Thursday, April 28, 2011

Taking Shelter

Although I am quite bullish over the long term towards the US equity markets, I believe we are imminently about to be hit by a strong squall - the components of which have been accumulating over the last several weeks. I believe I have addressed many of them in various fashions in my previous work. 

Technically speaking, traders were looking at SPX 1345 as a major test of the market's moxie to move higher. On Tuesday, the market broke through it. Yesterday, it tested that level and sprung higher post Bernanke. All in all, very healthy price action (structurally speaking). However, for the bulls to keep driving, that level needs to be maintained. 

Where will the additional fuel come from in the short term?

Momentum can only carry the market so high without additional catalysts refreshing the animal spirits. Based on the momentum oscillators that I follow, the market is at the extreme end of this momentum squeeze. It is basically in the hands of the shorts that have been forced to cover at this inflection point and the reluctant investors and money managers that have been sitting on the sidelines waiting for a correction. David Rosenberg's latest about face towards equities is one example of this dynamic. How deep their bench is, will depend on how far the index can get away from the pivot. The market will still need more fuel to maintain its upward trajectory. 

With a respectable, but certainly not spectacular earnings season in the rear view mirror, and this month's Fed decision out of the way, the market will turn its attention to the next major market moving event - the conclusion of QE2 and the next Fed meeting on June 21 through the 22nd. Between now and then, the market will wrestle with the notion of a less accommodative fed, higher energy and commodity costs, increased inflation expectations, higher interest rates and a saturation of bulls on the same side of the fence.

Based on various stock-timing research, institutional participation has been waning since early February while retail investors (as noted in the Rydex data) have become increasingly bullish - notably towards the extreme. I like to look at these data sets rather than the sentiment surveys for the equity indices, because traders ultimately vote with their wallets not with their mouths.

Will the market lob a beach ball or a grenade to the retail traders now following the rather obvious breakout pattern in the SPX?

If we look at the VIX, we are sitting right below the bottom of the range that the market has been trading in for over four years. And while it would be misleading and false to interpret a falling VIX as overtly bearish towards the market here - it does indicate complacency in the options pits, even as we approach and move through some key technical levels. 

Contrarian perspective would find that bearish.

It would be preferable to see a moderating to rising VIX, as in the 1990's when the market moved higher in concert with a rising VIX. 

In essence, the market is priced to perfection here. 

Appraising the commodity sector (a component of the everything goes up market), we can see that we have pulled up to both the 61.8% fib retracement level from the 2008 top and what could end up being the right shoulder of a very broad H&S pattern. Considering the commodity trade has been partially a trade against the US Dollar, and the Dollar is about as washed out as it could possibly become from both a technical and sentiment perspective (yes, and even the great currency trader - Matt Drudge, believes the greenback is headed significantly lower) - there remains to be seen what will propel the sector higher at this inflection point. 

As everyone is well aware of by now - I have been following silver as the canary in the commodity sector and a reference perspective to fast money in the asset class. At this point, anyone arguing the fundamental underpinnings to the silver story is at the very least a pollyanna to the obvious parabolic trajectory it has taken in the past several weeks. This is not a continuation pattern - it is an artifact of exhaustion. Apparently Mr. Roger's and I differ on what would be construed as parabolic. I think we can all read between the lines - the editors apparently thought so as well. 

CNBC On-line
Interestingly, as of this Thursday afternoon, the market has pulled through the monthly meridian line I created a while back. The market would need to loose approximately 10 points on the SPX tomorrow for my bearish bias to hold up according to merdian theory

We will soon find out. 

In conclusion, I believe the markets are primed for a rather large bull-trap. Anecdotally, reading that the esteemed David Rosenberg has reluctantly turned bullish towards equities at this level gives credence to my perspective. While I have great admiration for his research and writing - economists typically make lousy trading decisions. 

(Positions in ZSL, UUP & TWM)

Wednesday, April 27, 2011


"I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms." - Paul Tudor Jones.

Tuesday, April 26, 2011

Waiting on a Train

Cut your losses quickly.

As a trader, you hear it as often as, "Have a nice day."

The problem with these axioms is that they are generalizations towards a discipline that in many cases is antithetical to stereotypes. I wholeheartedly agree, it is prudent advice to follow in a typical continuation or trading range environment.  However, when it comes to extreme market behavior, there is an exception to the rule. 
  • It's Always Darkest Before The Dawn
By late January of 2009, the equity markets were about as psychologically bludgeoned as a market could sustain. The financial index (BKX) had loss over 70% of its 2007 market capitalization and the media was debating the merits of a broad nationalization of the banking sector. Nouriel Roubini was sharing a table at Nobu with Brangelina and ZeroHedge's byline of "on a long enough timeline, the survival rate for everyone drops to zero" was about to be penned at the market bottom.

It was dark out there - real dark. 

And yet, we should have all bought more.  

I started accumulating a position on the long side in the financial sector in late January after the BKX liquidated over 20% on one Monday morning session alone. And while the position became almost immediately underwater in a matter of days - I had done my research (a snipit of it here and here), believed in the trade's thesis and waited for the stars to align. 

The trade took about one month to materialize. 

Because I was utilizing leveraged ETFs to commit the trade, the initial position would lose roughly a third of its intrinsic value. However, by layering equal positions into the trade, my cost basis was eventually within a few percent of the market low that March.

A few months later the aggregate position had more than tripled. 

I had traded the initial position's intrinsic value for time. Time would be the great revalator once again. 
  • The Exception To The Rule 

Buying and selling into a market extreme is one of the few occasions where dexterity doesn't count for much. Caveat being, as long as you are operating without extraneous margin on your position, have done your research and know which side of the tracks to wait for the oncoming train. This kind of trading strategy only works during major market inflection points where it pays to be aggressive and buy fear. 

The angle of incidence will equal the angle of reflection. 

However, if you have misread the tea leaves of continuation for exhaustion - then it's just magnified pain and in hindsight - reckless. It is a high risk, high reward trading strategy. 

The comparison of my financial sector washout trade in 2009 and silver today (see here), seems appropriate because they both display(ed) all of the characteristics of extreme price action. In late January of 2009 it was a waterfall bottom. Today in silver it's a parabolic top. They are both artifacts of exhaustion in the tape. The Ying and Yang of disequilibrium. They are not discrete patterns to notice. 

Leverage ETFs should only be utilized by professional traders. In the right desensitized hands they are outstanding tools for capturing a trading thesis over the near to intermediate terms. Many traders bleed themselves to death and second guess their research by entering and exiting a trade several times before the market turns. It can be death by a thousand cuts and quite confusing to navigate.

In a trading and media environment that is so heavily dominated by the approach of high frequency trading, "cut your losses quickly" can at times preclude you from missing the train entirely. It is often prudent advice to follow in the typical continuation or trading range environment.

However, when it comes to extreme market action, there is an exception to the rule. 

I have heard on numerous occasions over the past week traders comparing a silver short in todays market as "picking up nickels in front of a bulldozer." 

That analogy does not seem appropriate to me, because I am not trying to pick up nickels - I am trying to pick up silver dollars. 

Perspective is everything. 

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Disclaimer: This is not investment advice. Always do your own due diligence and research. Erik Swarts is not a registered investment advisor. Under no circumstances should any content from this website be used or interpreted as a recommendation for any investment or trading approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor.

Saturday, April 23, 2011

Time - the Great Revelator

Quite serendipitously, I found myself at the ripe age of 21 riding a significantly underpowered motorcycle through the frontier states of the American and Canadian west. I had recently just graduated from college and was embarking on the traditional rite of passage so many restless young graduates make:  

Where to now?

Where the Wild Things Were, circa 1997
My friends drove, in what ironically we referred to at the time as, The Silver Bullet - a 1990 silver Ford Taurus station wagon my friends folks "donated" to the expedition's cause. I rode my motorcycle - a 1986 Honda Nighthawk that was just barely capable of carrying my large frame some 16,000 miles around the highest elevations of the country. I had a tent, a sleeping bag, my hiking pack and a guitar all strapped to the bike. I also had a softcover copy of Zen and the Art of Motorcycle Maintenance tucked into my saddle bags. I was ready and willing to receive all the wisdom the road and Mr. Pirsig could throw my way. 

. . . . . . . . . . . . . . .
"The main skill is to keep from getting lost. Since the roads are used only by local people who know them by sight nobody complains if the junctions aren’t posted. And often they aren’t. When they are it’s usually a small sign hiding unobtrusively in the weeds and that’s all. County-road-sign makers seldom tell you twice. If you miss that sign in the weeds that’s your problem, not theirs. Moreover, you discover that the highway maps are often inaccurate about county roads. And from time to time you find your "county road" takes you onto a two-rutter and then a single rutter and then into a pasture and stops, or else it takes you into some farmer’s backyard. 
So we navigate mostly by dead reckoning, and deduction from what clues we find. I keep a compass in one pocket for overcast days when the sun doesn’t show directions and have the map mounted in a special carrier on top of the gas tank where I can keep track of miles from the last junction and know what to look for. With those tools and a lack of pressure to "get somewhere" it works out fine and we just about have America all to ourselves."
. . . . . . . . . . . . . . .
I remember with great fondness passages such as these as I was lying under the billion star dome, reading by flashlight and following to some extent my own philosophical and literal journey through the Big Sky landscapes that make up the American west. Most people use AAA as their trusted travel guide and map provider. Luckily, I had Robert Pirsig's penultimate novel on both motorcycle maintenance and the philosophy of quality as my reference manual. 

. . . . . . . . . . . . . . .
"You see things vacationing on a motorcycle in a way that is completely different from any other. In a car you’re always in a compartment, and because you’re used to it you don’t realize that through that car window everything you see is just more TV. You’re a passive observer and it is all moving by you boringly in a frame.
On a cycle the frame is gone. You’re completely in contact with it all. You’re in the scene, not just watching it anymore, and the sense of presence is overwhelming. That concrete whizzing by five inches below your foot is the real thing, the same stuff you walk on, it’s right there, so blurred you can’t focus on it, yet you can put your foot down and touch it anytime, and the whole thing, the whole experience, is never removed from immediate consciousness."
. . . . . . . . . . . . . . .

Perspective is everything.

You sniff around today and the vast majority of investors, traders, S&P analysts, Republican's and Democrat's alike, all see the US through the very pessimistic lens of a diminishing republic on the cusp of insolvency. Some even go further out on the continuum of curmudgeondry - I suppose at this point in the cycle, fear pays better than logic (media speaking). However, if you want real alpha (the preferable meta-alternative to seeking alpha) go against the conventional wisdom here and realize that the US is not insolvent today and arguably headed towards confronting some of the greater fiscal issues that have haunted us for far too long. The general public's perspective is always in the rear view mirror of the market. It is why I follow the market and steer clear of the 24 hour12 hour, 4 hour news cycle. I am far too impatient to read about yesterday's news described as if held relevance to today, moreover - tomorrow. 

“The United States will always do the right thing—when all other possibilities have been exhausted.” -Winston Churchill

The market knows this. The US dollar knows this. The media will eventually catch up with its tail.

For all the dollar bears that are waiting on pins and needles for the bottom to fall out or for America to enter into a hyper-inflationary tailspin, just turn their attention to the historic chart of the American currency, post the Nixon Shock in 71'.  
Where's the doom and gloom? 

I see a rather normalized trending currency, reflecting moderate fiat debasement, within a technical framework remarkably similar to late 1980 early 1981. 

And low and behold, silver has very much been acting within the technical part as it did in 1980. 
This is why I have entered a position that is long the US dollar and short silver. It's not a daytrade, it's a thesis position (I can just feel traders cringe). Similar to John Paulson's trade on housing or Buffet's bet on the dollar - with the caveat that I am expecting a resolution in the market within the short to intermediate time frames. I can only use the previous price history and technical analysis as a reference guide for entering the trade. Realistically speaking, there is a very low probability of picking the absolute top in the silver market. For this reason, I am willing to trade the positions intrinsic value for time. 

Time is the great revelator

I approach a position in ZSL as an option trade on the silver market, without the serious risk of time decay you are exposed to with conventional options. I do realize that even these trading vehicles have their own inherent component of time decay. However, over the time frames I have described - it is the best fit for me.   

Thursday, April 21, 2011


To a certain degree, we are all slaves to the 24 hour, 12 hour, 4 hour financial news cycle.  A guru one morning - chop liver that afternoon. 

Here at Market Anthropology, we like to keep things in perspective and realize that not everyone's timeframes and expectations follow the same arc. And while many market pundits and money managers rightly deserve their various monikers of, lets just say - transient market utility; it is to a large degree expressed by their proportions to the market itself - or for today, their "stone". 

Disclaimer - This is a rather random selection of gurus and market prognosticators that in no way reflect's my own affinities or aversions.  

And yes, there is only love for Jeremy Grantham - that is a universal truth, no?  

Tuesday, April 19, 2011

Baromarket Pressure

Follow the money and you can typically arrive at the genesis of your surroundings. Here is another ratio chart that utilizes the S&P 500 Bank Index from Goldman. While I usually watch the BKX or the XLF for baromarket pressure differentials (yes - I did just create that terminology), the GSPBK goes back a bit further and yields greater perspective to the ratio. 

As you can see, the banks considerable underperformance over the past year has become a worrisome trend. And while the previous bear markets (1990 & 2002) had similar low pressure zones - they eventually snapped back with great strength to lead the broader market higher. 

Granted, they eventually rolled over with some similarity to the current ratio's technical predicament - but it was after a much stronger relative performance trend. 

This has everything to do with the interest rate environment transition we are approaching. 

As described in my previous work on the transition to a market environment with a less accommodative Fed - both the 1994 and 2004 tapes exhibited diminishing leadership from the banks. 

The conundrum is that the ratio is running out of downside field position. 


If we don't start splitting the SPX or reverse splitting the banks, like Citigroup - it could flatline in a few years... 

(and yes, I am joking and realize there would be no difference - just the same old ham sandwich)

More to come in this line of thinking. 

Monday, April 18, 2011


History shows us that each bubble needs a tragic muse. 

The Nasdaq Bubble had both the allure and fear of a new millennium. Y2K was on one hand a software and infrastructure motivator, as well as a philosophical romance; drunk on the notion of a new era that would transform all that we understood and perceived about the world through technology. 

With gold and silver today, it's just as manic, evermore disturbingly romantic - and really just plain dark.

It's a bubble with a raging mood disorder. 

At once both manic and depressive. Currency debasement! Manipulated markets! The experiment that was the fiat monetary system is over! Raging inflation is coming! 

Protect yourself! 

In the end, the inflation debate is a matter of relativity and coordination. We are not the only ones intervening in the marketplace with a monetary policy stopgap approach - it is entirely a global effort. And while it does make for a juicy soundbite (that is typically 9 times out of 10 either politically motivated or borne out of ones position in the market), there's a lot less hyperbole and a great deal more logic behind the Feds efforts than most give them credit for. Here's the byline for the Financial Crisis for Dummies softcover:

The private sector stopped spending - the government filled the gap. 

And although it is quite true that our current fiat monetary system is inflationary over the long run, the degree of distortions that are currently being reflected in both the precious metals market, the commodities market and the currency markets - likely do not reflect a representable correlation to inflation today, but more of a serious bubble in the commodities sector. I believe this minority opinion will prevail in the not so distant future as we emerge from the crisis relatively intact, albeit bruised nonetheless.

FT/Alphaville had a very interesting piece detailing the work from the boys at Deutsche Bank - that succinctly describes what I believe has been a massive misinterpretation by the risk trade into the commodity and currency markets. 

"The $2 trillion in purchases have literally gone down a black hole. Required reserves haven't been required to increase and the Fed reserve add has literally simply been hoarded as cash. Excess reserves at the Fed have subsequently soared by the same. In short, QE has been a spectacular disappointment in its impact on bank lending, whether via whole loans or securities. It was as if the banks conducted the very sterilization of QE that many thought perhaps the Fed should do to "contain" inflation expectations.

Risky security prices have risen since QE but not Treasuries, the main instrument of QE2. Yet banks' balance sheets have gone sideways. Effectively investors have marked asset prices higher by the Fed from an investor simply triggered a series of deposit for security switches through the investor base with banks never making an additional loan. This is consistent with a greater concern for risky asset post QE2 end, than Treasuries. The danger for investors is that they confuse the result of higher asset prices as reflecting excess liquidity rather than "irrational" exuberance given that actual liquidity (as broadly defined by the banking system) hasn't gone up at all

- Dominic Konstam and Alex Li, Deutsche Bank"

While I agree with their descriptions of a rather large miscausation within the risk trade, I disagree with their disappointment with bank lending. Once critical mass arrives in the economy - bank lending will resume a glide path towards normalcy. Post financial crisis, both the private and government sectors perceive critical mass through the lens of the stock market - not lending. To their detriment, economist always seem to forget the psychological perspective to the argument. It is why accurate market forecasts are a hybrid discipline of both art and science. 
  • From Lemons to Lemonade 
Personally, I would never advocate the path that the Fed and Treasury have embarked on in the last 40 years. However, to the best of his ability, Bernanke has utilized the tools at his disposal to mitigate the collateral damage to the broader financial system.

I like Ben Bernanke, I really do. 

There, I said it. 

Don't hate me because I chose the unpopular position - it's an inherent character trait. 

During these contentious times, I think he is about as balanced - without ego, smart and creative as we could hope for in a central banker. The pundits will always use every opportunity to argue his ignorance towards what they perceive as practical banking methods and how they should function during ideal market conditions. They will cite example after example, such as his downplay of the subprime crisis right before the broader credit crisis erupted, as proof that he is unfit to lead the worlds largest economy. And although he surely deserves criticism towards aspects of his communications and transparencies with the market, the net result of his bold monetary approach has been a system that avoided catastrophic failure and recovered much faster than almost anyone predicted.

And while I would never willingly choose the Too Big To Fail paradigm, it has facilitated the efficiency and efficacy that the Fed could respond to illiquid market conditions. Granted, the crisis was magnified by the Too Big To Fail model, but the rapid recovery was also a direct result of their size and scope and considerable bandwidth within the global economy. Dealing with only a handful of mega banks with very similar infrastructures is infinitely easier to navigate and dispense stopgap capital, then thousands of separate and smaller entities with disparate business models and means of capital conveyance. No doubt about it, it's a house of cards in the right market conditions, but it also can be utilized to neatly reflate a deflationary market environment in a crisis. 

With that said, there can be some rather large side effects of operating capital within such a dynamic system - even if they are just figments of the markets imagination (see below). 
  • The Bubble that is Silver
Since I last checked in on the state of the precious metals market (a whopping three weeks ago - and 400 posts before Silver Bubble Mania hit the blogosphere), the silver bullet train has continued its ascent higher - in what I like to refer to as its quest for its ephemeral peak. 

It's not a matter of if, it's a matter of... yada, yada, yada - you've heard it all before. 

It is a very crowded topic to broach these days. Definitely a bit disconcerting from a contrarian perspective, if you are positioned on the opposing side of the plate. You may ask, why would anyone ever willingly step in front of a train such as silver?

(thick BBC english accent)

Purely Ego. 

I'm smarter than the market; I'm smarter than you; therefore...(insert tragic personal anecdote here). It's typically a widow maker towards your net worth. Trust me. 

We all know, as so eloquently stated years back by the godfather of our modern fiscal debate, John Maynard Keynes,  "that market's can remain irrational longer than one can remain solvent.".

Truer words have never been spoken. 

With that said, there are a number of reasons - both fundamentally, technically and psychologically speaking that silver's historic rise is running out of motivational propellant. The crescendo of central bank fedspeak towards quantitative easing exit strategies and inflation concerns has reached a dissonant pitch in the market. What's the old market axiom, "Buy the rumor, sell the news"? Well the news flow has been absolutely tidal towards inflation expectations as of late. 

Internationally, the drumbeat from China has been as steady as Ringo's right foot in Come Together. They have raised rates twice since October, and just yesterday, their central bank governor declared they would continue to raise rates, "for some time". Meanwhile, the ECB has eschewed Bernanke's willingness to give the markets the benefit of the doubt and have followed rhetoric with action. 

Domestically, the inflation debate has intensified, and although the governing powers that be have yet to align a concerted approach towards addressing inflation expectations - the wheels are in motion and proceeding along that path. 

Two days ago, it was Fed Governor Plosser declaring his concern with "choreographing" an exit strategy towards quantitative easing. Moments before, it was Federal Reserve Bank of Richmond President Jeffrey Lacker stating his concerns with the, "need to heed the lesson of the last recovery that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend.".  

First rhetoric then action. 

Technically speaking, the silver market is as exuberant as the Nasdaq was in March of 2000.

I also like to look at the monthly charts as an apples to apples comparison of these two historic bubbles. For comparison, I bracketed both the Y2K hysteria trade in the Nasdaq and the current QE2 trade in silver. 

The RSI, MACD, Full Stochastics and CCI have all exhibited very similar artifacts of manic market conditions. Namely, a slope as steep as the current monthly MACD for silver is almost always immediately followed by only one phenomenon. 


Not a correction or consolidation of trend. 


The Nasdaq had Y2K as its tragic muse. Silver, and by extension the entire commodity sector, has QE2. It's ending in one month. Best look for a seat before the music stops. 

Just remember, Y2K=QE2


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