At The Margin
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, October 27th, 2009.
How can the stock market continue to set new rally related records week in and week out? Answer: As per our discussion last week, because at the margin, there have been enough bearish speculators, as measured by US index open interest put / call ratios, to continually squeeze prices higher. What's more, this, in itself is nothing new (sentiment largely drives market direction in fiat currency economies), and has been the primary driving force behind stock market direction for sometime now (decades). However because this is an X-wave top, meaning it will be more extreme than anything else we, the human race, have experienced since the decline of the Roman Empire, correspondingly, any rally (counter to the primary trend or not) can also be more extreme than comparables on a grand scale (outside the present Grand Supercycle). And in fact, that is what we have now witnessed in US stocks - the most intense post bubble rally sequence ever recorded. So, those looking at comparisons within more recent history, which includes any similarities within the present Supercycle sequence, will likely continue to be surprised.
So again, the stock market has rallied these past seven months not just because it was oversold, or because it's discounting the future, as many hair-brained talking heads on television would have you believe, but because of speculation, where due to the fact the stakes are so high (survival for many), the extremes will commensurately be as profound. What does this mean, 'the stakes are so high?' It means barring the speculation game, which apparently even Chinese pig farmers have now entered into in the metals markets (it's better than raising pigs while it lasts), our global fiat currency economy (think globalization) has not only resulted in the export of manufacturing jobs from Western economies to cheaper labor in the East, leaving little to do at home but speculate and bureaucratize; but more, even the 'peasants' in China have entered the speculation game now, perhaps out of greed (that's a given), but also because rising costs pressure them into doing so. Be that as it may however, from a contrarian's perspective, the fact Chinese pig farmers have entered the speculation game, likely putting them into the larger 'dumb money' category, cannot be taken as a bullish indication on the 'inflation trade'.
Additionally, these pig farmers should be taken as a microcosm of the larger speculative community in my opinion, telegraphing the message the big risk is not inflation at all, but the threat of a Kondratieff Winter sequence beginning as increasing strata of speculators are taken out of the game. This is what would sponsor a re-acceleration of margin debt contraction, which would cause further contraction in the larger credit cycle, increasing the possibility of a waking bear becoming a more permanent fixture in people's minds moving forward. In terms of process, and allowing for some seasonal strength to put the finishing touches on the sentiment backdrop if a seasonal inversion is to take hold, it should be noted while prices have recovered more than enough to end the bounce, it could take noodling around into April to close a time related gap. What does this mean? If stocks do not literally crash in the near future, which is possible based on other historical signatures by the way, then, the seasonal inversion pattern will likely not occur, with only increasing volatility during this timeframe, characterized by potentially more significant losses afterwards as next summer approaches. This possibility is evident in viewing an analog comparison of US stocks to the post crash Japanese bubble.
And in zooming in to examine the price action of key markets and relationships we are using for signals from yesterday, the possibility of further noodling around prior to a decided rally is also evident from the close on the Gold / Silver Ratio, finishing right on triangle support after attempting a stronger move higher. Here, the implication of such a close is a possible 'test failure', with renewed weakness still possible in putting in a 5th wave to complete the indicated zigzag on the chart below. So, please be aware this is still a possibility. And if it's going to happen, it should become evident today in my opinion, with the ratio falling back into the triangle, the S&P 500 (SPX) finishing back above 1070, gold moving off near-term support at $1040, and the dollar ($) unable to break above 76 on the cash market. The reason it could happen is stock market bears are not sufficiently exhausted are still shorting sufficiently to sponsor yet one more rally, along with the bearish $ fundamentals helping out of course. In this respect the $ is a one way bet for many based on the view the US consumer is out of the picture consumption wise for years. (See Figure 1)
The thing $ bears seem to conveniently forget when discussing it's fate however is that all the carry-trade money put out since March (minimally) needs to be paid back, putting a synthetic bid back into the formula at some point. And as per above, the timing associated with when we should expect a rally in the $ to reflect this is a function of speculator betting practices in stocks, which as you should know in reading these pages, is best measured these days in US index open interest put / call ratios. Right now it's too early to say which way things will break on a lasting basis just yet, however the closes today will be telling; and, weekly / monthly closes conclusive in this respect. I can tell you based on the fact total volume put / call ratios remain low despite the volatility in stocks over the past few days is supportive for the bearish case, along with the crash signatures in the Transports and bank index. Compounding this negative picture is rising interest rates in the face of such equity related price action, making it appear to be a 'credit worthiness' issue for the 'Banana Republic of America', which could also put a bid under the $ if the situation persists.
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Good investing all.