Welcome My Son - Welcome To The Machines
The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, July 8th, 2010.
Every morning it's the routine, the bureaucracy's price managers goose the stock market futures, only to see any early gains given back not long afterwards. Of course they are a persistent lot, and have unlimited funds in theory, so they also show up in the last hour of trade prop up prices as well. And this occurs day in and day out, which has kept prices artificially high for quite some time. Of course if the effects of increasing austerity measures around the world have the same effect as at the last super-cycle top in stocks, it's also quite possible a 1929 style crash in stocks is witnessed given this set-up, which from a technical perspective includes similar contracting breadth and liquidity conditions comparable to way back when as well. Now put all that in your pipe and puff on it for a while.
Further to this, and in pointing out the irony associated with all this price fixing by our self important bureaucracy, is that at present every time they goose the stock futures it has an opposite desired effect, weakening the underpinnings of the faulty and fraudulent markets a now collapsing economy has become depend on. This is because, as mentioned the other day, bearish stock market speculators remain exhausted due to the ferocity of the short squeeze out the March 2009 lows into April, as measured by falling US index open interest put / call ratios, updated here for your benefit. So this means every time price managers goose the futures all they are doing is driving more and more shorts out of the market at a time when exactly the opposite is required to support prices via the squeezing action short covering / put selling provides.
What's more, and in referring back to our opening comments, it should also be pointed out that stocks are now in fact in a position to crash like they did in 1929 not only from a policy / political will mistake perspective (austerity), but also from a sentiment perspective as well in connecting the dots. Of course as evidenced by yesterday's squeeze one should be reminded our price managing bureaucracy will not just roll over and die. To the contrary, one would do far better to expect just the opposite as they turn the computers loose on us mortals, using high frequency trading (HFT) to screw the average Joe out of the few pennies he has left. More specifically, and to begin formally commenting on the attached US index open interest put / call ratios, this blog aptly points out the squeeze is working off the SPY, the larger rally becoming even narrower and on lower volume. And of course we know why this is happening. It's occurring because although not in profound enough in fashion to sponsor a lasting rally, still, the ratio (along with most other US indexes except the SPX seen in the attached above) did cross up above the price at the June expiry, which has proven to be enough to save stocks from a more meaningful break for now.
The whole idea behind yesterday's jam job was to get the S&P 500 (SPX) as far away from 1020 as possible, along with retaking not only the former lows at 1040, but also 10,000 on the Dow. And now that the price managers and bulls have done this, don't expect stocks to turn back lower right away, not if history is a good guide. From our comments the other day you will remember we were only expecting a bounce up to approximately 1070 at the outside for a few days. Now, due the viciousness of yesterday's squeeze, we must allow for more, but not much, say 1080 before the shorts are committing suicide. Even the best programmed machines will have difficulty lifting stocks past this point before they turn back down again. And unless the VIX is about to make another trend change very early in the present cycle, it should find support well before the 200-day moving average (MA), bolstering the view any strength in stocks should be fleeting; again, with intra-day volleys into the 1070 to 1080 range the best case scenario if the bear trend is still in tact.
In returning to the attached ratios now, something profound did happen to the open interest put / call ratios for precious metals and energy (XLE) related ETF's / indexes over the past few days however, which also helped the rally along today in oil & gas stocks, and could buffet the broader measures of stocks from more meaningful declines later on if precious metals remain buoyant, throwing off an inflation signal. Again, and more specifically, one should notice the profound advances / buoyancy in the ratios attached above for GLD, SLV (which is new), GDX, and XLE (also new), which if persistent past the upcoming options expiry on July 16 next week, would provide support for prices in these groups, making for flatter larger degree corrections expected to possibly persist into the fall. In terms of the energy related ETF (XLE), I am sure many shorts / puts were blown out of the water yesterday, and won't be back. However, if the larger investing population truly believes the deflation risk is real, speculators may continue attempting to pick a top in gold and silver, especially since they are close to all time highs, which again, would counter the drag associated with falling broad markets, setting the stage for strong advances later on.
What does all this mean in terms of prices and patterning for precious metals and the broads? As suggested above it means present weakness will amount to only being corrections in the final measures, with the head and shoulders patterns (see Figure 3) across stock indexes negated, and gold for example, bottoming in the $1150 to $1160 range before the larger degree rally resumes. In gold's case it would be better from a wave related perspective to have prices vex at least $1100 before continuing higher to provide confidence the next wave higher was 3 of C, however if open interest put / call ratios remain buoyant like this we may not be so lucky. This may sound odd, wishing prices of gold and silver lower, however the basic understanding here is if prices do not correct enough before heading higher the preferred count could be wrong, ultimately limiting the full potential of larger degree price movements later on. I don't want to get too far ahead of myself, but this is the concern. Of course with gold and silver being held back by our price managing bureaucracy for so long, and in various ways, such concerns may prove moot when the mob finally buys into the metals on a more meaningful basis and in proper fashion. (i.e. by buying physical.) You should know gold is still severely under-owned, which in itself, will buffet any liquidity related weakness moving forward as increasing numbers exit our failing fiat currency economies.
Of course the really good news for the precious metals complex is bullish paper silver speculators may finally be exhausted, exhausted in as much as the retail crowd has now decided to dabble on the short side of the trade in thinking deflation and lower prices are certainties. As such, this could finally cause sustainable and meaningful gains in the Silver / Gold Ratio, and visa versa in the Gold / Silver Ratio, which as you may know, would be supportive if the broad measures of stocks. Does this mean no more downside for stocks within the present cycle is likely? No, not at all, as we are still within a Bradley Model crash window until month's end, however as suggested above, it does mean potential losses could mitigated considerably, which has been a possibility we have been pointing to for some time. Under this scenario, the SPX would run back up to 1300 sometime in the first half of next year.
And now we know why this possibility must be taken seriously.
Is there another reason why the stock market might bottom at the end of July / beginning of August? Answer: Yes indeed, that being the democrats need to goose the system to get the economy going again before the mid-term elections in November. What would happen under such circumstances is all the bad news would likely cause speculators to begin buying puts again, turning US index open interest ratios higher once more, and a squeeze back up in the broads would ensue.
What is the big risk such an outcome will not occur? Answer: There are actually two profound risks, although they are related. First, there is the risk that speculators do not begin buying puts on balance beginning in August, which would scuttle sustainable rally attempts. And then there is the risk the machines trigger another flash crash that doesn't bounce back like the last one. Both of these risks exist both together and independently, and must be take seriously. This is of course the inferred message within the title of this article (taken from Pink Floyd's 'Wish You Were Here' album) having seen what the machines can do on the upside fresh in your memories from yesterday. The machines exacerbate price movements / volatility - to say the least.
Good investing is becoming increasingly difficult because of this, if not impossible in understanding the risks involved.
See you next time.