U.S. Stock Market - Chinese Water Torture For The Bears

U.S. stocks were mixed yesterday, the last trading day of May. However, the closely watched S&P 500 Index and the Dow Jones Industrial Average both managed to close at all-time record highs. For bears like me, it was another week of slow torture as short S&P 500 positions continued to post losses. Much has been written recently about the general collapse of so-called "volatility" in stocks, bonds, and commodities across the globe. You can see one measure of volatility on this chart list below. The CBOE VIX Index (last line below) is now at 11.40. This measures the implied volatility in a basket of index options on the popular SPX contract at the CBOE. In the financial press, the VIX is sometimes referred to as the "Fear Index". When there is general unrest and multiple crises developing simultaneously throughout the world (as in the months following the Sept 2008 Lehman bankruptcy), stock prices often become volatile and the VIX index rises sharply in reflection of this volatility. The official CBOE VIX Index was introduced in 1993. This index climbed to near 90 when Lehman declared bankruptcy. However, when I traded in the OEX pit at the CBOE in the 1980's, I saw OEX Index (S&P 100) implied volatility near 200 during the crash week of October 1987. And on the low side, in the summer of 1984, I saw implied volatility in the OEX options near 8. Today's VIX near 11 is definitely on the low side historically, but the lack of actual volatility in recent stock price movements does provide some justification for this low VIX reading. I think it's safe to say that there is very little "fear" among investors right now. Complacency in the financial markets is relatively high, and most of Wall Street has declared "victory" for the central banks across the globe in their collective management of the post-Lehman crisis. The so-called Bernanke/Yellen "put option" myth is stronger than ever (meaning that the Federal Reserve will supposedly step in to support risk asset prices on any significant drop), and now Mario Draghi, President of the European Central Bank, is effectively communicating the same monetary stance for Europe. What could possibly go wrong for these "omnipotent" central bankers?

On the list below, one sector index stands out from the rest. The Philadelphia Gold/Silver Stock Index was down 3.58% last week, the only loser. Every other index below managed to creep into positive territory by Friday's close, although some were just barely positive on the week. 7 of the 18 indexes listed below posted gains on the week that were actually less than 1%.

Courtesy: Wall Street Journal Online Edition

For regular readers of this column, you already know my fascination with the gold market, especially over the last few years. In previous recent columns I have written that Gold is now the "most hated asset class on Earth", with most institutional fund managers and hedge fund traders clearly under-weighted or outright short in this key sector. The latest weekly data from the Commodity Futures Trading Commission overwhelmingly supports my view here. In the week ended May 27th, money managers trimmed their net-long position in Gold by 24 percent. Short holdings are now the highest in 15 weeks, and assets in exchange-traded products backed by the yellow metal are now at the lowest since 2009. The value of ETP holdings contracted $2.6 billion in May, the worst month since the end of 2013, The net-long position in Gold fell to 68,393 futures and options contracts in this latest week, while short holdings (betting on a drop in Gold) surged 72 percent, the biggest gain in six months!  

Could all these Gold bears be right? Not likely!

For my managed accounts I have been in and out of gold/silver mining stocks several times over the last year, with great success so far. Over the last couple of weeks, I have re-entered this sector slowly, at first, and then much more aggressively this past week In the interest of full disclosure, I own Goldcorp (GG), First Majestic Silver (AG), Endeavour Silver (EXK), and the Junior Gold Mining Shares ETF (GDXJ) in my managed accounts. Of these four trading vehicles, the Junior Gold Mining Shares ETF is the most interesting to me right now. Friday's price action (5/30) in this ETF was nothing short of spectacular! Despite the fact that Gold futures were down $5.30/oz (-0.42%), the GDXJ gained 2.13% on the day! And from its intra-day low, the GDXJ actually rebounded +4.37%. Admittedly, there may have been some end-of-month "marking" pressures by traders and investors in this relatively illiquid market, but I think there is much more going on here. At Friday's close, daily chart buy signals were triggered in my computer trading system for the GDXJ and also for Goldcorp (GG), the premier gold mining company. The GDXJ ETF is now down 81% from its all-time high at 179.44 as posted in December 2010. For comparison, the price of Gold has fallen about 35% from its record high as posted in September 2011. Depending upon who you talk to and what data you consider, I think it's safe to conclude that we are now operating in a negative "real interest rate" environment, at least through 5 years on the yield curve. And if you think inflation is greater than 2.50% (or will be soon), then negative real interest rates now exist through 10 years on the yield curve as well. Given the fact that Gold prices seem to do well in an environment of negative real interest rates (or the perception of negative real interest rates), then all the fuel is now in place for an unprecedented liftoff in Gold prices.

Bottom Line: I strongly believe that a major bottom is now in place for Gold/Silver mining share prices and that the GDXJ will more than double between now and year-end 2014.

Junior Gold Mining Shares ETF (GDXJ) 2-Minute Chart for Friday, May 30th, 2014

Junior Gold Mining Shares ETF Daily Chart with Computer-generated Buy & Sell Signals

Junior Gold Mining Shares ETF Weekly Chart

Gold ETF (symbol GLD) with Computer-generated Buy & Sell Signals (and a Perfect Head & Shoulders Bottom!)

Is Today's Plunge in Gold Prices The Start Of A New Sustained Slide?

Gold prices fell 2.2% today to a 15-week low. Today's loss was the single biggest dollar decline in the yellow metal so far this year.

Should gold bulls be worried that a major new downtrend has begun? The answer, of course, is yes! If you are long gold (or related investments), like I am, you have to be crazy not to be worried. However, I think today's decline in gold prices is a red herring. As mentioned in my previous column, dated Saturday, May 24th, I firmly believe that gold is the single "most hated" investment class on the planet right now (and therefore "under-owned" by almost every major asset manager). And one number clearly supports this view.

On Wednesday, May 21st, holdings in the SPDR Gold Trust, the largest bullion-backed exchange-traded product, fell to 776.89 tons, the lowest level since December 2008. Can we conclude from this fact that the "weak hands" have completely liquidated their gold holdings? You bet we can !!

Now, here is the REALLY interesting number. Assets in the same SPDR Gold Trust jumped 1.1 percent today to 785.28 tons, the biggest one-day gain since August 2011! The pendulum appears ready to swing the other way for Gold, with "smart money" now recognizing the "sold out" nature of this market.

In the interest of full disclosure, I aggressively added to my gold/silver mining share positions late today (EXK, GDXJ, GG, & AG). While I am unsure what the catalyst will be to trigger sharply higher gold prices, there are no lack of potential black swans on the immediate horizon to serve this purpose. The biggest trigger of them all, of course, would be a proclamation from China that the Yuan will be backed by Gold. If China wants the Yuan to displace the U.S. Dollar as the world's #1 currency (which it does), then this is one logical path to get it done! Is this even a possibility? I think it's more than a possibility, I believe it will happen within three years! Rumors, of course, will surface well before then, but first China needs to accumulate more gold.

Gold ETF Weekly Chart (symbol GLD) with Downtrend Line & Computer-generated Buy & Sell Signals

U.S. Stock Market - Leave The Dance With The One That Brought You

The more familiar saying is probably "Dance with the one that brought you", but the title of this column as written seems appropriate, especially given the subject matter here.

As a trader, investor, or adviser, if you followed the tried and true formula of "Don't fight the Fed", then you made a lot of money over the last five years in the financial markets. The Fed's quantitative easing programs have been hugely successful at inflating asset prices, especially in the stock market since March 2009. 

However, the "dance is over". The Federal Reserve has turned out the lights and left the party! Remarkably, no one seems to have noticed as yet, but this will soon change! And the consequences for equity markets won't be pretty!!

The Fed's monthly bond purchases have been "tapered" steadily over the last 5 months, and rhetoric from most Fed governors and from Chair Yellen herself is that monthly bond purchases will end completely before year end 2014. And Philadelphia Fed President Charles Plosser said last Tuesday that a strengthening U.S. economy may force the Central Bank to actually hike rates "sooner rather than later" to stay ahead of inflation. Affirming his hawkish stance, Plosser said that the Fed is at risk of falling "behind the curve" in its control of potential inflation if policy remains at its current loose level while the economy continues to grow and the labor market continues to improve. It's not hard to imagine a scenario where other Federal Reserve hawks like Plosser will soon be given the platform to express similar views.

Bottom Line: The U.S. Federal Reserve is quietly engineering a "normalized" monetary policy where bond purchases will soon end and short-term interest rates will then be allowed to rise from their current level near zero percent. I firmly believe that Wall Street has underestimated the Fed's resolve in its pursuit of this goal. In the interest of full disclosure, I am aggressively short the S&P 500 Index while also hedged with long positions in several precious metals mining stocks (AG, EXK, GG, & GDXJ) in my managed accounts. I think it could be argued that the U.S. Equity Market is the single "most loved" asset class on Earth right now, while Gold/Silver (and related investments) is the single "most hated" asset class.

The latest monthly Margin Debt data from the New York Stock Exchange is interesting and revealing. Margin debt fell for the 2nd straight month in April, another sign that U.S. stock prices could be vulnerable here to a major correction.

Russell 2000 Index Daily Chart with 50-day Moving Average Line and 3 Std. Dev. Bollinger Bands

DJIA ETF (DIA) Weekly Chart with Computer-generated Buy & Sell Signals

SPDR Utilities ETF (symbol XLU) Monthly Chart with Computer-generated Buy & Sell Signals

S&P 500 Index Monthly Chart with 50-Month MA & 3 Std. Dev. Bollinger Bands

U.S. Stock Market & Precious Metals - Ahead Of the Long Weekend

While I have never viewed myself as a "perma-bear" on the U.S. stock market, my negative stance on U.S. equity prices is well documented in this column over the last year. And I have been mostly bullish or neutral on Gold/Silver and related precious metal mining shares. On the surface, my market views in both these asset classes over the last year could easily have been recipes for disaster in my managed accounts. Fortunately, this was not the case. My largest managed account is currently up 32% year-to-date, and up 64% over the last 12 months. How is that possible?

The answer is pretty simple, but not easily duplicated. I accumulated large positions in precious metals mining shares last June and then again last December. And when these shares rallied sharply from panic lows during those two months, I liquidated 100% of these positions with gains of 50% or more on each stock. While I lost a significant percentage on a core "short" S&P 500 position over the last year, my trading positions in this same asset class were almost always positive. In other words, I've been flexible and even a little lucky!

On Wall Street and LaSalle Street, it is often said that "you are only as good as your last trade!" Fair or not, every trader, investor, and adviser faces this reality almost every day. My managed accounts are doing well this year so far, thankfully, and over the last 12 months my performance results have been exceptional, especially given my less than optimal market views all along the way.

However, I know from personal experience that success in the financial markets can be fleeting. Maybe I've been lucky. Maybe I won't be so flexible on the next major investment position that moves against me. And with more than 35 years of experience now, I know for sure there WILL be a next time when I commit to a major investment that moves against me. 

While I normally write this weekly column on the weekend, I made the decision to write this particular column tonight (Thursday night), ahead of the long Memorial Day Weekend because I think two major separate markets are now at key turning points. No one will be surprised to hear that I think that the U.S. stock market will soon turn down with conviction. Some of you may be surprised to hear that I have now accumulated a sizable position in precious metals mining shares (EXK, GG, GDXJ). If you've been around as long as I have, you already know that there are at least a dozen reasons to be bullish or bearish on any given market at any time. Great researchers (and especially chart technicians) can easily make a solid case for either view, depending upon their inclination at the time (or to support those companies or individuals that pay their salaries). It's sad, but true!

I wish I could tell you that my current market views are NOT biased by my positions, but you all know better! Hopefully, my positions reflect solid research and strong quantitative methodology. I have a couple of charts for you that may better illustrate my thinking right now.

For the U.S. Stock Market, here is the latest Weekly chart of the Dow Jones Industrial Average ETF (better know as "The Diamonds" symbol DIA). Please note the official sell signal from my computer trading system from last week!

Dow Jones Industrial Average ETF Weekly Chart (symbol DIA) with Computer-generated Buy & Sell Signals

And here are the latest monthly charts for the Gold and Silver ETF's (GLD & SLV). The way I have drawn the key trend lines, Gold has already broken out to the upside, while Silver is poised for a major upside breakout very soon!

Gold ETF Monthly Chart (symbol GLD) with Downtrend Line

Silver ETF Monthly Chart (symbol SLV) with Downtrend Line

U.S. Stock Market - Record Highs, But Then Down On The Week

The closely-watched Dow Jones Industrial Average, the S&P 500 Index, and the New York Composite Index all printed record highs last week, but each of them posted a loss on the week. Bulls and Bears were both equally frustrated last week.

Is it too early to call someone "Legendary" when he's earned 28.5% compounded annually over the last 20 years for his investors (net of fees!)? In addition to a stellar return for his investors, David Tepper, founder and chief executive at Appaloosa Management (a hedge fund) earned $3.5 billion for himself last year, which makes him the top dog in the hedge fund industry for 2013. I think it's safe to use the word "Legendary" when describing David Tepper in terms of his investment management skills. However, I don't think we can use the same word to describe his oratory skills.

At the SALT hedge fund conference in Las Vegas last week, Mr. Tepper used the following words to describe his recommended position in the U.S. Stock Market here:

“Don’t be too fricking long right now!”. “The market is kind of dangerous right now,” said Tepper. "I’m nervous.” 

Tepper's less-than-positive comments on the U.S. Stock Market probably contributed to last Thursday's slide of about 1% in most major averages. However, buyers were back on Friday and most major stock indexes recovered about half their losses sustained the prior day.

So where does that leave us?

The S&P 500 Index, the New York Composite Index, the Dow Jones Industrial Average, and the Dow Jones Transportation Average all remain close to record highs, while the Nasdaq Composite is down about 6% from its 2014 high, and the Russell 2000 is down about 9% from its record high. So-called momentum stocks, the big winners from last year, are down about 20% to 60% (or more) from their all-time highs, depending upon the name.

Bottom line: Large-cap stocks are showing remarkable resilience in the face of significant recent damage to small-cap stocks and momentum shares. However, I remain convinced that the entire equity market will move in sync on the downside very soon. While I am unsure what the negative catalyst will ultimately be, I strongly suspect that most investors will soon come to the realization the Federal Reserve is now in "tightening" mode. I feel that most market participants are underestimating Chair Yellen's resolve to end Quantitative Easing (at least for now). The vote on the latest $10 billion taper was 12 - 0 in favor. And the vote on the next $10 billion taper will almost certainly be unanimous in favor as well. Corporate earnings won't be strong enough to offset a Federal Reserve that is sending strong signals that "the punchbowl won't be refilled any time soon" and maybe the party is over!

Russell 2000 Index Weekly Bar Chart with 30-Week Moving Average Line

S&P 500 Index Weekly Bar Chart with 30-Week Moving Average Line

When The Soldiers Fall, How Soon Before The Generals Surrender?

One of the more interesting stories from last week is the extent of outflows (redemptions) currently being experienced at key exchange-traded funds (aka ETF's) like the Russell 2000 iShares (symbol IWM). This is the largest of the small-cap ETF's with $23.6 billion under management where outflows totaled $2.2 billion, or 8.6%, last week. The smaller leveraged cousin ProShares Ultra Russell 2000 actually lost an incredible 41.4% of its assets under management last week. While outflows in the largest ETF of them all, the SPDR S&P 500, weren't nearly as significant on a percentage basis (-1.77%), the total redemption (outflow) in the SPY ETF was still noteworthy at $2.8 billion last week. 

The Russell 2000 Index closed below its 200-day moving average line last week, and most technical analysts are all asking the same question. Will the small-cap stocks rebound or will large-cap stocks soon turn down to match the losses sustained recently in small-cap stocks? My best guess is reflected in my current position which is effectively a leveraged bearish short in the S&P 500 Index (using the SDS ETF). 

The Russell 2000 Index peaked on March 4th, 2014 at 1,212.80. It then fell almost exactly 10% to an intra-day low at 1,091.50 this past Friday, May 9th before bouncing about 1%. If the 5-year bull market in U.S. stocks is still alive, then small-cap and battered momentum stocks will rebound sharply in the days and weeks ahead, and the larger stocks will probably tread water or trend slightly higher. If a major correction is now underway, as I believe is the case, then the large-cap "generals" will soon fall sharply to join the small-cap "soldiers" in full retreat.

Russell 2000 Index Daily Chart with 200-Day Moving Average Line

Russell 2000 Index Weekly Chart with 20-Week & 40-Week Moving Average Lines

P.S. In my February 16th, 2014 column I wrote the following: "Gold/Silver mining stocks are probably "fairly valued" now and should therefore be scaled back or completely liquidated in most portfolios." Gold/Silver mining shares had rallied between 30% and 100% from their December 2013 lows to their February peaks, and my recommendation in mid-February was to take profits and wait for the next great opportunity in this volatile sector. While my computer system has yet to trigger any meaningful "buy" signals here, on Friday, May 9th I purchased several Gold/Silver mining shares for the first time since February. My allocation to this sector went from 0% to 14% this past Friday. While 14% may seem high, my allocation to this sector peaked at 40% in late December 2013. Right now, I like Silver more than Gold, but if one rallies then both will probably rally. And if/when the Silver ETF (symbol SLV) advances above it long-term downtrend line at $20/share, then upside potential for silver mining shares looks explosive. In the interest of full disclosure, I am now long First Majestic Silver (AG), Endeavour Silver (EXK), and Primero Mining Corp (PPP) in my largest managed account.

 

U.S. Stock Market - Record High, But NYSE Margin Debt Declines

The Dow Jones Industrial Average posted a new all-time closing high on Wednesday of last week (just barely), but the intra-day record high for the DJIA, as posted in early April, was never violated. Except for the New York Composite Index, no other major index saw record highs last week on either basis, intra-day or closing. In fact, the Russell 2000 Index is still about 7% below its record high as posted on March 4.

For the bearish camp, the recent rotation out of small-cap stocks into large-cap stocks has probably been frustrating. However, the really great bull markets almost always end with one last rotation into the so-called "blue chip" large-cap names. 

How are we to know when this dance is really done? I wish I could write that there was a magic formula and that I had it! Unfortunately, there is no magic formula, just a trail of bread crumbs that may show the way.

I've attached two charts here that may suggest that the music has already stopped. Weekly chart sell signals were triggered by my computer trading system at Friday's close in the blue chip drug giant Johnson & Johnson (JNJ) and also in the Dow Jones Utility Average.

Johnson & Johnson Weekly Bar Chart with Computer-generated Buy & Sell Signals

Dow Jones Utility Average with Computer-generated Buy & Sell Signals

It may be worth noting that NYSE Margin Debt exploded in recent months to a record high $465.72 billion as reported at the end of February 2014. Equally important is the fact that Margin Debt had expanded for eight straight months between July 2013 and February 2014 before finally contracting in March (the latest reporting period) by $15.44 billion to $450.28 billion. Movements in NYSE Margin Debt as plotted against the S&P 500 Index show a 96% correlation coefficient. I believe it was the great Stan Weinstein (author of The Professional Tape Reader) who once said that expanding Margin Debt is bullish for stocks (even at record levels), while contracting Margin Debt is bearish. This first significant monthly downtick for Margin Debt in March (as reported by the NYSE last week) may actually represent another important clue that the bull market in U.S. stocks is over!

Also, a daily chart sell signal was triggered on Friday in the Dow Jones Industrial Average ETF, better known as the Dow Diamonds (symbol DIA). 

In the interest of full disclosure, I currently hold a significant position in the double-short S&P 500 ETF, symbol SDS, in one of my managed accounts.

Dow Jones Industrial Average ETF (DJIA Diamonds DIA) Daily Bar Chart