SuttonWatch.Net: 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.