Commodities: Silver's Next Move

Over the last several days, the blog ran a sentiment poll, asking you guys where you thought Silver would trade by years end. Looking at the response, we had almost 80 votes which is not a bad for such a short term notice. A slight majority of traders and investors (57%) who read this blog, are bearish and think Silver will decline below $26 over the coming trading sessions; while a slight minority of 43% think Silver will rise above $36.

The poll was conducted while the price of Silver was relatively quite to its recent history, therefore the survey is quite fair. We started the poll last week on Wednesday, as Silver traded around $31.80. Today, one week later, it still trades at $31.80 in a small pennant as it tries to make the next decision (chart below).

Furthermore, it is worth saying that despite two major crashes of around 35% and a large amount of negativity towards the world economy and commodities, Silver is still up for the year at a net gain of 2.8%. On top of that, Silver is still up 12.7% over the last 52 weeks. Both of those figures are quite remarkable if you look at the recently volatility and downside movements. Keeping that mind, it is also worth saying that Silver is currently down about 37% from its recent peak in late April / early May of this year.

An interesting thing about Silver price right now is its mimicking Euro's movement almost identically. Consider that since middle February 2011, both Silver and Euro moved into the early May peak, followed by a strong sell off. They both experienced a July rally, followed by a panic sell off in September. From the early October bottoms, both of them rallied into late October only to fall back and re-test those lows in late November again. Correlation coefficient between these two assets is as high as 85% positive in the last 20 trading days and as high as 80% positive in the last 260 trading days (one year). That means Silver is moving opposite to the US Dollar, which is currently gaining traction due to the on going Eurozone Crisis problems and the constant need of EU banks to fund themselves in Dollars.

Silver's sentiment is extremely negative when we look at variety of published survey's. As a matter of fact, the negative sentiment readings have remained at current levels of a large amount of time. Positioning in the Futures COT market is also extremely bearish, which is associated with previous bottoms. Precious Metal inflows have slowed in recent weeks, but we do not yet see any major outflows - like we did during September of this year. All in all, there are plenty of signs that sentiment is very negative, so the current Poll results on the blog do not surprise me. We are either approaching a bottom in the coming sell off or we could be looking at one already right here.

On the closing price basis, the Lehman Brothers panic sent Silver down over 57% in 170 trading days. That was quite a bear market compared to other major corrections which occurred in 2004 and 2006. While the price fall was quite harsh in 04 and 06 (30% plus drop), the time it took to bottom out was only a month or so. Currently, this is the second worst oversold reading Silver has registered since it began its secular bull market rise in 2001. And when I say that, I mean a very oversold condition both in time and price. When we overlap the two analogues, they seem to be following each other quite well. Silver counties to sit above $30 support and has not moved up or down too much recently. The question now is, have we already bottomed or will the price follow the 2008 analogue into one last sell off crash?

I think the answer is connected to the US Dollar's next major movement. If the greenback continues to go higher through its resistance (chart above), due to on going Eurozone Debt Crisis problems and lack of Dollar funding, as showed by previous Credit posts on the blog, that will obviously push the Euro lower with the chance of Silver following down the same trajectory too. When it comes to Precious Metals and many other commodities, all eyes should be on the Euro Dollar exchange rate. The line in the sand is about 80 on the USD Index and about $1.31 on the EUR/USD exchange rate. Breach of these important levels could decide the faith of Silver's next movement.

Quote Of The Day

"We can't solve problems by using the same kind of thinking we used when we created them." ~ Albert Einstein

Credit: Italy, Spain & Belgium Heat Up

Taking a step away from the noise of daily news that the media throws towards us in regards to the Eurozone crisis, I thought I would look at the European bond market closely in this credit post. First of all, it should be quite clear to everyone that the markets important line in the sand for a governments which are experiencing debt problems seems to be around 7%. The chart above shows that when Greece, Ireland and Portugal crossed above that threshold, it was literally a point of no return.

All of them were bailed out, so in other words - all of them were put on life support as they could not rise money in sustainable fashion anymore. The chart also shows that Italy is now at the exact same place where the other PIGS were only months prior. This is a worrying development, because Italy has more debt than all the other PIGS put together. Furthermore, adding to the heat, it also seems that Spain and Belgium do not want to be left out from the spot light, so they are literally racing up the yield level, just to catch up to Italy and also make front page news of various media outlets.

Let us zoom in on Italy for a second. The yield curve is showing troubling aspects of inverted returns, similar to 2008. That means the shorter term maturities are now yielding more than the longer term maturities. This usually happens during a crisis or during a recession, or in this case both. On a side note, the yields from the 2 Yr all the way to 10 Yr bonds are all much higher than they were during the 2008 crisis. This shows a several of a long term falling interest rate trend that started back in the early 1980s. My question is who will save Italy, and even if it was to be bailed out by some miracle - i.e. EFSF, how will the fund manage to save Spain and Belgium at the same time as well? Surely, a "trilli" is not enough!

While the Spanish yield curve is not inverted just yet, it is moving very close towards that outcome. Just like with Italy, Spanish yields from the 2 Yr all the way to 10 Yr bonds are all much higher than they were during the 2008 crisis. On top of that, the Spanish 10 Yr Yield is also approaching the "line in the sand", which is around that all important 7% yield. Honestly, we are only about 30 basis points away from it and just as it was with the other PIGS, we know how quickly yields could spike and problems could escalate. Sometimes, it just takes a matter of days before it all turns from bad to worse.

Finally, Belgic bond yields have now all moved above their 2008 highs as well and the curve itself is slowly moving towards an inverted outcome too. Not the greatest of timing for the European politicians. It seems they have to turn out three fires at once now, instead of just one at the time. Mind you, Belgic 10 Yr Yield is still a decent way from the 7% yield that Italy and Spain seem to be flirting with, but nonetheless it is moving in a that direction - and for the time being moving there in a fast manner.

Summary

European bureaucrats are working on the plans and details of the leveraged EFSF bail out fund, which would have the fire power of about a trillion euros, give or take some change. However, the problem seems to be bigger, or at least the bond and credit markets are telling us that it is. Mr Market is not reacting positively to the progress of the bureaucrats at all... but they aren't listen.

Credit markets are still deteriorating and letting the Europeans know that, once again, they are a whole step or two behind the curve, but these boys and girls never seem to learn or maybe they just refuse to listen. It seems that Mr Market is asking for a much bigger bazooka than EU or Germany is willing to do, so the solution to the problem could need several trillions of euros. With Europeans not having that much capital, could the answer to the question be ECB printing press? With Germans constantly refusing, what else could the "silk pyjama wearing bureaucrats" do? (thanks to Hugh Hendry for the quote)

Equities: IMF Bailing Out Italy?

Rumours are out that Italy is about a receive a 600 billion euro bail out from the IMF. The risk markets all gapped up, from Copper to Euro and from S&P 500 to Aussie Dollar and Crude Oil. I'm not buying the news. I do not think IMF has that much money. Last I heard they had about 300 billion Dollars at their disposal. It seems the politicians are panicking now...

Yes, the markets are extremely oversold and yes, you shouldn't engage into any shorting activity right now because risk to reward is very skewed unless we have a full blown crash. But at the same time a decently large gap up in Asian mornings usually spells trouble as the market pulls back majority of the time, so don't rush into anything just yet.

On top of that, a massive 2% gap up on Monday morning during extremely oversold markets in the middle of a European crisis is a perfect recipe for the bulls to get taken to the cleaners. This reminds me of of April 2010, when Greece was bailed out for the first ever time and the Euro gapped up. Few weeks later we had the final climax crash and eventually a real proper bottom.

This is a sling shot rally from oversold conditions based on hope and the gap is massive. If, and I say if because I do not know what will happen, but if the IMF doesn't come through with the deal and Italy's bonds spike above 7.3%, the sling shot could revert back towards the other side with twice as much force. Be careful here!

Weekly Recap: November 2011, Week IV

Blog Summary

• Monday - Commodities: Long Term Picture
• Tuesday - Bonds: Treasuries Sentiment Extremely Bullish
• Wednesday - Poll: Up Or Down For Silver?
• Friday - Economy: Chinese Monetary Easing Has Started

One of the most important topics on the blog this week was the extremely bullish sentiment governments bonds are portraying. Yes, Europe is coming undone and yes, investors are fearful, but you have to remember not to follow the herd. Maybe bonds have a little bit more upside or maybe they even have a lot more upside. Bubbles are irrational that is for sure, but nonetheless the higher Treasury prices go and the more extreme the sentiment becomes, the harder and faster the reversal will be. When money starts leaving the bond market, commodities and stocks should do well again.

Market Summary

Price movements this week were quite negative once more. Surprisingly, US small caps got hurt the most, by losing over 7% this week. This sector usually under-performs when the domestic economy is slowing down, because majority of the business activity in the US is done by small and medium sized business. Moving on, we can see that the Soybean complex got hurt very badly this week, but in general it was a very bad week for major risk assets like equities, currencies and industrial commodities. On the other hand, Natural Gas and Cocoa experienced oversold bounces this week, while the US Dollar had another great week, gaining 2.0%. The Yen and Franc held their own.

Talk Of The Week

There is a lot going on, so everything and anything can be the talk of the week really. Italian yields are back above 7%, Italy and Spain now have inverted yield curves as their economies are most likely in a recession, Agriculture had an awful week to extremely oversold levels and the Japanese equities are making new lows.

However, one thing really stood out for me, and as we can see from the chart above, that was S&P 500 experiencing the worst Thanksgiving week since 1932 to clock up its 7 consecutive down day. This is now on par with the August crash of this year and the inability for the market to bounce is a worrying sign for the bulls. Nevertheless, one should consider a contrarian bullish position here - at least for a short term trading bounce, because we are approaching oversold levels on many technical, breadth and sentiment indicators. The up-and-coming week should be very interesting indeed...

I hope everyone enjoys the rest of their weekend!

Economy: Chinese Monetary Easing Has Started

China is now starting to initiate the loosening of monetary policy as the economy is showing signs of growth slowing down. Consider the recent PMI readings, which have now dipped below 50 for the first time properly - not a small fake-out we saw a quarter or so earlier. The authorities now see a potential recession as the main threat with exports slowing considerably, instead of inflation fighting which was a front seat in the central banks policy for months. Consider the following from the recent Barclays Capital GEMs Research Newsletter:

• The PBoC’s latest policy report confirmed that policy easing has started, although it may take months before the central bank adopts an overall loosening bias. This shift will probably take place in Q1 12, in our view.

• The timing of the policy change depends on two factors: the future trajectory of the economy and policymakers’ ability to resist political pressure.

• The central bank now aims to achieve stable growth in the money supply, bank credit and total social financing. The recent uptick in bank credit, however, was a response to shrinking off-balance-sheet activities.

• We expect the authorities to focus on controlling systemic risks, especially those related to small enterprises, private lending, shadow banking and local government finance.

• With the increasing importance of cross-border capital flows and off-balance sheet transactions, adjustments of certain policy instruments can be viewed as having been made to stabilise liquidity conditions, not necessarily to affect pace of economic growth.

• Market interest rates could decline, although policy rates are likely to be on hold for now. Currency appreciation may also slow in the coming months as both capital inflows and exports slow.

• There is a risk of a premature and aggressive shift in monetary policy, which would be positive for asset prices in the near term, but negative for growth sustainability in the long run.

I would like to comment on the above points publish by Barclays Research Team. There seem to be a reoccurring pattern of thinking, especially when I watch CNBC Asia or Bloomberg Asia during morning breakfast, where market pundits believe that Asia has a very strong buffer in the monetary policy department. In other words, these guys believe that since China and the surrounding Asian economies pushed interest rates higher during 2009 and 2010, now they have the ability to cut interest rates and therefore stimulate their economies. This even applies to Australia, where our Treasurer Wayne Swan keeps saying the same thing on TV all the time. Therefore, this thought process leads the bulls to conclude that falling interest rates will make risk assets rally sharply.

Honestly, I am not so sure about that. While this type of wonderfully bullish thought process sounds good theory, it might not be as rosy in real life. First of all, cutting interest rates will put pressure on currencies like the Australian Dollar, Korean Won, Brazilian Real and Mexican Peso - and these currencies have strong correlations with risk assets like equities. Second of all, when I see the PBoC turning away from inflation fighting, towards easing - that to me signals that there must be a very important reason for this change. Why? Well it is not as inflation is really falling. Smart people state everyday that inflation is running between 10 to 15 percent annually. It is not as if China "accomplished" its inflation fight.

So in other words, the reason of a policy shift is an urgency to protect the economy that is really slowing down substantially. Super bears have been waiting for a signal to when the Chinese economy and its property bubble might hit the edge of the cliff, so a recent move by the central bank towards easing, has now maybe given that signal. Therefore, further easing by China and Asia in general, could be a strong reason for investors to believe that "shit is really hitting the fan" and press a sell button. On a final note, consider the interesting video below by Mr Chanos on Bloomberg (nothing new):

Poll: Up Or Down For Silver?

Silver has been one of the most hit assets in the current bear market which started earlier in the year. Currently, Silver is down about 35% from the top, but at one point is was down as much as 48% after peaking at almost $50.

As recently as a month ago, the famous technical signal known as a "dead cross" occurred, where the 50 day moving average crossed below the 200 day moving average. This type of signal is used by some traders and investors as a negative sign of further price falls. The recent high was just shy of $36, while the recent low was at $26. We are now sitting at $31.50, which is just about smack in the middle. So tell us what you think of Silver by voting in the new Survey Poll and by leaving a comment.

[Update on the poll results]

Bonds: Treasuries Sentiment Extremely Bullish

Don't Chase Best Performers

Treasury Bonds have experienced the strongest rally since 2008 Global Financial Crisis. It has been quite an impressive rally, which was already covered in last weeks Grid update (Article: The Grid: October Recovery). As we can see in the chart above, out of all the bond lasses, Treasuries have returned over 23% year to date. As a matter of fact, we can only really compare this type of panic bond buying to 2008.

Don't Chase Overbought Prices

The smartest thing any investor should do is follow the price of an asset. Common sense right? Well it seems common sense is not so common in the markets. You should never buy an asset when its too far away from its long term trend line, also known as the 200 day moving average. That just spells trouble as you chase bulls into a trap that eventually loses you money every time. The chart above shows us that when 30 Yr Long Bond prices get too far ahead of themselves, they tend to top and correct in a very abrupt and violent manner. Currently, Treasuries are at the second most overbought readings in at least two decades. In my opinion, this sets them up for a perfect short.

Don't Follow Dumb Money

Recent Merrill Lynch Fund Managers Survey from November 2011 showed hedge fund managers hold a relative high exposure to Bonds when compared to their decade mean. Consider that in February 2011 almost no one wanted to touch Treasury Bonds, while today the picture is completely different. I have to admit, hedge fund managers are not completely overweight this asset class like in late 2008, but nevertheless they are completely out of equities and commodities, and overexposed to cash and bonds.

The chart above is thanks to SentimenTrader website. The bond indicator above is a total sum of many sentiment tools from survey opinions, to speculators positioning, options positioning and money fund flows. It is quite obvious what the chart is saying - people are scared, expecting deflation and expecting a total economic collapse similar to that of 2008. I am not sure if things in Europe will get worse from here, where a certain country goes bust in coming weeks or months, however data is what I trust more than opinions and historically the data above tells us to stay away from Treasuries at present.

Don't Follow Economists

Consider the chart below - what we have is a ratio of price between S&P 500 and the Long Bond futures with a 200 day moving average, also known as a Stock Bond Total Return Ratio. At the same time I have overlapped the Citigroup Economic Surprise Index at the bottom of the chart with a neutral line. Rising price signals stocks are outperforming bonds and visa versa for the following price. Citigroup ESI above 0 signals that economy is beating economists expectations and visa versa.

What is interesting to note is how the economy has being doing better than economists expected it to. In other words, expectations of a recession became a consensus in recent months, but Developed World economy itself has not been that bad. So while the Citigroup ESI has now popped above the 0 line, the outperformance of bonds over stocks should already be in the process of ending. A smart fund manager should be buying risk on assets like equities and getting out of risk off assets like bonds. It sounds simple in theory, but hard to do while news constantly covers stories of pessimism.

Protect Yourself From Money Printing

People say they are waiting for Bernanke to announce QE3 before they buy something. That is fair enough, but I am pretty sure QE3 in stealth mode has already started anyway. Bernanke is king at lying to us all and he has proved it again. Every time a crisis occurs in our current economic system, authorities and central bankers have no proper solution but rather just flood the system with liquidity expanding money supply. What is interest to note is that over the last two decades, every time money supply and in particular M2 skyrocketed, Treasury Bond yields bottomed and started to rise. In other words, Treasury Bond prices topped and sold off. Currently, Bernanke is in there doing his magic again and I presume Treasury yields are about to reverse shortly...

Deflation Is Consensus

What is the main reasoning behind bond bulls purchases? They claim that the global economy is constantly suffering from deflation. Well, according to the Merrill Lynch Fund Managers Survey, for the second time since 2008, deflation seems to be the consensus outlook. What is interesting to note is that during both of those times, in late 2008 and middle 2010, as prevailing consensus frightened itself into a deflationary talk, Treasury Bonds sold off in a very very violent manner. I assume this time will not be different either.

Asset Allocations

The chart below is an asset class allocation statistics from the recent Merrill Lynch Fund Managers Survey. It shows the exposure managers have in their portfolios towards Cash, Equities, Bonds and Commodities on relative basis. The percentage readings are not as important as are the deviations from the decade's average.

So, imagine you were a fund managers and the Treasury Bonds rallied over 25% this year. What would you do when you see your industry peers - other fund managers - are holding high exposure of both Cash and Bond compared to its decade average? At the same time you also notice these same money managers, are currently underexposed to both stocks and commodities.

Summary

I'm not sure what you would do, but buying Treasury Bonds would be the last thing on my mind. Holding cash is where I am overweight right now, however in Australia we earn 6% interest on our high cash hoard. So therefore, personally, our fund is getting ready to allocate funds to commodities, which we believe are extremely oversold in recent weeks - especially Agriculture. At the same time, unlike Treasury Bonds, sentiment is very pessimistic. So therefore in summary, I'll keep it simple: short Treasuries, buy Commodities!

Commodities: Long Term Picture

Commodities are my favourite asset class in the current environment. If you have read this blog before, it is quite possible you already know that. I constantly find it hard to explain to people that it is very smart to own commodities, but they argue against it. I also do not understand why many people hate this asset class, so I thought I would answer some common myths about the current commodity secular bull market... let us start!

1. Why invest in commodities when they follow stocks?

During bad economic conditions, like we are experiencing in current times, clueless investors will tell you that high commodity prices are not sustainable and that you would be crazy to consider investing into commodities as they fall with stocks. On top of that, media will try and brainwash you with the risk on / risk off correlation talk, so majority of retail investors will think that as soon as the economy slows and stocks start falling, commodities will crash too. But that is far from truth. Commodities have been great performers during current turmoil and that has always been the case throughout history.

The chart above shows that commodities do amazingly well during the periods where secular bear markets create sideways trading ranges in the stock market. So in other words, commodities do amazingly well during the periods of awful economic growth, during either high inflation or deflation, during debt problems and during periods when governments and banks fall apart. Commodities do well during constant recessionary periods like the economy experienced in 1900s/10s, 1930s/40s, 1960s/70s and 2000s/10s. Whenever global economies where in terrible shape - commodities did great - not the other way around.

Sure, commodities experience cyclical bear markets and corrections during their secular rises. For example Crude Oil has fallen by more than 50% over three times in a recent decade. However Brent Crude is still up 11 times in a 11 years. Silver has crashed many many times by over 25 to 30% and during 2008 it crash by almost 70%, and it is still up over 8 times since a decade ago. That is how markets work and that is why you should buy low like a contrarian.

2. "They say" the commodity bubble is about to pop?

What bubble? So many people have no idea what they are on about and even less ability to detect a bubble. "They" call everything a bubble - every week new asset class is in a bubble according to CNBC or some random deflation blog. So what is actually a real bubble? A real bubble or a speculative mania is something everyone talks about regularly, but not only that. Bubble is something that everyone talks about and owns (buys and sells), but not only that. Bubble is something that everyone talks about, owns and is making money on constantly because prices only go up. If you really want to understand what a real bubble or speculative mania feels like, instead of just stupidly throwing that word around everyday, you should watch a four part episode by PBS from 1997 on the Nasdaq Bubble (Article: The Greatest Bull Market Bubble Of All Time). I highly recommend it!

Look at the chart above, showing the asset portfolio of an average millionaire around the globe. How many of them do you think own Gold, Rice, Crude Oil, Sugar or a Commodity index fund? How many people do you know who own Soybeans right now? Do you know any farmers who have been making a killing on the farm season after season after season? No... agriculture has been an awful sector of business for 30 years.

Today, farms are deserted places. UK farmers have the highest suicide rates in the world. Many hundreds of thousands of Indian farmers kill themselves everyday as they go bust. In Japan, farmers are over 68 years old as young people have all moved to the city and refuse to work on farms. In other Western countries many young people attend university getting business and law degrees. How many young people do you know who have studied Agriculture? When I finished high school in 2001, every one of my friends went to study IT. Today we have nothing like that in the commodities boom. How can that be a bubble?

How many pension funds do you know who own Gold? And what is their weighting towards it... 1% of the overall portfolio? Probably even 0.5%. I bet majority of the people reading this do not actually own any Gold or Silver, let alone other commodities. How many friends of yours are talking about Rice or Coffee, let alone making money in it? Don't believe me, get of your computer and go attend some investment forums. Ask some people what they own or have recently invested in. Less than 10% of people on average own commodities and they aren't really making a ton of money on it year after year, like during the Nasdaq bubble.

During the period between 1996 and 1999, so many people where making money on Tech stocks they never even knew anything about. The whole world was gambling in Tech stocks, buying and selling everyday and making a ton of money. The whole world lost the plot. Silicon Valley programers became millionaires overnight... for doing nothing. Lets compare Gold and Nasdaq in the chart above. How is Gold anywhere close to the Tech bubble? Calling Gold a bubble or a mania is actually a total non sense!

3. What will end the current commodity boom?

Well obviously it will be the final bubble stage. That's right... commodities will one day soon enter a bubble, just like stocks did in late 90s. That might be in a few years from now or that might be in several years from now. I cannot tell you when it will happen, because I am not a prophet. When you see people gambling in Gold and Silver as it spikes to insane levels on daily basis, like Nasdaq did in late 1990s (go and watch that PBS video), you will know we are close to the end of the run.

Also look at the first chart. Going back about 300 years of history, the shortest secular bull market for commodities was 15 years, while the longest was 21 years. The average is about 17 years or so. If we assume that the commodity bull market started in 1999 or even 2000 - as seen in the chart above - than we can say the current secular trend has lasted about 11 to 12 years. That means commodities could rally for at least a few years more as a worst case scenario or a decade as the best case scenario.

However, I could also tell you what will end the boom or at least signal that the end is near - demand and supply. I commonly hear this... "my friend who follows markets said to me Oil is in a bubble because US and Europe are in big trouble. You should also short Oil like me because it will crash due to economic recession and deflation." No offence, but your friend is an idiot and so are you. Yes I agree that Oil collapses for awhile when we have economic pain, but Oil is up 11 times since 2000 and S&P 500 is up 0 times... so yes your friend is an idiot.

US, EU and UK have almost nothing to do with the Oil market as well as the overall commodity sector. It is the rest of the world, including the 3 billion people in Asia, that are in control of the rising demand and therefore the price of commodities. This is where the action is, this is where the growth is and this is what is setting the tone to the current secular bull market. There is a whole new world growing in the East, but the US and EU centric economists and investors fail to recognise this. They constantly point to the US consumer or the US Oil demand or the US GDP growth as a barometer of everything on our Earth. That is, once again, non sense. Asia is consuming the Soybeans, Crude Oil, Copper, Sugar, Cotton and Rice. Asia needs more Corn, more Natural Gas, more Uranium and their central banks need more Gold. Asia is starting to like chocolate so they want more Cocoa and they are starting to drink Coffee regularly like Westerns do.

Part II of the post will be covered later in the week, including the Supply side shortages that "no one" seems to see.

Weekly Recap: November 2011, Week III

Blog Summary

• Monday - The Grid: October Recovery
• Wednesday - Stocks: It's Decision Time!
• Thursday - Interview: Kyle Bass On BBC HardTalk
• Thursday - Stocks: It's Decision Time - Part II
• Saturday - Credit: Banks And Governments In Trouble

The main focus on the blog this week was technical triangle setup on the S&P 500. I hope some of you trade red it on the downside and collected some profits. It was quite easy to do so, and personally I shorted Silver mid week and covered Friday for a try nice and quick gain. Rest of the focus was turned to the credit markets yesterday, all of which paint a picture of serious troubles and turbulence balance the market has already experienced. However, do keep in mind that markets focus on the future - not the past or present. Therefore, as credit risk remain elevated and sentiment bearish, all we need to see is Europeans engage into money printing and the can will once again be kicked down the road!

Market Summary

Another week, another sell off. Precious metals and Agriculture were hit hard this week. Palladium, Cocoa, Silver, Oats, Cotton and Corn all got beaten down by 4% or more. Natural Gas was also a huge loser, falling over 7.3%. On the positive side we saw the "Safety Crowd" regulars like US Dollar and Treasuries hold their own, but the surprise gainer was Lumber.

Portfolio Update

Portfolio wise, I deserve to do some re-construction. So from now on, the blog will show only the main investments. Trades and quick executions will not be posted anymore. I do not have the time necessary to write that I shorted Silver on Tuesday and than once again write how I closed it out Friday and why. We also tightened our stop loss on Cotton and we are down on that investment a couple of percent at current. Japanese Yen on the other hand has been doing very well.

All in all, it has been quite obvious that our fund has mainly been sitting in cash for months now, but just like majority of other investors out there, we are very eager to get back into risk as soon as we "hear" the right things out of Europe. Our focus is mainly on commodities like Agriculture and Precious Metals. As soon as we open some major investments, they will be posted on the blog and tracked against major asset classes.

Talk Of The Week

Apart from the regular European Crisis chit chat, I have noticed Crude Oil has been receiving a large amount of attention as of late on CNBC and Bloomberg. Therefore, it should come as no surprise why I asked you readers on your opinion when it comes to the reason for Crude's rally. However, looking at the results majority of the readers said that they either didn't know or that it was just a technical rally from oversold conditions. Very interesting...

I hope everyone enjoys the rest of their weekend!

Quote Of The Day

"We are on the path to significant currency devaluation around the world that will likely result in significant inflation." ~ Kyle Bass

Credit: Banks And Governments In Trouble

The last time I did an update on the Credit Markets was way back in the middle of September, when majority of market pundits were extremely bearish, expecting S&P 500 to decline below a 1,000 or even back towards March 2009 lows (Articles: Credit: The Pressure Is Building & Credit: Greek Charts Of Warning). Since than the S&P 500 has recovered all the way back towards 1,290 and now trades around low 1,200s. While pessimism is still evident without a doubt, extreme negative views have diminished somewhat with majority of equity investors.

Market pundits continue to put forward strong evidence of US economic improvement, continual earnings beat rates and top margin improvements, however Credit Markets are having none of it. Plain and simple - Credit Markets are not really improving. Systemic default remains a very big risk and the contagion is spreading all across Europe now, not just throughout the infamous PIIGS.

It is difficult to be invested until some resolution occurs, because fundamentals of supply & demand or earnings are not very relevant right now. It seems majority of the money is on the sidelines waiting for a catalyst - either a default in EU or another ECB/Fed money printing program. They say a picture tells a 1,000 words, so lets get to some charts which show the elevated credit risks...

This chart above is a total disaster. Forget about the European peripherals like Greece and Portugal, we now have some big problems ahead of us. Bond investors have lost faith in some major EU countries, which include Italy and Spain. But the problem gets worse as the Core Europe is now also under attack. France and Austria has seen their funding costs skyrocket in recent weeks. This is very very dangerous stuff. On top of that even Finland and Netherlands have seen their interest rates jump to Euro-era highs. In other words, investors are now testing the whole Union as the contagion spreads from PIIGS to whole European Union.

As European Government bonds fall and interest rates rise, Credit Default Swaps are also in correlation by confirming trouble with moves to all time new highs. Spain, Italy, Belgium and France have all seen their CDS prices reach all time new highs time week. This could spell trouble ahead, unless it is backstopped.

Insurance costs on Europe corporates, including banks, also remains very elevated mimicking 2008 crisis. Credit Default Swaps on banks especially (not shown in the chart above) are all either making new highs or close to all time new highs. Banks have been and still are the main focus, as investors do not give this sector any trust whatsoever.

As already stated, investors do not trust banks and government, but the truth is that banks do not trust other banks either. As they say... wherever there is smoke, there is fire. The overnight lending rates, also known as 3 Month Libor Rates, between banks have risen without a pullback or a rest since July. Lending freeze between banks is slowly building.

The above lending freeze between banks is evident with this next chart. European banks are finding it very difficult to fund themselves in US Dollars. Since other banks are not helping, they are forced to bid up the US Dollar on the swap market. The 3 month EUR-USD swap reached almost -130 bps this week (chart only shows -125 as of earlier this week). These levels are the widest since post Lehman Brothers back in November and December 2008.

This type of credit freeze overrules fundamental outlook on earnings, commodity outlook of supply & demand and economic outlook which shows possible return to decent growth. Therefore, risk assets remain venerable until we see a catalyst or a solution to the problem, even if the can is once again kicked down the road. Rising credit spreads on corporate and junk bonds, thanks to Merrill Lynch data in the chart above, spell trouble for risk assets like S&P 500 and CRB Index, making investors pile into Treasury Bonds. If we see credit risks fall, the Treasury long trade will unwinding and cash from the sidelines will move into risk, but until than... cautious is advised.

If we overlap some of these credit readings with the S&P 500, we can see what I mean. Rising credit risk equals lower equity prices and falling credit risk equals higher equity prices. In other words, it is quite obvious that all markets are highly correlated due to fear of a sovereign default. That type of an event could than create a domino effect. Therefore, key is to keep your eye out on the credit markets, spreads and interest rates, because they seem to be "in charge" for now. A catalyst which makes Credit Markets calm down, will a signal to go back into the risk trade.

Chart Of The Day

Today's Chart Of The Day comes from The Wall Street Journal on 16th of November 2011, article titled "S&P 500 Forms Potentially Super-Bullish Triangle", two days before the S&P 500 triangle broke down. Once again, I will state that we should consider ourselves very lucky we have "experts" to help us make money (end of sarcasm).

Quote Of The Day

Today's Quote Of The Day comes from Bloomberg News on 17th of November 2011, article titled "U.S. Stocks Decline as Europe Concern Offsets Economic Reports", one day before the S&P 500 triangle broke down:

The S&P 500 has formed a “triangle” pattern, a sign to analysts who study charts that the rally is about to resume after the benchmark gauge for U.S. stocks rose as much as 20 percent last month. The index’s trading range has narrowed since October, as the index stalled after rising to its average level over the past 200 days. Based on the size of this triangle pattern, the index may climb as high as 1,430, said Craig W. Johnson, a technical market strategist with Piper Jaffray Cos.

“A triangle or a pennant formation forms during the middle part of a move, and typically these patterns resolve themselves in the direction of the preceding trend,” Johnson, based in Minneapolis, said in a telephone interview yesterday. “That would suggest that this is ‘the pause that refreshes’ before we get the next leg up.”

We should consider ourselves very lucky we have "experts" to help us make money... all we have to do is listen to their "tips" and than do the opposite!

Stocks: It's Decision Time - Part II

Just a quick follow up to the previous post from yesterday. Many markets now stand at watershed. It is time for market participants to decide what the main assets class will do over the coming short to medium term. US Dollar is in a rally mode as of late, slowly approaching resistance, while Treasury Bonds - just like equities - are stuck in a range. Reminder of 2008 is everywhere, so we will soon find out what awaits us...

Keep in mind that during a bear market, usually the price does not exceed the 200 day MA a.k.a 40 week MA. Majority of the time, as the index approaches the 200 MA, that level acts as a resistance.

Also keep in mind that during a bear market, usually the % of stocks above 200 day MA does not exceed 50%. As it approaches 50% threshold area, that level tends to act as a resistance. Continuation of a March 2009 cyclical bull or a start of May 2011 cyclical bear market? To answer that question, over the coming days I will be focusing on the Credit side of the market, which tends to lead equities.

As an aside note, I have failed to figure out what everyone is so bullish about. I mean, I constantly read opinions of other bloggers who claim that economy is improving (linking Citigroup ESI as their proof), that EU is closer to a solution or its own QE program, or that there is a success with soft landing in China (showing M2 growth and PMI data as their proof). Sure, I can go ahead and number any of positive (or for that matter negative) points, but the price of the market matters more than anything.

Consider that Investor Intelligence Survey showed bullish sentiment rose and bearish sentiment declined every single week in the last four weeks and yet the equity markets have failed to make new highs. The numbers in the chart above are the exact dates of when the sentiment readings came out. S&P 500 is lower today, than it was at point (1) and yet there are now 47.4% advisors who are in the bullish camp, as opposed to 40% four weeks ago. I particular blog I follow, which was super bearish during September, is now recommending no short exposure as the market has further upside.

On top of that, consider the chart above, which shows the 10 day average of Rydex bullish fund inflows. We have the strongest bullish inflows of funds since August 2009. Fund flows tend to be a contrarian indicator majority of the time, but it is important to understand what the trend is. Strong inflows are common in early parts of a new cyclical bull market that moves from extremely oversold conditions, like in middle of 2009. These early inflows are not a negative signal to the markets advance. However, strong inflows are not that good of a sign three years into the bull market cycle. It is hard to say if the signal in the chart above is truly a real sell signal. Nevertheless, even though Rydex is considered dumb money, not every buy or sell signal works, but do keep in mind that majority of the time it doesn't pay to follow the herd!

So the question is... what is everyone so bullish about? It is not as if their portfolio is increasing in value with the price breaking out. The truth of the matter is, S&P 500's euphoric surge into October 27th connected to the Eurozone EFSF news, touching the highs of 1,292 is yet to be exceeded by the bulls. If the market breaks to the downside, it might not be the end of the world as we still have supports at 1,200 and 1,100 - but nonetheless it might prove that bulls, once again got too confident, too soon. That is something I already discussed last week (article: Stocks: Are Bulls Over Confident?). Until we exceed 1,292 or lets say 1,300 to round it off, I wouldn't really join the bullish camp like a "market-pro-expert-guru-advisors" from II Survey or the "herd follower" from the Rydex camp.

Interview: Kyle Bass On BBC HardTalk

Chart Of The Day

Today's Chart Of The Day focuses on bogus inflation figures from the government of United States. Before we even start, lets be honest and say none of us actually believe these figures or any other economic statistics any government prints. Having said all that, lets us assume we do at least for the purpose of this post.

My question is this... where is deflation? If you have kids you are paying almost 20% more on education than you did since 2008, if you believe the government figures. If you are sick, or if a member of your family became sick, you are paying 12% more on medical bills since 2008. Geez... I'd hate to see the actual true figures. The point is... has the average salary in the US risen by 5% or 10% or even 20% since 2008? Is anyone actually getting a job in the US? Who benefits from constant QEs aka money printing - Main Street or Bankers?

What the hell are bond bulls talking about anyway? They are trying to convince us that QE does not increase money supply. Has anyone seen M1 or M2 growth in recent times? Deflation talk is total nonsense by bunch of academic dummies and the quickest way to losing money in your portfolio.

Money printing creates inflation but does not recover growth. In history, money printing has never created prosperity, but it has wiped out currency and bond holders almost every time. Is this time going to be different? You are free to believe what you want. What we have in the US, UK and Eurozone is called stagflation... a perfect environment for no one other than farmers and miners, who benefit from rising commodity prices.

Stocks: It's Decision Time!

Short term traders should be saying... it is decision time! What does that mean? Well, every now and than the market actually has no idea which way it should trend. It consolidates and digests information from the future through a discounting process. In other words, the market hits a road block and indecision between bulls and bears builds. Prices tend to consolidate into a point, what I usually call a pressure point, out of which either bulls or bears eventually must win. As prices tend to move in the path of least resistance... I guess one could say we are about to find out the direction of that path very shortly. Consider the following charts:

Triangles or decision points are now evident in many individual stocks, sectors and even the overall sector like the S&P 500. Many technical analysts are now waiting for the breakout, before they make future predictions. Many traders are now waiting for the breakout, so they can trade it and make some profits. S&P 500 is getting close to decision time and a lot of people smart traders must have their finger on the trigger...

Telecom ETF is pretty much in the same setup as well...

... and so is Oil Services ETF. It seems that decision time is close to approaching almost all sectors. The story is quite similar globally too, with the Australian ASX 200 and Brazilian Bovespa in a similar formations. On top of that Gold has now made a small triangle at the peak of its recent rally, without being able to make a directional decision over the last week or so. Palladium, an economically sensitive metal, also falls into this category as well. Finally, consider the two charts of Silver below:

Very similar to S&P 500 in terms of pressure building for a resolution in coming days...

... and if you apply simple moving averages to the price, once again a well defined technical triangle.

Summary

This post is very technical, something that I do not use very often. However, no one can deny that currently we have a similar setup across many asset classes and a breakout from these setups, that is confirmed across the board, could give us an important signal when it comes to the path of least resistance. Traders, especially, should keep their eye out on these setup and coming moves for opportunities. Personally, I will also be engaging into a few trades as well with minimal risk. Finally, a few words of wisdom. Don't be a hero trying to figure out which way the price will break out, even if you already know.

"In a narrow market, when prices are not getting anywhere to speak of but move within a narrow range, there is no sense in trying to anticipate what the next big movement is going to be. The thing to do is to watch the market, read the tape to determine the limits of the get nowhere prices, and make up your mind that you will not take an interest until the prices breaks through the limit in either direction." ~ Jesse Livermore