Thursday, September 29, 2011

Perspective On Commodities - Part I

Here are two reprints from the Market Anthropology archives that should set up a new note I am thinking about related to the now bursting commodity trade. And while it has certainly been an ingredient to the liquidity gaps now being felt downstream, it does not mean other asset classes, such as stocks - will continue following the same path lower. 

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. 

Tuesday, May 3, 2011

Fade the Institutions

Dollar willing, one scenario that appears ever more likely to gain traction over the coming weeks is a break in the macro commodity trade. And while it is a key ingredient to my longer term bullish perspective towards equities, it will likely have an intermediate term disruptive effect to market equilibrium and liquidity.  

As everyone is well aware of by now, the hot money sector over the past ten years has been in commodities. Just last month commodities beat stocks, bonds and the dollar for a fifth straight month - the longest such stretch in the last 14 years. 
"Commodity investments stood at $376 billion as of Dec. 31, 2010, up from $270 billion the year before, helped by net inflows of $62 billion, the report said. While those net inflows were down from a record $72 billion the year before, institutional investors accounted for an ever-greater portion of the total as the year progressed — with a record $8 billion in December alone, according to the report. For the year, Barclays’ analysts estimated net institutional inflows of almost $46 billion, or almost three quarters of the total inflows. 
The return of the institutional investor, massive inflows into precious metals led by the desire to hedge against financial market risk, and the gradual shift towards active management of commodity strategies were among the key stories of the year,” the Barclays report said." Pensions & Investments 
(Reuters) - "Commodity funds drew the most new cash among nine tracked sectors in the fourth week of April as investors sought to counter effects of a weaker dollar and rising inflation, EPFR Global said on Friday. 
Commodities funds took in $961 million in the week, putting them on track to exceed the record $32 billion of 2010, said EPFR, which tracks fund flows."
What is worth noting here is not just the magnitude of inflows - but the ever growing participation by institutions. While many traders would find a greater institutional participation as favorable to market conditions, I would strongly disagree with that logic. Institutional managers during market extremes are rarely doing what they personally would advocate. Because of the infusions of new money during rallies and redemptions during crashes, they are forced to invest or liquidate against their own best judgment. 

In a sense they create the monster that eventually takes down the house. 

Look no further than the institutional participation during the melt-up in equities in 2007. The retail investor/trader was basically a nonparticipant (net inflows), yet the market eventually collapsed upon the weight of the institutions. 

It is why trading is often counter intuitive to the obvious perspective of the financial media. 

Babak, over at Trader's Narrative has a nice footnote to this story, specifically addressing Jeremy Grantham's latest musings on commodities:
"My objection was that at or near the top of every single major market move, we can find intelligent people who argue that we have said goodbye to the usual cycles of the past and are now embarking on a new period of linearity. If you were around the last equity market top in 1999 and 2000 you won’t have to strain hard to remember the arguments. Who could forget “Dow 36,000″?
Casting back a few more years to the infamous 1920 equity market bubble, we have the infamous words of Yale economist Irving Fisher, who said days before the crash, “Stock prices have reached what looks like a permanently high plateau.” And I’m sure you won’t have any difficulty in coming up with more examples.
While we may scoff at these past arguments with the perfect knowledge that hindsight provides us, at the time they were intelligently sourced and convinced many.
So that provides the biggest caveat emptor whenever we hear the words “it is different this time” or any variations thereof." April 28, 2011