Measuring The Likely Strength Of This Impulse
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, November 24th, 2008.
As promised Friday, here we are with a look at the Amex Gold Bugs Index (HUI) in an effort to gauge the likely strength of the anticipated impulse into the first quarter of next year. And as you will see below this move could get quite impulsive if Bollinger Band (BB) widths begin to expand during the move. Certainly such thinking would not be a stretch considering Friday's 45 point move higher in the HUI, however we are not making any assumptions in this regard as option expiries often cause violet moves if prices are either too far above or below equilibrium thresholds. So you see the true test of how strong the present impulse will be is likely better judged by what happens this week, along with other considerations which will be dealt with below.
In terms of factors that will influence the trade we have a few, with the dominance of these various factors depending on all intermarket relationships that make up the nexus. As for the dollar ($), you will remember from last week it's the stock market that is driving it's direction, which in turn is driven by speculative betting practices of options players. So, it's important to realize that if open interest put / call ratios remain low, any bounce in the equity complex (including precious metals) should be viewed as suspect, where profits on the rally will be taken sooner than later. I will publish the post expiry open interest put / call ratios for US indexes (including the XAU) on Wednesday morning, along with an opinion as to how things look at the time.
This is all new in terms of degree of the larger cycle, so although history can be used as a guide, which would point to a good corrective rally into next year that would take the HUI back above 400, we will not make any assumptions in this regard. We will watch our indicators very closely so not to give back as little of our trading profits as possible, attempting to sidestep any future collapses. And I think there will be continued future stock market calamity, where if we are in the midst of a Grand Super-Cycle correction, for example, the S&P 500 (SPX) could head all the way down to 100, a 99% retrace of the entire move from 1982. Make no mistake about it; such an outcome is possible given the challenges we have before us, not the least of which are peak oil, an aging population, and credit cycle gone bust.
Not getting too far ahead of ourselves however, first things first, where again, now that we have this apparent turn higher in the equity complex, we will be watching closely this week for continued follow-through, $ weakness, and confirmation speculators are finally growing some respect for stocks, which will in turn affect their betting practices. That's right, we will be looking for confirmation options players have finally had a change of heart and will start betting bearish on stocks so that a sustainable short squeeze can counted on. It's either that or the reaction higher will be exactly that, a fleeting reaction, done on or before week's end. So again, this is why we will be taking stock of open interest put / call ratios mid-week, in gauging whether we should hold on to our trading positions longer or not.
This is because once we get past Thanks Giving Day trading machinations, the largest of which being a natural tendency for stocks to finish higher around holiday weekends due to lower trading volumes, the influence of put / call ratios will come back into play next week as expiry approaches once again. Enter the possibility of tax-loss selling, along with a bunch of unfilled gaps on the charts, the most prominent being on precious metals shares / indexes across the board (except juniors), and believe it or not we have a recipe for a retest, as demonstrated in red on the HUI plot below, which from a longevity point of view, would in actuality be the preferred outcome because these gaps (hourly, 10-minute, etc.) will need filling at some point. So, if they are not filled now, you know what that means. (See Figure 1)
Of course given the child-like mentality traders have developed over the years, spoiled by a fiat currency monetary system gone wrong, where bailouts are common to avoid inevitabilities, if it were left to this market, and given ample opportunity, anything is possible, so we cannot discount something more substantial prior to a meaningful correction (denoted in black), with all the little question marks positioned along a possible path higher, defined by Fibonacci retracements primarily. At this point however, given the above gap / tax-loss selling concern, along with the fact the Gold / Silver Ratio was actually up on Friday to accompany the big moves higher in equities, even before we see them one must assume put / call ratios remain low.
Do put / call ratios control that much / many markets? Answer: You bet they are. They are the center of the universe. They control the outcomes in the equity markets, which in turn control debt, currency, and commodity markets via intermarket relationships. Just look what the permanently bullish players in Citigroup (C:NYSE) did to that stock, which was telegraphed by the 'crash signature' in the trade, a topic that was broached here just last week, prior to its collapse. At the time it was stated not to expect a lasting rally until the lower reaches of the accumulation / distribution pattern was vexed, and sure enough over-zealous speculators brought the mighty C to its knees within the week. The great C would be gone right now due to its inability to raise financing, which again, is a function of it's share price / equity. (See Figure 2)
So if you can believe it, the speculators control the economy, which is a natural development in a mature fiat currency based system, this, and all the bailouts, which of course will not work. In the meantime however, the fact C has likely hit bottom, as can be deduced by observing the fact the 'crash signature' in the trade has been removed, along with the traditional run-up into Thanks Giving Day weekend expected in the broads, facilitated by the lack of influence by open interest put / call ratios being this far away from expiry, gives rise to the observation no matter which scenario in Figure 1 prevails, more strength in the equity complex should be anticipated, with precious metals leading the way if this picture of the HUI / SPX Ratio is to be believed. (See Figure 3)
Thus, if you are already positioned for the larger move, please don't get twitchy and sell to early. Even if we need to fill gaps before going higher, the point is higher prices are in the offing. And there are more reasons to be concerned about the longevity of the present rally sequence in addition to those already mentioned above, including lack of response in Asian markets, a stable $ (it should be declining to support equities), and the fact we just had a fresh break lower on the monthly Nasdaq / Dow Ratio. And while it's always possible this could be accounted for by financials lifting the Dow faster during reflation, such an assessment is unlikely, because remember, what this ratio is measuring is speculator zeal, which has only very recently broken. (See Figure 4)
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Good investing all.