Silver Investors Shock and Horror, Where Next?

By: Clive_Maund

Silver newbies discovered to their shock and horror last week that silver can actually go down as well as up, and even worse, that it drops a lot faster than it goes up. We were partly fooled ourselves last week by the seemingly bullish COT figures, but not to the extent that it stopped us implementing protection in the form of Puts, or Calls in silver bear ETFs such as ZSL. 

After last week's devastating plunge the silver battlefield is littered with the corpses of silver longs, with those who are still breathing being exhorted to "put their shoulder to the wheel" again by undismayed silver cheerleaders, who are hailing a "fantastic buying opportunity" for the ride of a lifetime. Is it?? - let's see what the charts have to say... 

On its 6-month chart we can see that after hitting the top of its intermediate trend channel in the high $40's, where it showed signs of running into trouble that we will look at in more detail on a one-month chart, silver suddenly turned tail and plunged, crashing through the lower support line of the channel as if it wasn't there. This near vertical plunge took the form of a rare and very bearish "4 Black Crows" that we will also delineate on the one-month chart. By Friday silver had gotten deeply oversold and the steep downtrend paused at the support level shown, with a more bullish long-tailed candlestick appearing on the chart. The cheerleaders are certainly right that silver is now short-term oversold, and some sort of rally looks likely soon, probably after some choppy action near the upper support level on our chart - and it could drop even lower towards the lower support level shown and its 200-day moving average before a significant rally occurs. 

Should such a rally get going it will of course be hailed by the cheerleaders as the "start of the big one" and it could be if the dollar tanks, but what concerns us is the bearish 4 Black Crows" candlestick pattern that occurred last week, which portends a more prolonged and severe decline - possibly even a bearmarket. Yet how can that be? - isn't the Fed's reckless and relentless money printing and zero interest rate policy pushing the dollar ever close to the abyss and the US towards hyperinflation. Yes it is, but do you think the Fed doesn't know that? These people should not be underestimated - keep in mind that they engineered a financial system which essentially turned the rest of the inhabitants of this planet into servants of the United States, with their reserve currency status for the US dollar, and have cajoled the rest of the world into handing over its savings to be used to support a sumptuous standard of living in the US and a big miliary to police the globe in furtherance of US interests. So put yourself in their shoes now and imagine that you are faced with a collapse of both the US dollar and the Treasury market - what's the best way to prop up both and buy some time? Give you a clue - think 2008. Got it yet? - well in case you haven't I'll spell it out for you... 

With its back to the wall everyone expects the Fed to wheel out QE3 in a timely manner. If they don't what will happen? - the first thing that will happen is the threat of higher interest rates will cause the commodity markets and stockmarkets to tank - and where will the liberated funds go? - into the dollar and Treasuries of course, not because they are good investments, but because most investors and fund managers are too dumb and unoriginal to think of anything else. Commodities and stocks have not been going up because of economic recovery because there is no real economic recovery, much less because of genuine demand for end use - they have been going up because of the huge leverage employed in these markets by speculators, who have been borrowing money at zero or near zero rates and turning round and pyramiding speculative positions, as set out by smooth talking Karl Denninger in his timely article But It's All Money Printing . 

As soon as these markets percieve a threat to the supply of cheap money they will tank and the drop will be magnified by margin calls against hordes of distressed speculators. The Fed can quickly achieve this result by making noises to the effect that it is not going to do QE3, and then do it anyway a little later to save its cronies in the big Wall St banks from the threatening consequences of a derivatives implosion. When they do QE3 after all, the commodities and stocks roadshow can get rolling again. Just imagine how much money will be made by the elites who are in on this game plan - it certainly helps to know which big levers are going to be pulled and when. We don't that this is going to happen for sure of course, it is a hypothesis, but the first whiff of it would certainly explain the bearish action in commodities last week. 

Getting back to the charts we will now look at recent action in silver in more detail on a 1-month chart. This chart demonstrates the power and utility of candlestick charting, for on it we can see clear warnings of an imminent reversal occurring very close to the highs, which is why we took defensive measures such as buying Puts, and Calls in bear ETFs, to protect open long positions in silver. For as we can see two pronounced dojis formed during the weeks of the top. Dojis are where the open and close for the day occur almost at the same level and indicate a condition of stalemate, which, occurring after a long runup, often precedes a reversal. Last week we saw 4 heavy down days in succession, with the price opening near the previous day's close and falling heavily to close not far from its lows for the days. When you see 3 such days in succession it is known as "3 Black Crows" and it is bearish in purport, as it is a sign of heavy and determined selling. Four such down days in succession, "4 Black Crows" are much rarer and correspondingly more bearish. However, by completion of the 4th day, bearish or not, the market has obviously dropped a lot and become heavily oversold short-term, so it shouldn't be chased down - what normally happens is a relief rally that often retraces about half of the drop before renewed decline to lower lows sets in. So you might want to keep this in mind as the cheerleaders become more vocal on a bounce in coming days/weeks. 

What about the latest COT chart? As mentioned in the opening paragraph we were thrown somewhat last week by the bullish looking COT chart, but the COTs didn't save silver which plunged, bullish COT or not. The latest COT chart looks a lot less bullish than the one last week. This is because despite silver having fallen heavily for 2 days by last Monday's close, the Commercial short and Spec long positions had barely moved, and we would have expected them to decrease significantly if silver was set to reverse to the upside soon. So on the basis of these erratic indications, we are going to attatch somewhat less importance to the COT figures for silver going forward, especially after them being grossly misleading last weekend.

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Is It Time to Buy Silver?

By: Jared_Levy

Unless you have been hiding under a rock, you probably know that silver has had a major correction over the past week. The precious metal plummeted about 30% from a high of almost $50 an ounce to less than $35 yesterday. This six-day drop is one of the largest since 1983.

Silver has given back just about all of its gains for the past month and some traders are thinking it might be time to get long. But before you run and buy silver, there are a couple things to consider.

Forces That Move Silver
The U.S. Dollar
There are many theories on why this sell-off is happening. Obviously, any real strength or even support in the U.S. dollar will generally be bearish for precious metals like gold and silver. This is mostly because the U.S. holds the largest stockpiles of these metals and they are traded in U.S. dollars globally. Even though gold is more of a recognized currency, they both have sensitivity to changes in the U.S. dollar's value.

The falling U.S. dollar has recently leveled out. That means we've seen a small correction in dollar-denominated commodities and metals overall. Earlier this week, the European and London central banks held their rates steady. The ECB also hinted that they may not raise their rates next month either. This is good news for the U.S. dollar.

The U.S. dollar traded higher late in the day yesterday and sent other dollar-sensitive commodities like oil and even stocks much lower on the day. Oil had its largest percentage drop in three years. If you don't believe that the dollar is in control here, think again...

For now, it seems that the U.S. dollar will continue to be relatively weak. The rally seems more like a short-term bump rather than a long-term trend. Current Federal Reserve policy puts general downward pressure on the U.S. dollar.

Gold/Silver Ratio
Then there is the historical ratio between gold and silver. A good "average" ratio of gold to silver is about 55, according to many experts. That means 1 oz. of gold should buy 55 oz. of silver. The gold premium is because there is much more silver on this Earth than gold. Even though silver has industrial uses beyond gold, there is a global desire, respect and currency reserve with gold that silver just does not have.

If that ratio gets extremely high, like 100, that means that silver is cheap relative to gold and may be a good value. If the number is low, silver may be getting overly expensive.

On April 28, the gold-silver ratio was about 30, relatively low. Now the ratio is back up around 43, still low, but not extreme. I'd like to see that ratio above 48 if I were thinking of buying.

Using current gold prices of $1,494, that means a drop in silver prices to $31.12 an ounce. Remember, though, that ratios are a two-way street. That means gold prices can climb, too, putting the ratio closer to its "good average."

Technicals
Technical formations also play an important role in finding buy and sell points. Looking at iShares Silver Trust (SLV:NYSE), you can see the sharp sell-off on the right side of the chart. In my opinion, it seems that we are nearing a short-term bottom. The lower Bollinger band (gray area) was just broken yesterday, as prices dipped below the lowest level of the band. This is generally an indicator of an oversold condition just before a bounce.

I also would look to the 50% Fibonacci retracement line (dotted) of about $33 for support. (For more info on Fibonacci retracement lines, read this Smart Investing Daily article.) The danger here is the fact that we have broken below the 50-day moving average, which is not good for the bulls. To solidify a strong trend, I would like to see the price of SLV get above that 50-day moving average, at about $38.

You can't simply view the charts in a vacuum. There are other things "manipulating" the market.

Margin Requirements
The manipulation here is the recent 500% jump in margin requirements for silver futures. When you buy a futures contract on silver (one futures contract is for 5,000 ounces of silver), you are required to put up a deposit called "margin." That initial cost has risen tremendously as of late. They have also raised the amount of margin you have to pay once you are already in the trade and it starts to go against you.

If traders cannot meet the new margin requirements, they are forced to sell their contracts. This new rule will deter new buyers.

It's like someone raising your rent from $1,000 to $5,000 in a month. Higher margin requirements can also make a sell-off worse, as contracts are sold to cover losing positions. These requirements affect everyone from individual traders to hedge funds. This is one of the main reasons why silver is making 10% moves daily.

Now in all fairness, the dollar cost of margin will rise as the price of silver rises, but the CME (COMEX) has increased the margin requirements abnormally in the past week and will raise them again Monday.

May traders are selling ahead of this hike.

ETFs
ETFs like the SLV hold actual silver and futures contracts. At present there are about 600 million ounces of silver held by ETFs. When traders begin to sell shares of an ETF like SLV, the ETF may sell silver futures to keep everything in balance. About 6 million ounces of silver have exited ETFs in the past week.

ETFs can also add to the domino effect, both long and short. But remember that stocks usually take the escalator up and the elevator down!

Once the hype settles down and the CME completes its margin increase on Monday, we should see silver prices stabilize. From my perspective, I see $33 as a level I may cautiously begin to buy. If silver breaks below that level, I think support will be around $29 until the Fed decides it's time to cool inflation.

I am sure that Ben B. was feeling quite happy with the corrections in gold, oil and silver this week. Perhaps Americans will feel some reprieve as well...

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Small Cap Stocks at a Critical Juncture

by Bespoke Investment Group

The small cap Russell 2000 index finds itself at a critical juncture to start off the week. As shown in the chart below, the index is currently sitting just above its 50-day moving average (DMA). Whether or not the index can hold this level will help to dictate short term sentiment towards the smallcaps in the days ahead. 

Adding to the importance of the 50-DMA is the fact that breadth in small caps has been weak. While the Russell 2000 index made a higher high in the most recent rally, its underlying breadth lagged and failed to make a higher high. As long as the index holds above the 50-DMA, you won't hear many people grumbling about the negative divergence in breadth. If the Russell does not hold the 50-DMA, however, you can expect to see a lot more people turn negative on small cap stocks.

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Commodities Crash Pain Eased by Dividends From Large-Cap Stocks

By: Money_Morning

Jon D. Markman writes: After several weeks of quiet in the markets, economy and geopolitics, last week exploded with excitement and volatility, seeing commodities tumble and large-cap stocks end strong.

It started with news that Seal Team Six had taken out Osama bin Laden in Pakistan and ended with silver crashing 26%, crude oil plunging 15%, and corn down 6.5%. Determining how these events are connected will provide historians with rich material to ponder in years to come.

It is very rare to see the prices of unrelated commodities plummet like that in a single week. It's an event that might occur once in a generation. Now you can say you were there.

When you consider that these commodities are all inputs for industrial manufacturers, you would intuitively imagine that stock prices would jump on the news. Suddenly the prices of two major expenses -- raw materials and fuel -- are lower. But that's not how it worked out.

Large U.S. companies' shares fell by 1.5% over the week, while small companies' shares sank 3.6%. Overseas markets fell 3.5%.

The big news of the week was in the commodity pits, where crude oil futures plunged under $100 a barrel for the first time since February. On Thursday alone, gasoline futures plummeted 7%, heating oil fell 8% and natural gas fell 7.9%. Over in the metals, gold sank 2.7%, silver sank a whopping 12% and even palladium sank 4.5%.

The grains and softs were in no better shape. Corn fell 2.8% despite a difficult start to the growing season in the rain-soaked southeast, while oats fell 3.6%, rough rice fell 5.6% and cotton fell 3.3%. All commodities are represented in the PowerShares DB Commodities Index Tracking Fund (NYSE: DBC) chart, above, which broke down in a big way.

The main issue that traders were dealing with Thursday, and really the spark that puts the whole engine in motion, was the sharp advance in the value of the dollar. As you can see in the accompanying chart, the U.S. dollar gapped up Thursday in a way very reminiscent of the last two times that it shot back to its declining 150-day average.

I've read a lot of explanations as to why the dollar rose, but it was probably stirred by the European Central Bank's surprise decision not to raise interest rates.

The last two times the dollar jumped like this led to a prolonged commodities price decline and more important for us, a multi-week decline in stock prices. Surely you remember the tough month of August last year, as well as the difficulties of last November. They both started with a dollar spike higher that looked very similar to Thursday. For reference, check out the chart below.

Large-Cap Stocks: Strength in Numbers

Showing resilience during a tough week was a group of stocks that has not been heard from much in the past two years. A group that has been standing on the sidelines of the big dance, waiting for someone cute to tap them on the shoulders and pull them in.

I'm talking about large-cap stocks, like the dividend-paying defensive stocks in the telecom, drug and utility sectors, such as AT&T Inc. (NYSE: T), Eli Lilly & Co. (NYSE: LLY), Exelon Corp. (NYSE: EXC) and the enigmatic, suddenly awesome Intel Corp. (Nasdaq: INTC), which is almost hard to categorize these days. The chipmaker is acting as if it is high on Red Bull and pixie dust -- the surprise leader of a fairly moribund technology sector.

Everyone who thought Intel would be up four times more than Apple Inc. (Nasdaq: AAPL) three weeks after each reported Q1 earnings, as shown above, raise your hands. I don't see too many. Not sure what this means, but look back a few days to find my 12-year chart of Intel and you will see it is lifting out of an excruciating downtrend now and has a legit shot at $30 if the animal spirits continue to stir.

That was the 2002 high, though of course it would have to triple from here to get back to its 2000 high. The $30 level is very possible, as Intel is one of the very few survivors of the 1990s tech bubble that has not at least kissed its 2001 level for a minute in the past five years.

Even Microsoft Corp. (Nasdaq: MSFT), a bag of bones and old code, has done that, in 2008. Dell Inc. (Nasdaq: DELL), a lonesome dove, did it in 2005. Oracle Corp. (Nasdaq: ORCL) did it in 2010 and has not stopped since, and is now pressing on 2000 levels. So keep an eye on Intel. Its forward Price/Earnings multiple is a meager 9.6 despite a year-over-year earnings growth rate of 39%, and a robust return on equity of 25%. It's so cheap it makes your eyes water.

Indeed, this is a great example of a company that could double merely from an increase of confidence that took its P/E up to the low to mid-teens like, um, Kimberly-Clark Corp. (NYSE: KMB)and Colgate-Palmolive Co. (NYSE: CL), which are not exactly growth powerhouses. Keep in mind that one of its chief antagonists, the mobile chip giant ARM Holdings Plc (Nasdaq ADR: ARMH), rocks a P/E of 90, as befits a king.

What kind of world do we live in where the world's biggest chipmaker is less highly valued than tissue and soap makers? The recent price move is signaling the start of a change of opinion, and the mood does not have to change very much for shares to lift. I don't own it, and it is not in any of my models, but I find the story intriguing and worth investigating further.

Divvy It Up

One fascinating thing about the Tuesday session in particular last week was that if you look at the stocks in theDow JonesIndustrials that pay a dividend yield of 3% or greater, you will see that all but one was up, and some performed very well -- much better than you would expect given the fact that the index finished flat. Here they are, with the Tuesday change in the last column.

The two stocks that pay the lowest dividend in the DJIA -- Bank of America Corp. (NYSE: BAC) at 0.3%, and Alcoa Inc. (NYSE: AA), at 0.6% -- were actually up a little more than 2% each as well, suggesting that they are seen as good values despite their low yield.

The point of these observations is that if you were in this elite set of high-divvy stocks -- mostly non-speculative, conservative names -- then you didn't even notice the volatility that wracked the rest of the market. Most of the strong negative, churning action in the market occurred in the commodity-related stocks that have become a bit more speculative due to a nascent reversal in the dollar to the upside.

This could be a change of tone in the market, though two days' action is not enough time to say for sure. But if we just look at the one-year returns of most of these conservative dividend payers, we can see that they at least have been buoyant for most of the recent past.

The upshot is that the DJIA has quietly become the leading index of the past month among institutional investors -- better than the Nasdaq, better than the Standard & Poor's 500 Index. I think it is most likely part of this move we have been discussing toward a refocusing by institutional investors on big, strong, reliable, high-earning, high-yielding thoroughbreds in the next phase of the cycle.

Over the course of the whole year, the evidence still suggests that mid-cap growth will be the winner of the size/style sweepstakes. But the homeboys of the Dow could make it a race. We'll look for a good location to buy them. Maybe it really will be that simple this year. Could happen.

The plain-wrap version is in the fund SPDR Dow Jones Industrial Average ETF (NYSE: DIA), and there are also two leveraged versions, the 2x ProShares Ultra Dow30 ETF(NYSE: DDM) and the 3x ProShares UltraPro Dow30 ETF (NYSE: UDOW).

The Volatility Factor

As for volatility, it's been in an epic downtrend for the past 24 months, as the CBOE Volatility Index has sunk to around 15 from 80. As you can see in the chart below, the index, sometimes called the Fear Gauge, dropped to a four-year low last week.

I'm sure that most investors would be perfectly happy if volatility continued to trend even lower. And with inflation low and liquidity abundant, there is no reason why it could not ultimately get back to the 10 level, which prevailed during much of 2005-2007, by this time next year.

That would constitute a big surprise for bears who expect the market to crash under the weight of debts, lifting volatility skyward again.

In the near term though -- i.e. the next couple of months -- my research does suggest that a combination of factors, including the end of the Fed's bond-buying program, the rise of energy inflation, and austerity politics in Congress, could create a lot more jumpiness.

This would actually give us the best of both worlds: We like volatility because it shakes loose windows of opportunity. Any major setbacks such as what we saw in March would give us a chance to buy our favorite long-term ideas -- energy, industrials, healthcare, emerging Asia and possibly Europe -- at lower prices. Stay tuned.

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Commodities After The Crash, No Way But Up

By: Andrew_McKillop

After a suspiciously short and likely programmed commodities crash we can only have the right hand leg of a "V" profile for commodity prices - until and unless big things happen with the major currencies and national debt crises of most OECD countries, or we have a global economic crash. To be sure, this is the context for highly classic speculative frenzies, where fundamentals are put on the back burner, and the front burners are turned to full on.

By May 9, after a week of slaughter on the precious metals, energy, food and metals exchanges there was no place else to go but up. The commodities rout of April 29-May 6 knocked at least US$ 90 billion of nominal or paper value off the estimated value of all 24 commodities included in the S&P GSCI index. The value of market tradable paper in this group of leading commodities fell to about US$ 805 billion on May 6, from around US$ 891 billion on April 29, according to Bloomberg.

This was a classic - and short - bear squeeze needing very large falls in the nominal value of "underlying assets", commodities themselves, to temporarily drive out the speculators who had been bidding up prices. Signalling the probable degree of advanced preparation and warning for informed players - some call them insiders - Goldman Sachs Group Inc. added its own weight to the rebound. After forecasting the plunge and adding its weight to it in the days preceding April 29, it was predicting price recovery for commodities (announced as "a possible recovery" by GS Group Inc.) exactly one week later, on May 6.

WHAT HAD CHANGED ?

Through March and April in a process dating from the start of 2011, investment funds made near-record bets on commodity price gains, pushing indexes like the Rogers RICI, the CRB, CMCI and the S&P GSCI to their highest levels since late summer 2008. Commodities beat stocks, bonds and the dollar to the end of April, the longest winning streak in at least 14 years. Behind the euphoria was the spectre of penury, with relentless industrial growth in China and India, and other Emerging economies pressuring natural resource production capacities and stockpiles.

More realistically and carefully excluded from market-correct explanations, and even closer behind the euphoria, the continuing fall of the US dollar's world value - the dollar being used to price and transact more than 72 percent of the world's total commodity trades - can only intensify any fundamental factor levering up commodity prices. Retreat of the Eurozone-16's money, the euro, from its current unsustainable highs (measured against the structurally weak dollar) will also tend to bolster commodity price gains against stocks, bonds and currencies, due to the euro now being used to transact - if not price - increasing volumes of physical commodity trades.

THE DOLLAR REMAINS WEAK

To be sure, the Obama team's hunting-and-shooting triumph in Abbotabad followed by a fishing trip to the Oman sea could only drive up the world value of the dollar, but long-term trends and economic reality show the true trend. The US dollar index, measuring the dollar's performance against 6 other currencies, but weighted to give the dollar's performance against the euro some 58% of index weight shows long-term decline as the only main trend - until and unless the euro falls.

Taking performance of the US dollar index July 2010 we have this read out:

The Abottabad adventure is signalled by the 1.2% upward blip on the chart's right hand edge, above, but rather little in this chart allows us to believe there can or might be a longer-term upward recovery in the dollar - although the index will improve considerably when or if European Union monetary disorder goes into higher gear, and the overvalued euro moves backward.

OIL FRENZY

Oil prices best reflect the weakening US dollar and the onrush of central bank "injections" - rather than hits and misses on presidential palaces in Tripoli, and hits on demonstrators in a range of countries from Bahrain and Yemen to Syria and Tunisia, with the largest focus always on possible civil unrest in Saudi Arabia, potentially affecting oil production and exports. Oil prices also reflect claims by the OECD's International Energy Agency and large oil companies like Total, claiming Asian oil demand is very strong, while the US Energy Department's TWIP shows relatively high US oil inventories, and European oil consumption is in many countries still 5% - 10% below 2008 demand level.

The one-liner marketspeak for this context of fundamentals which can be read any way, and unknown geopolitical trends is that the balance of risks and fundamentals still points to a supply-constrained world, not only for oil but almost all other commodities, except US-only shale gas. The financial and monetary risk of a sudden plunge into steep recession, as in 2008, driven by national debt funding crisis, also generates so much new liquidity on financial markets, including commodity markets, that until the global economy crashes commodity price must rise.

Taking estimates for Quantitative Easing by the US Fed, Europe's ECB, Japan's BOJ and other central banks as 20 trillion dollars since end-2008 we can relate this to the world value of the physical oil trade at a year average barrel price of US$ 100. The issued money and near-money covers more than 12 years of world total traded oil supplies. Oil is by far the world's biggest traded commodity, priced and transacted to a dominant extent in dollars - so the real question, here, is how can its price not rise ?

The unnatural fall in oil prices during the Apr 29 - May 6 crash is shown by the US benchmark West Texas Intermediate falling nearly US$19, and the rest-of-world benchmark Brent falling US$ 21 in the 5 days of last week. From the bottom point of the "V", rebound could only be as much as 3.5%-per-day in a technical rebound offering zero risk gains for the best-informed market makers and players.

THE REAL GATEKEEPERS

To be sure there is no watchdog in a mass speculative bidding spree that favours commodities more than equities, but the very small size of most commodity markets makes for self-limiting feedback. This size limitation applies firstly to value and turnover, relative to vastly bigger equities markets, and to the special characteristic of commodity markets: physical deliveries and transactions.

Silver is the best recent example - despite the fantastic drubbing taken by silver prices during the Apr 29 - May 6 crash, the largest global silver market, the Comex, is in permanent physical shortage of the metal. Several of the food commodity markets are highly vulnerable to cornering and to physical under-supply. With rising prices, soothsaying of the Goldman Sachs type will give way to physical rigging, producing what many analysts already claim is happening: market movements with no relation at all to underlying fundamentals.

The twist is these analysts usually judge commodity prices as overpriced and likely to fall back 10%, or 20% or even 30% from current levels, without warning. The opposite is also possible, and more likely under current conditions: that is massive unexplained price rises in a few days of frenzied trading.

The gatekeepers are the precious metals. When or if gold prices rise above US$ 2000 per ounce, and silver prices attain some level above US$ 65 per ounce, this is a deadly challenge to the US dollar, and its fiat friends and also-rans, starting with the euro, which is already seriously overvalued. From high and sustained gold and silver price levels, the gates of inflation will very surely open wide - making panic rises of interest rates, and slump into global economic recession almost inevitable.

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Commodity Bounce Likely In The Short Term

by Dr. Joe Duarte

Markets Are Headed For Crucial Week 

 

Traders are clearly bent on testing the resolve of those who sold commodities off last week, setting this week up to become pivotal for all markets.

Last week’s nearly 9% pullback in the CRB Index was impressive, especially when key components, like silver and oil are considered individually. Yet, if you step away from the drama, the pullback falls within the realm of an intermediate term correction in what may still be a long running bull market.

Chart Courtesy of StockCharts.com

The key to the selloff was the presence of computer trading. So, in fact, what we saw last week was a repeat of the “Flash Crash” in the stock market, which happened just twelve months ago. As sell stops got hit, the computer programs began to sell, then the margin calls came in, and more sell stops got hit, setting up a vicious cycle. Silver and oil clearly took the brunt of it. Oil may have been moved by the death of Osama bin Laden. Selling in silver accelerated once the news that the Soros funds were sellers hit the mainstream press.

According to The Wall Street Journal, the cascading selling in crude oil on Thursday came as a result of “sell orders” which had been set in place to protect profits by traders (sell stops). And “once the liquidation gained momentum, each successive price drop triggered a wave of these automatic sell orders, sending crude sliding further—and starting another round of selling.” The selling was described as a “panic.” One trader told the Journal that at one point “the orders (to sell) were just pouring in.” The Journal added: “Much of the selling, however, wasn’t carried out by traders, but rather their computers, which were programmed to sell once the price of oil hit certain levels—$105.50 and $102.70, for example. Investors, not companies that produce and consume oil such as refiners, are the primary users of such sell orders.” So, the selling was speculator or trader driven, which should come as no surprise to anyone as “Those speculative investors were present in the oil market in near record numbers on Thursday. Open interest, or the total number of open contracts, of the Nymex’s main oil-futures contract surged to a record 1.65 million.”

Chart Courtesy of StockCharts.com

So the key to success in this market now is to remain patient. Crude oil and silver will have their bounce. West Texas Intermediate has support as far down as the $92 area, its 200 day moving average, while resistance is in the $100-$105 area. It will take a few days for this situation to sort itself out, but at least we have some parameters. And yes, what happened on the way down, could also happen on the way up, as computer related buy stops could get hit and the market could melt up.

Chart Courtesy of StockCharts.com

Silver, on its own right, also has support near the $30 area, with resistance in the $35-$40 price range. Silver bulls are more like bulldogs, with plenty of them shrugging off the selling last week and reaffirming their support for the metal. One set of bulls in the silver market that won’t be coming back soon are likely to be small investors who got in within the last two weeks as prices were blowing off.

Conclusion 

The markets are in the midst of a very risky period which is being exacerbated by the presence of mechanical, computer driven trading, in stocks, and commodities. There has been little evidence of the bond or currency markets being as vulnerable to this kind of activity, as of now. But it makes sense to consider that as another possible event in the future.

The key difference between bonds and currencies and stocks and commodities is that the two former markets are much deeper in their liquidity and their size. That means that smaller amounts of money can get lost in the bid and ask process of the bonds and currencies while stocks and especially the often relatively small commodity markets are much easier to move.

What’s the best recipe for success right now? Patience. Stick with stocks that are working and let the commodities do their thing for the next day or two. As those key resistance and support areas, listed above, are approached start considering your trades. We’ll be monitoring the markets and updating as needed. We suggest monitoring our Twitter feed regularly as we’ll be updating changes there as soon as they are updated on the web site.

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