Fund Managers Are Very Bullish

Chart 1: Recent fund manager long exposure has averaged above 80%

NAAIM Exposure Source: Short Side of Long

Contrarian investors should start to pay attention. Over the last several months, NAAIM survey has been showing signs of extremely optimistic investor behaviour and it could be a dangerous signal. Since November of 2014, the average weekly reading for the survey was 83% net long, with the lowest level recorded at 65% (refer to Chart 1). This is a far cry from the levels seen during the recent intermediate bottom in October 2014, as exposure fell to only 10% net long.

Furthermore,  the difference between the net long managers relative to those who are net short, has been skewed more and more towards the bullish side. This is especially true over the last month, where the intensity has averaged 200% - a maximum reading possible - signalling outright greed. This kind of persistent bullishness, usually but not always, results in a sharp and fast shake out. For those who are net long equities as of today, caution is advised!

Chart 2: overall positioning is very skewed towards the bullish side... 

NAAIM Intensity Source: Short Side of Long

Breadth, Volatility & Volume

If we observe the overall broad index performance, US investors have been enjoying a relatively uninterrupted ride higher during the current bull market. But that does not mean that all is well within the equity space. The overall MSCI World Index has been struggling since June of 2014, so let us look at the way breadth, volatility and volume have been behaving. Let me quote some great research from Gavekal Capital, on two different occasions to put my breadth point forward:

For every country in the MSCI World Index, we measure the percent of stocks that are outperforming the index. The results give us some indication of the breadth in the equity markets. Currently there are only three countries where the percent of companies outperforming the MSCI World Index over the last 200 days exceeds 50%--the US, Japan and Hong Kong. An extreme example of underperformance is Austria, where none of its companies are outperforming the MSCI World Index. Most difficult for active managers is the fact that many large markets are experiencing terrible breadth. In France, only 19% of the companies have beaten the MSCI World Index over the last 200 days: in Canada, only 28% have outperformed: in Germany, only 19% have outperformed.

...one of the ways we like to measure what is going on underneath the surface is to take a percentage of stocks that are trading at levels less than 10% off its 200-day high, 10-20% off its 200-day high, 20-30% off its 200-day high and greater than 30% off its 200-day high. By doing this, we get a good idea of what the price dispersion of stocks currently looks like. So while the MSCI World Index is basically at its all-time high, almost half of the 1600+ stocks are down 10% from its 200-day high (i.e. in a correction). Also, almost 1/4 of all stocks are in a bear market and 10% of stocks are down at least 30%.

Chart 1: Equity volatility has been on the rise since the summer of 2014

Volatility Index Source: Short Side of Long

If we observe Chart 1 and Chart 2, we can clearly see that volatility and volume has been on the rise over the last two quarters. In other words, investors have been selling down their positions, but certain large cap stocks continue to rally, pushing the broad indices higher and masking the underlaying weakness.

Volatility, in particular, has put in some kind of an important low in June of 2014. Using a three month moving average, volatility has been rising over the last two quarters, despite the fact that the index continues to rally (refer to Chart 1). Pervious instances during the current bull market have shown that the rise in volatility has correlated very closely to a decline in stock prices, but not this time.

So why has breadth been so weak, and volatility / volume rising since June 2014? There will obviously be many explanations, but I would state that the US Dollar rally has created deflationary pressure on majority of the asset price, with only some managing to buck the trend. If we once again refer to the start of this article, the only equity markets that have benefited are the ones where the USD is either an official currency (US & HK) or where USD strength is welcomed (Japan).

Chart 2: Selling pressure via volume has seen spiked in recent months

S&P 500 Volume Source: Short Side of Long

Swedish Krona Under Pressure

Chart 1: Swedish Krona is the worst performer out of all the majors... 

Currencies Annualised Performance Source: Short Side of Long

Unless you have been living under a rock or in a underground cave, you've surely have noticed how the powerful US Dollar has been rallying against just about every other global currency. Media coverage has been focused towards currencies which have been falling apart, such as the Russian Ruble. Majority of investors, including myself, have been discussing the European Euro, showing how oversold it is.

However, one currency that isn't frequently discussed, and yet has been totally hammered by the US Dollar, is the Swedish Krona. Out of all the majors, Swedish Krona has performed the worst over the last 12 months (refer to Chart 1). The currency has lost about quarter of its value, as the greenback has managed an impressive rally of 12 monthly candles in the row.

Impressive rallies such as these definitely let us know that from the short to medium term perspective, US Dollar trend is now highly recognised and over-owned. Therefore, investors who are thinking of buying the Dollar right here and right now should exercise caution and patience. In my opinion, there is an above average probably that the greenback is due for a major correction or at least a pause in the uptrend.

Chart 2: ...falling for 12 monthly candles in the row against the US Dollar

Swedish Krona Source: Bar Chart

Euro Is Extremely Oversold!

Chart 1: European Euro has become extremely oversold vs the Dollar!

European Euro Performance Source: Short Side of Long

The European Euro originally came afloat against global currencies in the late 1990s, so we do not have a lot of data to go on by. But one thing is for certain, the currency is currently at one of the most oversold levels it has been since 1999.

The quarterly performance (green line) shows a persistent oversold condition at almost 2 standard deviations away from the mean. Furthermore, annualised performance (blue line) shows the second most oversold level, well below 1.5 standard deviations away from the mean.

With these two points in mind, one could argue that the European single currency has only been more oversold in early 2000 and late 2008, both marking major bottoms.

Precious Metals Shake Out

Chart 1: Precious metals are still in well defined pattern of lower highs...

Gold COT Source: Short Side of Long

Precious metals continue to puzzle majority of investors. From the bullish aspect, market participants see great value and extremely depressed prices, so it only makes sense that we see a random "guru" or "finance expert" call a bottom in this sector every second month. Recent price action showed us an oversold condition being reached in December 2014, from which a powerful rebound occurred in January of 2015. Obviously, it was only normal to yet again hear calls that the Precious Metals sector bottom has finally been reached.

But the simple analysis of the price action so far disagrees. Neither Gold or Silver registered a higher high on the weekly chart, which usually in its purest form, signals an uptrend. It is quite clear that both metals still keep printing a pattern of lower highs. Finally, as we should be able to observe in both Chart 1 and Chart 2, hedge funds and other speculators piled into the hype and were holding the largest net long position since late 2012. So, should we be surprised at the way both Gold and Silver have reversed in recent weeks?

In my opinion: No.

The recent purchases at the start of the year, of GLD and GDXJ from my newsletter portfolio, have been closed this week for only a very very minimal gain.

Chart 2: ...while hedge funds & speculators have piled into the long side!

Silver COT Source: Short Side of Long

Gold’s Bear Market

I regularly receive emails regarding Gold and Silver. Questions range from where it will be going over the next few weeks or whether or not the bear market is finished? If not, how low will it go? Should I buy it now or should I short it now? What's the point of holding PMs when they keep going lower? And so on...

Chart 1: Gold has not shown any major signals that the bear is finished

Gold Downtrend Analogues Source: Short Side of Long

Gold prices peaked in early September of 2011 just above $1,920 per ounce. Today, Gold trades at $1,245 per ounce, as this mornings early European trade. The chart above shows that after Gold peaked, it consolidated in a sideways fashion for many months. Eventually, it broke down sharply during early months of 2013. Since the crash, Gold has once again consolidated in a sideways fashion for many months.

While it has attempted to break down towards new lows during late 2014, that move was negated and quickly reversed, trapping many bears. Having said that, the recent rally has failed to hold the 200 day moving average and post a higher high (definition of an uptrend), so bulls haven't been successful either.

The price now remains in no mans land, without a major direction or trend. A break above $1,400 per ounce could restart Gold's bull market, while a break down below $1,180 per ounce (as long as its not another trap) will probably send Gold towards $1,000 psychological level.

My advice is: instead of guessing, just wait patiently for the market to give you a clue!

Opportunity Exists In China

Chart 1: Chinese stocks are still lagging behind other major economies

Global Stock Markets Source: Short Side of Long

Chinese stock market continues to lag behind other major economies. Chart 1 shows the MSCI World Index, followed by United States shares, German shares, Japanese shares and finally Chinese shares. Most regular readers already know my view on this matter, as I believe that Chinese stock market will eventually play catch up to other world indices. It is not a matter of if... but only when! Therefore, periodically, I will be updating this chart as we watch the Chinese market make an attempt to break out of its prolonged basing pattern.

US Assets Continue To Outperform

Chart 1: Dollar has been a major market mover over the last 6 months!

Global Macro Source: Short Side of Long

Chart 1 shows the performance of major asset classes since January 2007 (prior to Global Financial Crisis). All assets are priced in US Dollars and include the global stock market index, equal weighted commodity index, US Dollar index and US 10 year interest rate note yield.

Let us remember that the US equity market holds the largest weighting in the MSCI World Index, so due to its strong outperformance, the overall global index is giving an appearance of a consolidation. But the truth is, European and Emerging Market stocks have been under strong selling pressure in recent months, holding a lot of similarities to the commodity sell off.

Chart 2: US equities & bonds have outperformed all other major assets

Global Macro ETFs Source: Short Side of Long

Really, it is only the US assets that continue to push towards 52 week highs. US bonds and US Dollar have also been gifting investors above average returns. In recent weeks, US interest rates have approached levels not since since the Eurozone Crisis in middle of 2012 (bonds have rallied), while the US Dollar Index is trading at levels not seen since 2003.

Now, I understand that most investors don't play commodities due to the contango effect and usually don't invest (but only trade) currencies as returns tend to be small, unless major leverage is applied. Therefore, if we focus on the global macro asset classes by tracking the total return of the most popular ETFs, we still come to the same conclusion, that by and large US assets are outperforming the rest of the world.

The question now is... how long does this outperformance last? The basic answer is, as long as the Dollar keeps rallying, similar to the period between mid 1990s and into early 2000s. Federal Reserve seems determined to rise rates from the zero bound level.

Still Short Aussie, But Long AU Stocks

Chart 1: Aussie Dollar is extremely oversold & could rebound for awhile

Aussie Dollar Source: Bar Chart (edited by Short Side of Long)

In the previous blog post, written today, I was discussing how there is now a potential for the US Dollar Index to reverse from a powerful uptrend. Furthermore, last weeks blog post discussed how oversold Australian Dollar and Australian stocks were, when priced against the US Dollar. Interestingly, yesterday we saw a strong bullish reversal in the Aussie Dollar, just as the RBA announced a new rate cut. To me, this most likely indicates that majority of the bad news has been discounted (for now), as Aussie has been falling since August of 2014. It seems to be a perfect contrarian setup and the currency is most likely ready for a rebound and a short squeeze (refer to Chart 2).

Chart 2: Hedge funds & other speculators continue to press short side!

Aussie Dollar COT Source: Short Side of Long

Despite the coming rebound, which could easily take the currency back into the mid 80s handle, I will remain short the Aussie Dollar. I believe that there is more downside to come, after the rebound runs its course. Regular readers will remember that my initial AUD short position was taken in November 2012 around $1.05. My second position was executed in August 2014, just below $0.94. On any potential rebound, I would like to open new short positions.

Having said all that, Aussie stocks look good for a long trade right here. As discussed last week, sentiment on the Australian stock market was extreme negative, while the price itself was sitting on an important technical support level (click on the links to see the charts). Therefore, in anticipation of a breakout during last nights US market trade, I decided to enter long positions just below $22.50 in the Australian ETF  (NYSE Symbol: EWA). This morning showed a very powerful breakout candle. My risk management is very tight here due to the swings in the VIX, with a stop loss being moved to my entry level now.

Chart 3: I bought some Australian shares priced in USD, with a tight stop

Australian Stock Market Source: Bar Chart (edited by Short Side of Long)