Dollar Strength, Euro Weakness

Chart 1: Trade Weighted Dollar is pushing towards 52 week new highs!

US Dollar Performance Source: Short Side of Long

Quite a lot of interesting movements in the markets, however i have been quite busy as of late and unable to update the blog properly. Tonight we have a quick look at the recent currency majors. As we can clearly see in Chart 1, Traded Weighted US Dollar Index has been pushing higher in recent weeks and now sits very close to posting 52 week new highs.

One of the major US Dollar strengthening stories has been the weakening Euro theme. Recent economic data, which I always state is rather lagging at best, points to a slowdown in the overall Eurozone. We recently got a strong hint that German economy is quite close to a technical recession, while French economy is struggling just as much. Once again, Italy has already entered a recession and the debt levels in the overall union continues to rise.

Chart 2: Euro has been weak as of late as the Eurozone economy slows 

Euro COT Source: Short Side of Long

It seems the market has already been busy discounting these developments. Currency investors have been selling down the Euro very consistently since the major daily reversal occurred in early May on the day of ECB press conference. It seems to me that the market participants are pricing in a potential further ECB easing policies, just as the EU economy weakens.

Does that mean, one should rush out and short the Euro tomorrow morning? I am not so sure about that right now, even though I think Euro will be much lower in a year from now. Technically speaking, Euro has become quite oversold from the short term perspective, short positions continue to pile on and various sentiment surveys show that the current downtrend is very well “telegraphed” to all market participants. And when a trade becomes obvious to the public, it might be obviously wrong for the next little while, as potential mean reversion kicks in.

August Market Breadth

Chart 1: HL Ratio has recently fallen but stocks still remain in an uptrend

S&P 500 vs HL Ratio Source: Short Side of Long

The strong market recently went through a mini correction, so let us look at the recent market breadth developments. NYSE 52 week new highs & lows data showed a small uptick in new lows throughout the beginning of August, which has pushed the High vs Low Ratio lower, as can be seen in Chart 1.

According to this indicator the market breadth is now in neutral territory, neither overbought like it was in middle of July, nor oversold. Mind you, the last time market became extremely oversold was in October 2011 (almost three years ago).

Chart 2: Advance vs decline issues & volume recently became oversold

S&P 500 vs AD Line Source: Short Side of Long

One of the indicators that did show relatively oversold conditions was the 21 day advance vs declines together with individual up volume vs down volume (please refer to Chart 2). While the extremely oversold zone was not reached, the internals did fall towards 55% on the chart above.

Furthermore, the recent S&P 500 sell off registered 25% of the index at 3 month lows, 10% of the index at 6 month lows and 20% of the index components trading below RSI 30 (oversold). From a short term perspective, one could make a case that a bounce was due; however from a historical data we could hardly call that a wash out or capitulation.

Chart 3: Percentage of stocks above 50 MA became decently oversold

S&P 500 vs Stocks Above 50 MA Source: Short Side of Long

One of the simplest breadth indicators out there is the percentage of stocks trading above a certain moving average. I prefer to focus on two most used ones, 50 day MA for medium term breadth readings and 200 day MA for long term breadth readings.

Chart 3 shows that we became decently oversold into early August, with the indicator falling as low as 23%. This was the lowest breadth reading since November 2012, just as the recent leg of the bull market got underway. As the index remained above its uptrend line and rebounded, we are currently seeing an improvement in breadth readings. It will be very important to see how the rebound plays out as well as how many S&P components follow through on the upside.

It is also just as important to note that while medium term breadth did became oversold, long term breadth has been overbought for quarters on end and is currently sitting in the neutral zone.

Chart 4: Recent correction has so far weakened uptrend participation… 

Market Sector Breadth Source: Short Side of Long

We finish of the breadth summary by looking at individual sectors within the S&P 500, as well as their short term, medium term and long term breadth readings. We should be able to observe quite a few characteristics from the table above.

Firstly, the recent sell off has impacted the participation of medium term breadth readings, but not so much the long term. Therefore, a stronger sell off and a lower low will be needed to possibly change the trend.

Secondly, so far the short term breadth shows that there is a powerful rebound happening. Just about all major sectors, other then Energy and Gold Miners, are participating in a very meaningful way. A quick reversal in these short term numbers could signal a second wave of selling, so keep a close eye on this indicator.

Chart 5: …however Gold Miners participation is highest in three years!

Gold Miners vs Stocks Above 200 MA Source: SentimenTrader (edited by Short Side of Long)

Finally, we focus on the Gold Mining sector. I find it very interesting that 78% of the Gold Mining Index components are now trading above the 200 day moving average. So what does this mean? Well, that is a million dollar question.

Bears would claim that miners are most overbought since late 2011 peak and therefore should be primed for another correction. On the other hand, bulls would claim that miners participation is the strongest in thee years, just as the index attempts to breakout from its basing pattern. In my opinion, the wisest thing to do is to sit still and wait for the market to reveal its hand. Also be very well aware that a false breakout could occur in either direction as well.

Stocks vs Gold: Three Years On…

Chart 1: Three years ago, in August ’11 Gold peak & US stocks bottomed

S&P 500 vs Gold Source: Stock Charts (edited by Short Side of Long)

With only two weeks left in August 2014, I thought it was appropriate to revisit an interesting inflection point that occurred exactly three years ago. In August 2011, US default worries and the ongoing Eurozone Crisis sparked a panic sell off in the S&P 500 and many other stock markets around the world.

Interestingly Gold acted as a safe haven at the time, moving in an opposite correlation to global equities (refer to Chart 1). As the mini-crisis played out by months end, just about all traders were extremely bullish on Gold and overly bearish on stocks. It was back during those market conditions that I initially shorted Gold and later Silver as well, while calling a potential bottom in the stock market (sentiment posts here and here).

Side note: all the links go back to the old blog.

Chart 2: Over the last three years Precious Metals have under-performed

Global Macro 3 Year Performance Source: Stock Charts (edited by Short Side of Long)

Three years have now pasted since and precious metals have dramatically under-performed, while US equities have been the best major performing asset class. In Chart 2 we can clearly see what a powerful bull market S&P 500 has been in, posting gains of over 75% in the last three years. At the same time, Central Fund of Canada ETF (50% Gold and 50% Silver) has pretty much halved in value.

Obviously, traders who focus on shorter term horizons and follow trends will not give this post all that much attention. However, investors who tend to chase out of favour assets in a contrarian manner and purchase value at cheaper prices as longer term bets, should be looking at Chart 2 with an understanding that sooner rather than later, US equities will stop outperforming the overall global macro space. At that point, the question will arise as to where would some of the money flow towards? Which asset classes could would be favoured by liquidity next?

Chart 3: Historically, S&P 500 rarely offers better returns over 3 years… 

S&P 500 Performance Source: Short Side of Long

When we look at the 3 year holding investment history over the last five decades for both S&P 500 and Gold, I could come to plethora of observations. I’m sure you could come up with many more. Right now, I will focus on what some of the investors are currently saying as the conventional wisdom.

Stock bulls, and there is an abundance of the, would claim that the US equity market has broken out to new highs, indicating a start of a new secular bull market like in 1980s. These same investors will also claim that Gold’s magic ten year period has now ended and the best case scenario for the yellow metal is to move sideways (like it did during 1980s and 1990s).

While I do not share the same enthusiasm towards stocks and pessimism towards Gold, I do admit that these investors could very easily be correct. Nevertheless, to them I say that rarely does the S&P 500 offer better 3 year rolling returns then we have witnessed in the last few years; and at the same time rarely does the price of Gold offer such awful returns as we have witnessed in that same period.

Chart 4: …while Gold rarely becomes more oversold then it currently is!

Gold Performance Source: Short Side of Long

To play devil’s advocate, I could just as easily make a case that according to various valuation metrics, US stocks are currently very much overvalued. Certain metrics even argue that future projected returns over the next several years and even up to a decade could very well be flat.

With that in mind, one could also make a strong case that the current sell off in Gold usually does not get too much worse relative to its historical periods of underperformance. In other words, while it is possible for price to go down lower, downside should be rather limited as this asset is already extremely oversold.

I also do not see a reason why one could not entertain the idea that the recent Gold sell off is just a correction within secular bull market, with higher highs and higher lows still intact. If we observe Chart 4 very closely we should be able to notice that during 1970s, Gold tripled in value twice over a three year rolling time frame. Now that is what a true bubble looks like! Even though Gold bears have called the recent 2011 peak a bubble, according to this historical chart it would not qualify as one.

Gold Miners Update

Chart 1: Gold Miners have performed quite well since late May bottom

Gold Miners Source: Bar Chart (edited by Short Side of Long)

Yesterday I had quite a few conversations with various newsletter writers and traders about the same  topic: Gold Miners. It seems that a lot of market participants are paying attention to this asset right now, so I thought I would write a very quick update on the topic as well.

As we can clearly see in Chart 1, Gold Miners have performed quite well since the late May bottom. The initial rally in June has been consolidating in the month of July and August, as Gold Miners now find themselves at a first major resistance zone. Silver miners have also been doing just as well.

Chart 2: Gold Miners have been outperforming Global Macro assets!

Gold Miners vs Global Macro Source: Stock Charts (edited by Short Side of Long)

Gold Miners have started to show improving relative strength against major global macro asset classes (please refer to Chart 2). What does that mean? Well in plain English, Gold Miners are holding their own while the rest of the assets from global equities to junk bonds and from REITs to   agricultural commodities have been experiencing corrections.

From the price perspective, S&P 500 is currently testing its support trend line; while HUI Gold Miners Index is testing is resistance trend line. Gold bulls claim that a potential reversal in this trade is about to occur, where US equities enter a bear market while Gold Miners enter a bull market.

Furthermore, it needs to be stated the outperformance of Gold Mining shares is actually occurring during a strong US Dollar rally, which usually tends to be a headwind for the overall precious metals sector (refer to Chart 3). So far the rise in the Dollar can mainly be attributed to a weak Euro and has not impacted the Gold mining sector (yet).

Chart 3: US Dollar rally has not put any major pressure on miners (yet)

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

Finally, when we look at breadth reading in Chart 4, we could conclude that Gold Miners are showing very strong market participation. Now, I understand that precious metal bears will conclude that previous high breadth readings have led to sell offs. So why would it be an different this time around?

However, historical observation of this indicator shows that overbought readings very common during bull markets, where it is healthy for as many stocks as possible to be participating in the uptrend. If Gold Miners and the rest of the sector decide to break out on the upside into a new uptrend, high breadth readings should be considered a positive and not a negative.

Chart 4: Overbought breadth or a signal of strong sector participation?

Gold Miners Breadth Source: SentimenTrader (edited by Short Side of Long)

Bearish Agricultural Sentiment

Chart 1: Agricultural Index has become extremely oversold as of late

Agricultrue Source: Short Side of Long

Agricultural prices have been bashed, smashed and trashed very hard over the last several months. It is probably the worst performing sub-sector of the overall macro space. During the last few weeks we have covered these conditions and focused on the oversold grain prices as well as the battered down Cotton. Now we look at the overall complex as a whole, as it continues to suffer and moves towards 52 week new lows.

Quite a few readers have been asking for a new update in this sector. From the price perspective, there isn’t much to say right now that hasn’t already been said before. The key in buying a bottom is to let the selling pressure exhaust itself. We are definitely coming closer to that point. So far, I have not purchased any new agricultural positions just yet, but I am getting ready to do so soon enough.

As I was reviewing sentiment charts from SentimenTrader, I noticed that 5 out of 6 major agri-commodities are hated right now. And the one thats not hated, (coffee) already doubled earlier in the year. Last time we had majority of ags on pessimistic sentiment was in late December and in January, after which RJA rallied 16% in three months. However, this time around instead of an intermediate bottom, there is a possibility that we could be at a final bear market low.

Chart 2: Agricultural commodities sentiment is very negative right now!

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

The Ageing Bull Market!

Chart 1: Officially 2nd oldest bull market in 85 years. How much longer?

Aging Bull Market Source: Short Side of Long

The current bull market is now 283 weeks old, which is equal to about 5 years and 5 months. The ongoing bull market is currently making history against all those who doubted it (me included), as well as against any kind of long term fundamental economic and market data. Artificially goosed up by money printing, this is now officially the second oldest bull market in 85 years. How much longer?

Well, that is hard to answer. The average bull market lasts about 165 weeks, which is about 3 years and 2 months. Now, investors should consider that this bull market comes only second to the great roaring 1990s bull market which occurred during strong growth, fundamental tailwinds such as favourable demographics and falling interest rates. Furthermore, the great 1990s bull market occurred during an ongoing 20 year commodity bear market, with Crude trading at $10 per barrel.

Global Macro Picture

Chart 1: Sometimes it’s easier to look at one chart of all the major assets

Global Macro Source: Short Side of Long

We have had some interesting market movements as of late. Instead of going through and discussing each and every move for a major asset class, sometimes it is just easier to look at one chart for all the major assets and quickly summarise the global macro conditions. Here are some observations:

  • S&P 500 is barley holding on its uptrend line by fingernails
  • DAX 30 has broken its uptrend in strong fashion this month
  • Despite all the China negativity, HSI is posting 3 year highs
  • Euro could be r-entering another leg down against the USD
  • Huge move coming in the Yen, as the volatility has been quiet
  • Australian Dollar has found a new home below parity vs USD
  • After being most hated asset of ’13, bonds have rebounded
  • Huge move coming in Oil as its been consolidating for years
  • Prolonged consolidation is coming to a decision point in Gold

Positioning In Options

Chart 1: Options traders are starting to get negative on US equities

Put Call Ratio Source: Short Side of Long

There are various options indicators out there. Then, there are various ways of presenting those indicators and the message they give us. Therefore, the chart above is just one way of looking at the options market.

Indicator seen in Chart 1 is a CBOE Put vs Call relative ratio. The reason its called relative is because data is compared against to recent timeframe. At present, the indicator is signalling almost 20% more put vs call buying relative the last 6 month time frame. These kind of levels are associated with intermediate degree equity bottoms.

Last week I signalled that equities were becoming oversold from the short term perspective, particularly in Eurozone. With S&P 500 putting in reversal on Friday and holding the trend line seen in the chart above, one could interrupt the current PC Ratio levels as overly negative, giving us a short term buy signal.