Silver Reverses At Key Level

Chart 1: After a powerful rally from a base, Silver has reversed sharply!

Silver vs 200 MA Source: Bar Chart (edited by Short Side of Long)

The PMs recent rally, correctly predicted back in late December of 2014, seems to now be reversing starting with Silver. The base building process during November and December of last year, together with a powerful rally in January, was looking promising until last nights price action created a strong bearish reversal.

Silver approached a confluence of resistance lines, most notably the 200 day moving average seen in Chart 1, as well as the downtrend line and horizontal resistance line (seen in Chart 2). All of this happened as the price became overbought and hedge funds piled in at a rapid pace. While it is too early to say that a new downtrend has started, what we need to remember is that different investor characteristics and behaviour apply during a trend.

For example, during an uptrend, when sentiment becomes too bullish and price overbought, usually we see a correction occurring through a modest price pullback and a prolonged consolidation. On the other hand, during a downtrend (which we have been in since 2011), when sentiment becomes too bullish and price overbought, usually we see sharp reversal which indicates a continuation of the bearish trend and a strong possibility of new lows.

What type of behaviour do you think Silver investors are resembling right now?

Chart 2: Confluence of important resistance levels has reversed the rally

Silver COT Source: Short Side of Long

Australian Equities Are Oversold

Chart 1: Aussie stocks have dropped 20% from September 2014 highs!

Australian Stocks Source: Short Side of Long

Australian equities, when priced in US Dollars, have not performed all that well in recent years. All major fundamental aspects that were tailwinds and made Aussie stocks outperform during 2000s, have now become headwinds. Commodity prices have declined since 2011 and the strong currency has lost almost 25% in recent quarters. Technically, the price has been consolidating since 2009 (refer to Chart 1), similar to other emerging markets such as South Korea. This signals that the economy isn't booming, but at the same time it isn't in a recession either.

Traders and investors looking for a potential entry point, should now start paying attention. Having recently dropped 20% from intra day highs on 2nd of September all the way down to mid December lows, Australian equities now look rather interesting. They are oversold, sentiment very negative and price sits on a major support level. Sentiment is actually so negative (refer to Chart 2), that previous readings such as these have marked an intermediate low. The same can be said about Australian Consumer Confidence too!

Chart 2: Investor sentiment is incredibly negative on the lucky country

Australian Stock Sentiment Source: SentimenTrader (edited by Short Side of Long)

Having said that, it is difficult to say whether or not the index will bounce from the current support line. Certain traders could take this chance by executing the trade, with a tight stop loss below the support indicated in Chart 1. One of the main issues for Australian stocks, when we priced in US Dollars, is the fact that the index tends to suffer as the local currency goes down. From a contrary perspective, the Australian Dollar is now also incredibly oversold and seems to be in a final capitulation phase... dropping straight down (refer to Chart 3). If the currency shows signs of recovery, maybe the index itself could rebound too!

Chart 3: AUD is very very oversold and most likely in final capitulation! 

Australian Dollar Source: Stock Charts

Small Caps Trying To Catch Up!

Chart 1: Russell 2000 has under-performed S&P 500 throughout 2014!

Small Caps vs Large Caps Source: Bar Chart (edited by Short Side of Long)

Regular readers of the blog would know the reasons as to why I do not have any investment in US equities. The bull market is very mature, having started in March 2009 and already tripled in value (we are talking S&P here), while valuations and sentiment are both stretched on the upside. Consensus believes that US equities will continue to be the only game in town. Now... let us assume that consensus is right this time and US equities do happen to have another favourable year.

How would one play this?

Well, assuming I was a trader with a horizon of a several months, using a tight stop loss risk management, I wouldn't be buying large cap stocks like S&P 500 (NYSE Symbol: SPY). Instead, I would consider trading a potential upside breakout in the small caps space, through the Russell 2000 (NYSE Symbol: IWM).

Russell 2000 had a very disappointing 2014, especially on relative basis when compared to some of the other stock markets around the world (refer to Chart 1). Traders might remember how bearish the sentiment was during the October mini-panic, as every single blogger was pointing to small caps breaking down as a signal of a new bear market. However, it wasn't to be...

I've already mentioned this several times on the blog, but it is worth saying it again: Russell 2000 tape is acting rather bullish as the price consolidates underneath a major resistance. This isn't a topping pattern but a continuation of an uptrend. Therefore, more upside might be in the cards over the coming months.

Chart 2: The tape is bullish as price consolidates under major resistance

Russell 2000 ETF Source: Bar Chart (edited by Short Side of Long)

Global Macro Performance

Chart 1: Global bonds have outperformed all other major asset classes

Global Macro Performance Source: Short Side of Long

Let us quickly look at the 12 month performance of all major asset classes. Chart 1 shows three major equity regions: US, Europe and Emerging Markets. It also covers bonds with Treasuries, Corporate grade and Junk grade exposure. Finally, we also have alternative assets like International Real Estate Investment Trusts, Gold and Commodities.

If we observe the chart closely, we can clearly see that Treasuries have outperformed all other asset classes. This is very interesting because back in January 2014, just about everyone was negative on this asset class. On the other hand, commodities have under-performed just about all other asset classes by a large margin, mainly due to the sharp drop in Crude Oil prices in the second half of 2014. Eurozone equities also suffered a similar drop.

US Equities continue to outperform, mainly due to strong US Dollar rally and weak foreign currencies. REITs have done much better then Gold mainly due to their high dividend yield payout, while Corporate bonds continue to do better then Junk grade. When we look at less busier four major asset classes (Chart 2: US stocks & bonds, EM stocks and Gold), all assets have produced positive returns over the last 12 months. This is quite a rare occurrence...

Chart 2: US Treasuries outperform equities, emerging markets and gold!

Global Macro Performance Source: Short Side of Long

Emerging Markets To Rebound?

Chart 1: Since emerging market equities have been under pressure...

Emerging Market Breadth Source: Short Side of Long

Emerging market equities have been under-performing since May 2011 and have essentially gone sideways since late 2009. This is a huge contrast when compared to US equities, however it offers a great investment opportunity. MSCI emerging market ETF index, seen in the Chart 1, remains in a consolidation zone and can be best described as an ascending triangle. Price resistance is around $45 while support seems to be found around $38 range. Recent sell of about 20% from intra day highs in early September, all the way to intra day lows into middle of December, has pushed breadth to oversold levels.

Chart 2: ...fund managers have dramatically reduced their net exposure!

Merrill Lynch Fund Manager EM Exposure Source: Short Side of Long

Not only have the breadth readings fallen, but hedge funds exposure has also been dramatically reduced. According to the recent January survey by Merrill Lynch, global fund managers are -13% underweight towards Emerging Markets. While sentiment is not as negative as it was in March 2014 (-31% underweight), it is still negative enough to indicate a possible bottom when compared to +17% overweight exposure we saw in August 2014 (just before the sell off). Interestingly, just as hedge funds started to get bearish in recent weeks, the price is starting a rebounded from its well defined technical support level.

Chart 3: Chinese equities are breaking out after years of consolidating

Chinese Equities Source: Short Side of Long

Two biggest Emerging Market weightings by region are China and South Korea. Chinese equities are currently outperforming the EM space, after years and years of under-performance. The index is now attempting to break out from a significant consolidation pattern, which resembles a very strong base. If the break out holds in coming days and weeks (without any sharp reversals), then a move towards 2010 highs is very possible very quickly.

At the same time, South Korean equities are now finding some kind of support, after under-performing in recent months. Technically, the trend line support in the Korean index has been tested many times before, so It is very important to watch how strong the rebound will be this time. If bulls are enthusiastic, we should see a sharp rise with strong similarities to 2010, 2011 and 2013 bottoms. On the other hand, a mild rebound followed by a reversal could be a signal of more trouble ahead.

Chart 4: South Korean equities have found support after a recent decline

South Korean Equities Source: Short Side of Long

Global Macro Update

I want to quickly apologise for the lack of updates. I've had an annoying flu over the last several days. The dry cough doesn't really want to go away either, so to be quite honest, it doesn't put you in the mood for work. Let us go through the markets to see some of the recent developments.

Chart 1: Despite constant bullish commentary not all is well in US stocks

Nasdaq 100 Source: Stock Charts

Run of the mill opinions in the consensus camp are that US equities will produce another decent performance in 2015, rising anywhere between 10 to 15 percent. However, if history is any guide, this might not be a slam dunk bulls expected it to be. Dow Jones is currently up 6 years in the row, so to go into a 7 year winning streak would be a feat not match since 1870s I believe.

In general, the year has started of on a bad note. Despite the fact that majority of the US indices made a new all time highs in late December, the leader of the overall bull market and an investor darling - Nasdaq 100 - actually failed to confirm this upside move. Furthermore, the tech heavy index  once again broke below its 50 day moving average over the last two trading days.

Chart 2: Majority of the international stock markets have been struggling

All Country World Index Source: Short Side of Long

And while some potential trouble could be brewing in the US, as seen in Chart 1, the fact is that majority of the international stock markets have been struggling since June of 2014. While the All Country World Index remains in the uptrend, mainly thanks to the outperformance by the S&P 500, consider that less then 25% of the global indices priced in USD are trading above their respective 200 moving averages. In other words, three quarters of global stock markets are currently in a downtrend.

Chart 3: For months USD strength has been nothing short of amazing!!!

US Dollar Sentiment Source: Fin Viz (edited by Short Side of Long)

If there is one asset class to blame for all of the recent weakness, it has to be the US Dollar. The rally in the reserve currency has been nothing short of amazing, and interestingly since the rally began in June of 2014, many asset classes have suffered. These include commodities such as Crude Oil, major foreign currencies such as the Euro and the Yen, emerging market currencies such as the Ruble and intentional share markets from Europe to Asia.

I believe that majority of the damage is now done. From contrary perspective, US Dollar could top out and starts its correction quite soon. Daily Sentiment Index recorded 98% bulls last week, only the second time it has done so in almost a decade. The only other time we had similar amount of bulls was in May 2010, just weeks before the greenback topped out as Eurozone bailed out Greece.

Chart 4: A correction in the US Dollar could help many different assets

Commodities & Currencies Source: Short Side of Long

If the correction in the US Dollar would occur in coming weeks, it might boast many different asset classes. Firstly, the dramatic crash in Crude Oil could finally find some sort of footing. Stabilisation in energy prices could help energy stocks as well. Foreign currencies such as Japanese Yen and Australian Dollar find themselves at major historical support levels of 120 yen and 0.80 cents, so both of these could rebound for awhile.

Emerging market currencies have been under pressure recently, so a peak in the greenback could stabilise these currencies and put a bid under the extremely cheap emerging market equity complex. Finally, as already discussed in previous posts, Gold has been holding up well despite the Dollar rally. Therefore, Dollar weakness might only further strength Gold as it attempts to break out into a new uptrend.

China To Outperform The World?

Chart 1: Recently, China is outperforming other major stock markets...

Global Stock Markets Source: Short Side of Long

Let us have another close look at the major stock markets of the world, priced in US Dollars and without dividend yield adjustment (total return). We got a grid of nine indices in the Chart 1. These include: World Index, USA, Japan, Germany, China, Brazil, Russia, India and South Korea. Let us go through some of these:

  • The world index has done so well due to strong performance out of the US. So far there are no major clues with the price action to signal that this trend is changing. Having said that, valuations are stretched and sentiment remains very bullish. Personally I am staying away.
  • Japanese equities have done well locally, however priced in US Dollar they have been consolidating for months on end due to major yen downtrend. Opportunity exists here, because eventually there will be a breakout out of this tight range. The longer the consolidation, the more powerful the break out.
  • German stock market has been consolidating sideways in local currency, but due to very weak Euro, Germany in Chart 1 is in a downtrend since the summer months of 2014. The index could improve if and when the Euro stabilises.
  • Emerging market equities as a whole have been under pressure in recent months. Russia and Brazil are suffering from falling commodity prices and locally weak currencies. On the other hand, the same weakness in commodities is actually benefiting both Chinese and Indian economies. China is now attempting to break out to multi-year highs.

Portfolio Update: Buying More PMs

Please note that this post are a little outdated due to recent holiday break. Usually I try to update the trades opened within the 24 hours from execution, but in recent times I haven't been anywhere near the office (apart from an hour here or there). I did open two new trades just before new years eve, so here is the update as well as brief thinking process.

Chart 1: Gold has shown incredible relative strength during USD rally!

Gold vs US Dollar Source: Short Side of Long

Unless you have been living in a cave or under a rock, you surely would have noticed the amazing strength US Dollar has been showing in recent months. Whether its against the majors like the Euro, the Yen or the Aussie; or EM currencies such as the Ruble or Real, the greenback has been making up some serious ground.

If we observe Chart 1, we should be able to see four major global macro asset classes: S&P 500, Treasury Long Bond, USD Index and Gold. Let us not focus on the stock and bond market for a second, and only pay attention to the recent action in the US Dollar (inverted on the chart) and Gold.

Majority of the time, negative correlation between the USD and Gold is high. So in plain English, usually but not always Gold moving up means US Dollar is moving down, and visa versa. What should grab all of our attention is how powerful the recent USD rally has been and yet Gold has held its own (observe the blue box in Chart 1).

Chart 2: Price is compressed in a technical triangle and its decision time

Gold COT Source: Short Side of Long

The fact that Gold has barley sold off and still remains above $1,200 per ounce, similar price where it traded 18 months ago, indicates relative strength and buying interest. Other commodities, such as Crude Oil, have not been as lucky with greenback moving up so high. Eventually the US Dollar rally will pause and take a breather, because nothing can keep rising vertically forever. It is my view that Gold will outperform when that time comes.

Now... most trades would like to know when that will happen? Because I do not have a crystal ball, I cannot answer that question like other so called "experts". But what I can say is that the current price action in Gold shows a major compression in the form of a technical triangle. This pattern is edging closer and closer to a break in either direction, which should give us further clues (refer to Chart 2).

I believe this break will be on the upside and I recently purchased some Gold via an ETF (NYSE Symbol: GLD). Depending on how the price behaves, this could either be just a short term trade or a longer term investment.

Chart 3: Miners have been terrible performers since 2011 & appear cheap

Gold vs Gold Miners Source: Short Side of Long

Furthermore, Gold Miners have become extremely oversold and now trade at dirt cheap valuations. When compared to the Gold price itself, miners trade at the biggest discount since 2000... around the time last major precious metals bull market started (please see Chart 3). This is even more true when we look at Gold Mining Juniors (NYSE Symbol: GDXJ), which are down by almost 89% from the highest high in late 2010. I've started a small position here to test the waters (similar to Russia and Uranium if you refer to Chart 4).

Also worth an important mention, I have closed my major hedge on Silver, which was originally opened in early July of 2014 just above $21 per ounce. This was one of my biggest trades in recent times and a gain of 24.5% is really really huge.

I plan to use these profits to purchase more PMs and average down my previous positions which sit under water. Moreover, despite a huge rally in the US Dollar, I will continue to hold all my cash in this currency for the time being. My shorts on the Aussie Dollar also remain in place for now. Finally, only other position I have opened recently is the Chinese H shares bet, but more on that in another post.

Chart 4: Recent additions to the portfolio are PMs & Chinese stocks

SSOL Portfolio Source: Short Side of Long

Disclosure: Biggest trades in the portfolio are long Precious Metals, long Chinese equities, short Australian Dollar and finally cash held in US Dollar currency.

Interesting Global Macro Charts

As we approach last couple of days in the 2014, I thought I would review the year in point form, over 12 simple charts. Obviously I cannot and will not cover everything that has happened, but lets give it a best shot:

Chart 1: US stock market has outperformed this year & over last 5 years

Developed Market Equities Performance Source: Short Side of Long

  • MSCI World Index had a decent, but unglamorous year in 2014. Majority of global equity markets were very weak in the second half of the year, while the US outperformed. Not only has the United States outperformed this year, but it has been the best performer since the bull market began in March 2009. Close behind the US, we find Hong Kong shares. This is mainly due to the fact that HK Dollar is pegged to the US Dollar.

Chart 2: Short term market breadth has rebounded from oversold levels

Short Term Breadth Source: Short Side of Long

  • Despite the fact US has outperformed rest of the world, there has been quite a lot of volatility since September of 2014. S&P 500 suffered its first 10% (intra day) correction in several quarters, while small caps sold down by about 20% (typical bear market territory). Internals suggest that over the short term perspective, 52 week new highs continue to dominate new lows while we have over 80% of stocks trading above the 50 day moving average. Meanwhile monthly AD Line remains quite low.

Chart 3: After a decent correction, small caps are ready for a break out!

Russell 2000 vs 200 MA Source: Short Side of Long

  • As already mentioned, volatility was high during the second half of 2014. US small caps felt the brunt of that correction and sold of by almost 20% into middle of October low. The index was trading about 10% below its 200 day moving average... nothing serious from a bear market perspective, but nonetheless a decent correction. In recent posts, I've been hinting at the strong tape, which now indicates a move towards record highs.

Chart 4: In 2014, Treasuries outperformed stocks as the curve flattened

US Treasury Yield Curves Source: Short Side of Long

  • Even thought it has been mentioned before, one interesting fact about 2014 is that US Treasury Long Bond outperformed the S&P 500 stock index. Not only that, but the outperformance was quite direct in the sense that the longer maturity bond markets rallied for almost the whole of 2014, with barley a pullback. At the same time, shorter maturity bonds sold off creating a strongest flattening since the Fed's tightening cycle in 2005.

Chart 5: Bond market is telling us about low inflation expectations... 

5 Year Forward Inflation Expectation Rate Source: Short Side of Long

  • One of the main reasons bonds outperformed in 2014, was due to the fact that just about everyone believed interest rates will rise. The reason consensus was completely wrong was due to the fact that not one major forecaster correctly anticipated a crash in Crude Oil prices. As energy prices almost halved, inflation expectations have now dropped to levels where the Federal Reserve could remain more dovish, as it worries about deflation. Let us remember that at current level, previous stimulus programs were started.

Chart 6: Hedge funds remain net long the Dollar, as prices rise vertically 

US Dollar COT Source: Short Side of Long

  • A slowdown in the global economy has pushed many other central banks to cut interest rates and even enter into various forms of quantitative easing measures. In recent months we have seen Mario Draghi telegraph that ECB is ready to start a bond buying program, while Bank of Japan doubled down on its own QE. All of this has pushed the US Dollar Index to an 8 year high. However, word of caution should be advised as just about every hedge fund remains net long the greenback. Possibility of a shake out is high.

Chart 7: After an impressive run, Sing Dollar seems to have topped out

Singapore Dollar Performance Source: Short Side of Long

  • Singapore Dollar has been one of the strongest currencies during the decade long US Dollar weakness. Despite a powerful set back in 2008, as the Global Financial Crisis unfolded, the Sing managed to recover and achieve impressive gains rising from $1.85 per USD in 2001, all the way to almost $1.20 per USD in 2011. However, that seems to have come to an end, and if we were to break a major support seen in Chart 7, there could be more downside to come.

Chart 8: Equal-weighted GEM currency index is breaking to new lows...

Emerging Market Currencies vs 200 MA Source: Short Side of Long

  • US Dollar hasn't only been strong against the Euro, Yen and the Aussie. It has absolutely hammered some of the emerging market currencies in recent months. The obvious one that comes to mind is the Russian Ruble, but many others have also suffered to a lesser extent. The equal-weighted emerging market currency index is currently breaking below its 2002 and 2009 bottoms. This has really impacted GEM equities (and ETFs such as EEM), when priced in US Dollars.

Chart 9: Recent US Dollar strength has not impacted Gold all that much

Gold COT Source: Short Side of Long

  • Consensus outlook is that Gold goes lower, much lower and that US Dollar goes higher, much higher. Maybe consensus is right. However, consider for a minute that USD Index has gone through the roof since July of this year and Gold still remains at around $1,200 per ounce - same level that it traded exactly 18 months ago. If and when greenback takes a breather and pulls back, maybe Gold could surprise on the upside. Technically, the price remains compressed in a wedge, which should see a break in either direction sometime in earlier 2015.

Chart 10: Gold mining shares are oversold & rest on major support level

Gold Miners vs 200 MA Source: Short Side of Long

  • One of the reasons why I think Gold might break upwards is because US Dollar rally is overstretched and overbought. Another reason is because Gold Mining shares are incredibly oversold, recently trading as far as 30% below its 200 day moving average. These producers also sit on an important support zone, where market participants have a strong memory of buying. Upside surprise is possible during early parts of 2015.

Chart 11: Brent Crude Oil has crashed from $115 all the way below $60!

Brent Crude COT Source: Short Side of Long

  • North Sea Brent Crude Oil prices have almost halved in the second part of 2014. Now, who would have predicted that in January of 2014? Just about nobody. While I mentioned that the strong US Dollar has not had that much of an impact on Gold, it certainly has pushed other commodities such as Oil down... and down a whole lot! Sentiment is now incredibly bearish and positioning extremely short, so a rebound is definitely possible. Nevertheless, it is important to let the selling completely exhaust itself first.

Chart 12: Agricultural prices are currently rebounding from major sell off

Wheat COT Source: Short Side of Long

  • Finally, we look at the agricultural prices. For majority of 2013 and 2014, agriculture has been in a major downtrend. However, since early October grains such as Wheat (seen in Chart 12), Corn and Soybeans have gone through a short squeeze rebound. Wheat prices have rallied by over 40% in only a space of a few months, a phenomenon that is not all to uncommon when shorts build to over 60,000 contracts.