"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Monday, May 14, 2012

HUI Fails to Confirm the Upside Reversal Day of Last Week

Today's selling downdraft in the broader US equity markets, when combined with more of the risk off trades, derailed the tentative Upside Reversal Day posted last week in the HUI. You might recall that I mentioned it might be prudent to get some additional upside price action before becoming too convinced that we had a sure bottom in the mining sector shares.

The reason for this is that far too many of both these upside reversal patterns and downside reversal patterns are being generated by the nature of computer algorithmic trading. In times past we would see these patterns form ONLY AFTER A PROLONGED UPTREND OR DOWNTREND when prices had reached extreme levels of valuation.

Commercial traders, whose business deals with the actual physical commodity and who understand "VALUE" better than most traders, would be moving in to cover existing shorts in large size/instituting fresh longs or liquidating long positions/instituting fresh shorts in large size when they spotted these extreme valuation levels. Their buying or selling would be of such magnitude that the market would then reverse course.

Today's BRAINLESS HEDGE FUNDS have no such understanding of VALUE nor do they even make any attempts to discover what value might be. How can they when you have a collection of mindless machines doing the thinking for this lazy group of traders? To decipher value one must have a thorough FUNDAMENTAL KNOWLEDGE of the market that they trade. Such knowledge takes many years to formulate particularly during which the traders gets to witness firsthand changes in supply/demand structures affecting the market(s) that they choose to trade.

What we get nowadays a result of these runamok algorithms, is every single machine on the planet buying or selling merely because the last trade price happened to either go up or down. There is no understanding of WHY there is buying or selling. All anyone knows is that a "bunch of other machines" are buying or selling so just go with them.

The result is what we saw last week in the HUI. Apparently there was enough profit taking in the ratio spread trade that it forced the shares higher. Once a technical level was taken out on the upside, additional algorithm trading then took over to take the HUI through the previous day's high closing a chart gap on the Daily in the process.

However, and this is the key - there was little to no SERIOUS Followthrough buying that occurred to thereby validate the signal. The result was that the buying present last week evaporated in the face of fresh selling.

The close today was not at all constructive with the index not only taking out the previous LOW of that reversal day but also CLOSING below that level. This gives the bears fresh fodder at this point so we will now have to wait to see subsequent price action to get a hint or sign that a serious bottom is at hand. If the market can quickly reverse to the upside and take out today's high, we might have had another one of these all-too-frequent head fakes.

Let's see what we get moving forward this week.

Gold Probing the $1550 Level

Gold has continued to see further selling in today's session with traders once again exiting "RISK" trades in favor of the "Growth Off" or RISK AVERSION trades. Long commodity positions, along with long equities, are getting liquidated with money flows heading towards US Treasuries in general. This can be seen in the CCI, the Continuous Commodity Index, which is moving lower while bonds move higher, taking interest rates down even further as the yield on the Ten Year is now down below the 1.80% level. Remember, there has not been a week yet during which this yield ENDED BELOW that critical level.

Gold's move down towards $1550 has in the past attracted very substantial Central Bank gold buying. Hopefully this will remain the case as the market is now pushing towards the lower band of an eight month long trading range. If speculative selling of the metal is not absorbed down here and the market were to break below $1520 and fall to recover quickly, it will more than likely drop below $1500.

My own thinking on this is that the markets are moving so quickly away from risk and out of basically everything except Treasuries or cash, that the Fed is going to have a major problem on their hands if they do not soon give some sort of signal that they are preparing to act to stem the deflationary decline. JP Morgan's $2 Billion credit derivatives-based loss has spooked the banking sector and that is the one sector that the monetary officials do not want to see going from bad to worse. Keep in mind that back in 2008, once Lehman went under with Bear Stearns following, it was the woes of the financial sector that pulled the rug out from under the entire US economy and the US equity markets. The Fed is well aware of this and I suspect will not want to wait too long before beginning to make some noise to keep the markets from becoming too roiled.

The bank shares might be the first thing to watch for some signs of further monetary accomodation as one can be assured that there are lots of phone calls and discussions underway even now. If they were to show some signs of bottoming, it might be a hint of things to come.

Meanwhile gold will need to get at least back above $1600 to give the bulls some breathing room. With the Commitment of Traders report showing the NET LONG position of the big hedge funds at a 42 month low, there remains plenty of room for them to come back into this market and juice it higher but they need some sort of signal to tell them to do so. Right now they are not getting it; if anything, some hedge funds are now moving to the short side of gold along as well as a host of various other commodity markets.

Incidentally, China is lowering their bank reserve ratio requirements, a sign that they are responding to slowing growth there as their export markets are impacted by the woes in the Eurozone and the anemic growth in the US. This is one of the signals that copper has been sending for a while now as it descends in price. Were copper to finally show some signs of a bottom, that would be constructive for silver which is testing chart support down near the $28 level once again.