Sunday, November 16, 2014

Market Analysis for Week of 11/17/14

The current equity markets are a great example of why using technicals in trading is so important.  Market extremes get too far disconnected from fundamentals to rely on them as a guide for your decision making.  As much as it seems like the market should go down, it's just not worth playing the short side, and one of the big clues that we're going higher, and likely way higher, is that NO ONE IS SELLING at the top of a 12% move in three weeks this deep into a mature bull market.  That kinda shouldn't be ignored.  And once we shake off the short-term overbought condition I see no reason for anyone to sell in the forseeable future.  Clearly, there will be pullbacks, but I'm thinking right now that another 10% by May is totally do-able.  Does it make any sense to me?  No it does not.  Will I change my mind if the market tells me I should?  Yes I will.  But the evidence at the current moment is bullish.  And the fact that equities are correlated to the sinking Yen is only more reason to believe the bull market could be long from over.  The USD/JPY might make it all the way to 120 before having a significant pullback.  A strengthening dollar will eventually have a negative impact on equities due to international earnings, but that could be six months or more away.  Until then the carry trade overrides those concerns.  I've said this a million times but strong trends do not end in inverted V tops.  Could it happen?  Anything can happen.  But that would be an extreme outlier event.  Until we get a strong pullback that fails to make a new high on the retest, or makes one of those poke to new high reversals, there's no reason to short the equity indices because price will be in your face before you can blink.   Am I concerned about the Russell being a drag on the rest of the market?  Of course.  But if the shorts in the Russell get squeezed out and we breakout to new highs, watch out above for the rest of the market.

This week is options expiration week and since we never got the snap back pullback this cycle to scare people into puts, it's still lingering as a possibility for the next three or four trading sessions. Maybe it doesn't have to happen due to the difference in underlying positioning from the 10% Oct selloff as opposed to every other month this year, but it's just something to be aware of.  I'm sure there's a ton of stops resting under the day lows of the previous two weeks.  A 30 point sell off in the ES would run all those stops and work off the overbought condition.  But I would expect a massive amount of buyers to step in and buy any dip that occurs.  Think about how many trend following systems got knocked out of the market in early Oct.  Most of them have rules that should have triggered them back in, or are about to.  They will be buying the dips.

The bottom line is there's still more buyers eager to get in than sellers dying to get out.  And there's nothing in the immediate outlook to alter that, imo, so the path of least resistance remains up.  I've tried to express this on many occasions but the only thing that matters to me is the current position size of the large players and their immediate market outlook.  I play the other players.  I have no fixed beliefs.  I don't care about fundamentals.  I don't care about price.  I only care about what the others players are doing, how overextended they are, and what is coming up that could change or amplify that.  I am a trader.  I hate gambling.  Those two things are not even in the same universe.  One takes more skill than luck, the other takes more luck than skill.  I don't know if we'll get the snap back early in the week or not, but if it happens I'm a buyer, and I'm a holder.  I'm actually already holding but small enough to not worry about a pullback.  Day trading has been nice to me lately.

The short squeeze in the metals is playing out how I expected.  The chance of this being a short-lived rally that rolls over and goes way lower is VERY high.  Here's a great example of how I think about trading.  I track the COT reports, so I knew that the short spec position in silver and gold, and therefore the not-quite-but-getting-closer to a net long position of the Commercials, was at levels typically seen before a squeeze.  I knew the upcoming Swiss Gold referendum is on Nov 30th.  And I figured we've gotten quite oversold since July when silver peaked out with a net long position in the Large Specs that has been seen at previous tops.  So it makes sense that the short side is going to have a hard time staying short if pressed into that referendum.

The fact is we are in a monetary policy environment that is dollar positive and gold negative.  I do not believe the Fed can change its current line of thinking about raising rates next year (even though I don't believe it will happen) for at least a few more meetings.  Therefore, what you have in the metals is an overall downtrend that should continue once the short-term unwinds.  Think about the position of the Commercials.  They are hedgers for the physical world.  They are currently a lot less short than they would want to be to hedge against lower prices.  Therefore it follows that they are going to be very quick and aggressive about locking in prices so they can reduce their physical risk.  Which means as price rises from a short squeeze, the Commercials are at the ready to absorb as many contracts as the Specs will throw at them, which means in order for the Specs to move price very much it will require an enormous amount of long contracts and I don't believe in the current environment that is likely to happen.  They will run out of steam.  And while the Swiss Gold referendum, even if it passes, might ignite some speculative buying and more short covering, there's a lot of Specs who would normally play the long side who are thinking more like me, so that takes away potential longs and moves them to the short side, meaning they are looking to short the rallies, which is kinda the definition of a downtrend.

I'm thinking the metals market has a strong chance of peaking on, or shortly after Nov 30th, maybe by a week or so.  The next big event would be the Fed meeting on Dec 17th.  With the equity market strong and the dollar not really all that extreme yet, I don't see any reason they will say anything bullish for the metals.  In fact, the risk is more along the lines of removing "considerable time" and laying out a more detailed framework for the supposed first rate hike.  After the dollar is done pulling back I expect it will continue its rally, which will be yet another headwind for the metals above and beyond the desire of the Commercials to get really short again.  I'm thinking the dollar has a realistic chance of making it all the way to $100 by May.  If that happens, now you have a situation where the Fed might be forced to return to QE to battle the deflation of commodities that would result.  THAT would be a potential turning point back up for the metals.  But until something like that happens, there is too much need for hedging and too little need for speculating in this space.  The question, as always, is how high will the retracement go and what is the timing.

At the moment I think gold will make it to the $1220s.  It depends on how fast it gets there in relation to Nov 30th for whether I think that will be the top.  Silver looks like $17.40 is a possible area.  That's where I'm looking to get short at the moment, but I will adjust as I see it play out.  I'm also eyeing dollar support and Euro resistance.  Both have two sets of trend lines to use as guides for when the pullback could be over.  As usual, I'm always willing to drop everything I currently believe if the evidence suggests I should.  I'm currently long gold as of Fri on the pullback to $1170, but the real trade will be to the short side in a couple weeks, imo.

Gold's first resistance is the $1220-ish downtrend line.  Next is the $1240 horizontal area.  And last is the downtrend line thru $1300, which is unlikely.  The timing I'm thinking for it to potentially peak is between Nov 30th - Dec 7th.

Silver has a downtrend line it's been respecting from July that goes through $16.50.  If that clears I would think $17.40-ish could be the ceiling.  

The dollar has two uptrend lines that currently run thru $86.50 and $85.20 and they're rising everyday.  

The Euro has a downtrend line that goes thru 1.26.  If it clears, I would expect the 50-day EMA at 1.2724 to be the next significant resistance.

When the Euro loses the uptrend line from 2003, it can drop a LONG way, which also aligns with current monetary policy and the fact that the Eurozone seems doomed to break up one day.

If the ES pulls back at all, which is a big IF, it should happen early in the week and be met with a frenzy of buying that takes us higher thru December.