we could and probably should see the second counter trend rally in the dollar bear market. However if the Fed is creating too much liquidity for this to happen then the risk of the dollar rally failing is high. The fundamentals will eventually take the market were it has to go regardless of what the charts say.
Fundamentally, if there are just too many dollars floating around then the rally is doomed to failure. If this does unfold I hate to think where commodity prices are going.
Expect to see more media hype about evil oil companies and hedge fund speculation. I also expect to see margin requirements increased in the futures markets and perhaps we will see another round of index reweightings similar to the Goldman gasoline reweighting in 06.
I expect the powers that be will try any and everything to abort the stagflation outcome of the 70's from repeating. Heck they already measure inflation by removing everything that's inflating. It's a good start unfortunately it doesn't jive with reality.
Following down the same monetary inflation path as the 70's is going to ultimately lead to the same outcome as before no matter what new tricks and gimmicks the Fed tries.
Seems like the current thought amongst most investors is that a recession will put an end to the commodity bull market. Seems reasonable doesn't it? If the economy slows or shrinks commodity demand will contract. Falling demand equals lower prices right?
Now let's look a little deeper into that theory shall we.
First off let me clear up one critical point. Commodities have been in a secular bull market for the last 7 years for one reason and one reason only. Supply and demand imbalance. This goes back to our original question of will a recession cure the commodity price explosion.
Let me point out another important fact. Recessions don't last forever.
Now let's examine what is going to happen if the recession worsens and commodity prices fall.
If prices are falling rapidly does anyone seriously think oil companies, copper miners, gold and silver miners, farmers, etc. etc. are going to continue to rapidly expand production or exploration?
I can guarantee you they won't. They all remember the bear market years from 80-2000. Heck anons come on this blog daily to remind us of those times. No what's going to happen is commodity companies are going to start tightening their belts again and put expansion projects on hold waiting to see what unfolds.
The end result is as the economy comes out of recession and commodity demand surges again new supply will not be coming online. As a matter of fact new supply would now have been delayed even further down the line.
Now do you see why commodity bull markets last so long. Rising commodity prices tend to slow or stagnate economies. When this happens it just serves to slow the production of desperately needed new supply.
A serious recession will only guarantee much higher commodity prices in the future.
I've been calling attention to this to subscribers for a while now. The COT report for the crude oil market has been getting more and more bullish since the beginning of Mar. Notice the net short position has gone from -102835 to -24109 during this time. That's bullish enough by itself but this has happened while oil has rallied almost $22.00 or over 20% if you prefer. Seems like the commercial traders knew something was up with oil. That's pretty unusual for the commercials to buy into strength. The last time it happened was in the gold market in early 06. For the time being I think the energy markets are the lowest risk commodity investment. At least until we see the smart money starting to sell heavily.
I've pointed out in the past that the strong partner during the precious metals bull has been Platinum. A few weeks ago I noted that I was worried about the "crawling" action as Platinum hugged the 50 DMA. This often results in a break down. Well Platinum did break down. Except instead of following thru and correcting hard it's recovered and is again back above the 50 DMA and back to making higher highs.
Silver has now closed above the $17 resistance level. Silver is also not acting like it has in the past during D wave corrections. Silver should be in a waterfall decline by now. It's not happening.
When the Fed didn't reassure the market they were done cutting rates at the last meeting I think it didn't take commodities in general and oil and PM in particular, long to figure out the Fed isn't going to be withdrawing liquidity anytime soon. As a matter of fact it took two days before the commodity markets caught on.
When everyone can see something I tend to become skeptical that it will happen. Remember the market likes to take away the most money from the maximum amount of people. Everyone and their cousins can see that head and shoulders pattern in gold. I've got to wonder if the bull is using another trick to keep the fewest investors on board.
While everyone can see the H&S pattern no one is commenting on the successful test of the T1 move. No one is noticing that gold stopped dead in it's tracks at the old high of $850. The Hulbertgoldtimers sentiment index is gloomy at -10.7%. That means the average goldtimer is short the gold market by 10.7%. This reading is in the lowest decile over the last 20 years. Historically readings this low have led to one month returns of over 14% on average.
Notice that silver has also tested the T1 consolidation zone.
I think there's a good chance gold has now started the A wave rally. This rally rarely takes gold to new highs but it would be a confirmation that the D wave decline is over. Once the B wave decline is over and it should hold above the $850 low the next C wave will begin. Since gold is now in the second phase of the bull market these rallies are normally very powerful.
I'm adding some physical silver now and I will add the rest once the B wave decline is over.
If I'm wrong I don't worry because as Old Turkey says "After all it is a bull market". Bull markets eventually correct any timing mistakes and hey I'm getting silver $4 cheaper than 2 months ago. In my book that's a bargain.
I'm sure most people know the five stages of grieving. Denial, Anger, Bargaining, Depression and Acceptance.
Let's apply this to a bear market shall we.
Remember late 06 and early 07? Remember the repeated calls of a bottom in the housing market? DENIAL
Now let's fast forward to summer and fall of 07. The market makes it's initial decline as the bear market gets underway. At this point no one could deny that housing had been in a bubble and that bubble had burst. Now the world started looking for a scapegoat to focus it's wrath on. Predatory lending seemed to be the convenient target. It was the mortgage lenders fault. Definitely not the fault of all these people buying multiple homes and lying about their incomes. Definitely not the fault of home owners extracting equity out of those homes to buy cars, big screen TV's and go on vacations. ANGER
Now the government has jumped into the fray with plans to fix these problems. First off lets just let the Fed monetize bad debt. Maybe banks will forgive part of the loans. Or the government will give the states money to prop up prices so people that made bad decisions won't have to pay for their mistake. Hell they bailed out Bear Stearns. BARGAINING
There are two stages still missing. We need to move on to depression. At some point the world will realize that these problems can't be quickly fixed. It's going to eventually dawn on investors that in the end these people are going to have to face up to the fact that this bear market is going to play out till the end no matter what the government does. People are going to have to suffer the consequences of their actions. DEPRESSION
Finally the market will realize that there's no way around this and it will accept the fact that the cleansing process is necessary and once it's over the world can start fresh again. ACCEPTANCE
Then and only then will the secular bear market be over. We are just now transitioning from anger into bargaining. Despite the 3 month rally the housing collapse and credit bubble deflation is no where near done yet.
I repeatedly see comments that the market is irrational, that there's no fundamental reason for it to be this high, etc. etc.
Let me say this again. The market responds to liquidity and emotion. That's it! Quit worrying about whether the fundamentals support where the market is at.
That being said the fundamentals most definitely do matter. As some one once said in the short run the stock market is a voting machine but in the long run it's a weighing machine.
The next basic truth is that you can't get something for nothing. If that were possible we would never have bear markets because the Fed could just forever print away any declines.
I got news for you every nation and empire the world has ever seen tries to go down this path. The Fed is most definitely firmly on this path. I also have news for you it has never once worked. Nada! It won't work this time either. Inflating the money supply always leads to inflation, especially if you happen to be in a commodity bull cycle. Guess what? We are in a commodity bull cycle.
Now the Fed can throws billions or even trillions of dollars at the market and levitate it but sooner or later that liquidity always leaks into the commodity markets. When it leaks into energy you end up with $122 oil. Oil is the life blood of any economy. If the price of that lifeblood starts to spike it puts a crimp in economic expansion. There's just no way around it. If the Fed continues down this path they will avoid a deflationary depression like we saw in the 30's however they may very well put us in a hyper inflationary depression like Wiemar Germany.
I've pointed this out before but here goes again. Notice that the S&P is up 145 points from the bottom. That's 11%. That's not bad right? However in that same time oil is up 44%. Everything food, gas, copper, steel, etc. etc. is rising much faster than the stock market. Folks it's hard to see but the Fed is stealing your purchasing power right in front of your eyes and the sad thing is we're happy about it because the stock market is going up.
If this keeps up the market is going to rally us right into the poor house.
Oil has now completed the test of the consolidation zone of a T1 move. I've been noting in the weekend updates for several weeks that the commercials have been reducing shorts into strength in the oil contracts. This is usually a very bullish sign if the big money has to cover into a rising market. It's sort of like throwing gasoline on the fire. That last time we saw something like this happen was in the gold market in late 05 and early 06.
Energy inflation is the fly in the ointment of the Fed's reflation attempt. As long as liquidity keeps leaking into the energy markets it's going to be tough for the markets to rally to new highs. On top of that it's just plain bad for the economy. If the rising price of energy continues to weigh on the economy eventually the stock market is going to have to price in the worsening economic conditions no matter how much liquidity the Fed continues to throw at it.
The S&P recovered the 1400 level last week and that's a plus. Now however the real battle begins. 1425 is a major line of resistance as you can see. It acted as support from Aug. till Jan. Once the bulls finally gave up it has acted as resistance. This is going to be the least risky area for the bears to defend as stops are very close. Vice versa this is going to be the toughest area for the bulls to break through as risk is much greater. I suspect part of the reason volume has been so light is many institutions are not willing to get aggressively long into this line of resistance. This would explain the lack of buying pressure on the Lowry's studies.
I'm going to be watching the TOMO, TIO and TAF auctions in the coming weeks. Since Oct. the level of temporary loans has risen from 40 billion to almost 300 billion. The Fed is flooding money into the system. Will this be enough to push the market thru resistance? I don't know. It appears that they are willing to print how ever much money it takes though to accomplish the job. With oil bouncing off $110 support they still have an inflation problem though. So do they risk spiking oil even higher to inflate the market? Long term tenet #1 says that yes they will.
The longer I do this the more apparent it becomes to me that patience is one of the keys to success in the field of investing. Warren Buffett likens it to a batter standing at the plate waiting for that perfect pitch. The thing is he can take as many strikes as he wants. There are no strike outs in investing just because you aren't ready to swing.
The patience to wait for that perfect pitch is often the difference between getting stopped out or taking a severe drawdown and hitting a home run. The patience to hold on to your position once you have it is usually the difference between getting thrown out at second base and winning the seris. All great investors that I know of exhibt this trait in spades.
It's tough for precious metals investors to sit on their hands and wait for that sweet pitch right down the middle of the plate. After what the metals have just done it's hard to sit still and wait for the correction to finish. The fear of missing another big move can conjure up all kinds of bottoming scenarios. Luckily for us we have a pretty darn good indicator to tell us when to reenter in the COT reports. What better time to start buying than when the big money is also buying.
So for now I know it's tough but the best course of action is to sit still or look some place else where the pitcher is throwing that slow ball over the plate. Right now in the gold sector we're trying to face down Nolan Ryan.
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T1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected. T2. Reversal or resistance to a move is likely to be encountered: - 0n reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range - On approaching highs or lows T3. Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently. T4. Watch for "crawling along" or repeated bumping of minor or major trend lines and prepare to see such trend lines broken. T5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places. T6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations although triangles are usually broken on the flat side. T7. Watch for volume climax, especially after a long move. T8. Don't count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps and exhaustion gaps. T9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.
General Trading rules
G1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move. G2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases. G3. Limit losses and ride profits, irrespective of all other rules. G4. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing. G5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal. G6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation the the chart formation. G7. In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons - a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100% G8. In taking a position, price orders are allowable. In closing a position, use market orders." G9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules. G10. Moves in which rails lead or participate strongly are usually more worth following than moves in which rails lag. G11. A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.
Investing in the financial markets can involve considerable risk. Past performance is not necessarily an indication of future performance. The information included in The Smart Money Tracker and The SMT subscribers daily updates is prepared for educational purposes and is not a solicitation, or an offer to buy or sell any security or use any particular system. Information is based on historical research using data believed to be reliable, but there is no guarantee as to its accuracy. G.D.S L.L.C., nor Gary Savage, do not represent themselves as acting in the position of an investment adviser or investment manager for funds that are not under their direct control and fiduciary responsibility. GDS L.L.C., Gary Savage, will not provide you with personally tailored advice concerning the nature, potential, value or suitability of any particular security, portfolio or securities, transaction, investment strategy or other matter. From time to time, GDS L.L.C., Gary Savage, may hold positions in securities mentioned, but are under no obligation to hold such positions.