Panic Sellers Are Often Sorry

by Tom Aspray

Widespread recent selling in equities and gold looks to be a panic reaction by the masses, as opposed to a calculated response to real market data.

The over 5% decline in the Dow Industrials in the past two days has turned investors’ focus back on the downside, which is different from the positive spin that prevailed just a week ago.

From a technical standpoint, I have been making the case that the rebound from the August lows was a typical flag formation. The Nasdaq Composite has been the strongest since the August lows, but the negative signals from the McClellan Oscillator as of Tuesday’s close indicated even the Nasdaq had likely topped out.

Those who sold at the August 9 lows have had almost two months to watch the market stage a typical 50% rebound. If anyone sold yesterday because stops were hit or as a result of a previously developed plan, that is fine, but Thursday’s drop suggested many were just hitting the sell button in a panic reaction.

The bearish sentiment of individual investors jumped sharply this week, as 48% are now bearish with just 25% bullish. These numbers are as of Wednesday, so they should become more bearish by next week.

Gold was also hit hard Thursday and could be vulnerable to more panic selling before the current correction is over. By looking at the charts, we can get a better idea of what may occur so that you can develop a plan based on data, not emotion.

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Chart Analysis: The daily chart of the Spyder Trust (SPY) shows that it gapped below support on Thursday, line b, completing the flag formation. SPY is now just above the August lows at $110.27, which are likely to be tested over the next week.

• The 127.2% Fibonacci target from the flag formation is at $106.50, while the width of the flag gives downside targets in the $104-$105 area
• The NYSE Advance/Decline (A/D) line broke support, line d, with Wednesday’s close, setting the stage for Thursday’s plunge. The last rally had taken it just barely above its weighted moving average (WMA)
• The A/D line needs to move above its downtrend (line c) to turn positive
• The A/D line shows a band of major support between the March 2011 lows and the November 2010 highs
• Volume had been declining as the flag developed, but broke its downtrend on Thursday’s drop. It is still well below the levels seen in August, so the volume should be watched closely

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The Nasdaq Composite was much stronger than the S&P on the rally, but the PowerShares QQQ Trust (QQQ), which tracks the tech-heavy Nasdaq 100 Index, was even stronger, as it surpassed the 61.8% retracement resistance.

• Thursday’s drop gapped through support at line b, completing the flag formation
• The close was at the daily Starc- band with next support at 2330-2385. The 127.2% target from the flag formation (lines a and b) is in the 2250 area
• As noted Wednesday, the negative divergence in the McClellan Oscillator, line c, indicated the rally was over. It is back to -150 and could fall to the -250 or -300 level before the decline is over
• A rebound over the next week or so is likely to fail near the zero line
• Resistance now stands at the gap in the 2500-2550 area

The SPDR Gold Trust (GLD) dropped 2.6% Thursday on volume of 32 million shares and is down another 2% in early-Friday trading. This will take GLD close to the weekly Starc- band at $163. Over the past month, the closeness to the weekly and monthly Starc+ bands had indicated that risk on the long side was high.

• The break below support at $174.45 last week and the break of the daily uptrend (not shown) this week set the stage for the sharp drop
• The minor 38.2% support is in the $163.40 area with the more important 50% support at $156.70. This is very close to the weekly uptrend, line e
• The major 38.2% support from the 2008 lows and the long-term uptrend (line f) are in the $140 area
• As noted previously, the weekly on-balance volume (OBV) did form a negative divergence at the recent highs (see circle) and is now testing its weighted moving average. A similar divergence in late 2010 led to an eight-week correction
• The daily OBV (not shown) formed a divergence at the highs and is well below its weighted moving average
• There is resistance now at $172.20-$177.40

What It Means: If you look at SPY, a test of the August lows would be a 2% drop from Thursday’s close, while a drop to the 127.2% target at $106.50 would be another 5.6% decline. Of course, I expect that the tech sector will hold above its lows.

If you are still holding weak stocks, decide over the weekend how much more pain you can take and then stick to that plan.

Stops under the August lows for stocks or ETFs are risky, as marginal lows could stop you out before prices reverse. I do expect that prices will be 8%-10% higher in the next two weeks. Further weakness should be an opportunity to buy those cash-heavy, high-dividend stocks that others are dumping.

As for gold, a few weeks ago, it looked like gold could fall instead of rally if stocks dropped, and I recommended hedging long gold positions at that time.

The SPDR Gold Trust (GLD) is likely to reach the first downside target in the $163-$165 area over the next week. A drop to the $153-$155 area is possible before the correction is over, but the long-term volume analysis is still positive, so core holdings should be held.

How to Profit: For those who hedged their long gold positions, I would suggest covering half if GLD drops below $165, as there may be an opportunity to put the hedge back on at higher levels.

On Wednesday, I recommended that traders buy the ProShares Short S&P 500 ETF (SH) at $43.36 or better. Unfortunately, the low was at $43.41, just missing the buy level. The fund closed Thursday at $46.28…ouch! Cancel that order at this time.

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Gold Wave 4 Correction Continues

By: David_Banister

I got a bit of hate e-mail over the last few weeks from the Gold Bugs who thought I didn’t know what I was talking about when I forecasted a multi-month consolidation and correction in Gold was imminent. I’ve written ad nauseum about crowd behavioral patterns as they related to both stock markets and precious metals. It should not come as a surprise that Gold is continuing to drop after a 34 Fibonacci month rally from $681 to $1910 per ounce. That rally came in five clear Elliott Waves and ended with a parabolic race to the top. I consistently warned my subscribers and readers of my articles about not being caught holding the bag and to take defensive measures.

My most recent update was to simply try to figure out whether the continuing correction in Gold would take the form of an ABC pattern or an ABCDE Triangle Pattern. It is becoming more clear that the official pattern is ABC. In English it means that the first leg down from 1910 to 1702 was the “A” Wave, the rally back up to 1920 was the “B” wave. The C wave is continuing underway and one of my longstanding targets is $1643, which is a Fibonacci fractal relationship to the prior lows and highs, and also conveniently fills in a “Gap” in the Gold chart in the 1650’s.

During these 4th wave consolidation periods, it reduces sentiment back down to normal levels and lets the economics of the move in Gold catch up with the price action that was extended. The first area to watch is the re-test of $1702 spot pricing for a C wave low, but the evidence is for a further drop to $1643 before I would get too interested in trying to game Gold to the upside.

Here is the chart I sent out 9 days ago with Gold at $1837 forecasting a possible C wave continuing lower

I’ve stayed away from either shorting Gold or going long gold while I watch and confirm the 4th wave pattern. It’s simply the smart way to go knowing that upside will be difficult to obtain and downside risks are high. It does now appear that I am eliminating the Triangle pattern and sticking with the ABC Correction with the C wave still working its way lower. If $1702 breaks, then you should expect to see 1620-1643 as next pivot low ranges.

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Stock Market SPXU Has Broken Out

By: George_Maniere

Pro Shares Ultra Pro S&P 500 (UPRO) is a triple leveraged fund that seeks a 300% return on the performance of the S&P for a single day. Conversely, The Pro Shares Ultra Pro Short S&P 500 (SPXU) seeks a triple leverage or 300% return on the inverse performance of the S&P 500. 

Several days ago I called for a break under 1140 on the S&P as a buy on SPXU. While my thesis on this trade remains intact I must admit that China stepping up to buy Italy’s bonds changed the timing of this trade. The euro, which had been sold off at the end of last week, has finally found some stabilization as we moved through last weeks New York trading session.

Indeed for the last week the S&P has shown tremendous resiliency and it looked like my prediction of a test of lows of 1050/ 1030 were just plain wrong. Well yesterday after the FOMC announced “Operation Twist” The market went into a free fall and I knew that this was the moment I had been forecasting and waiting for.

“Operation Twist” consisted of selling $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds, starting in October and ending in June 2012.

While the move does not mean the Fed will pump additional money into the economy, it is designed to lower yields on long-term bonds, while keeping short-term rates little changed.

The intent is to thereby push down interest rates on everything from mortgages to business loans, giving consumers and companies an additional incentive to borrow and spend money.

Well when all of this money was injected into the treasuries it had the effect of stimulating the dollar. As the dollar grows stronger the equity markets as well as gold and silver sell off and that is exactly what happened yesterday.

I opened a half position at $19.09 and by the premarket I knew it was going to be a good day.

Take a look at the chart below.

As we can see by this chart, the S&P broke the trend line and had an intraday low of 1114. SPXU ran up on this. Once the S&P puts in a low of between 1050 and 1030, I will sell them and switch to UPRO because UPRO is a triple leveraged fund that seeks a 300% return on the performance of the S&P for a single day. That means for every point the S&P goes up UPRO goes up $3.00. I expect that once the S&P bottoms at 1050 it will quickly run up and when it does I will switch from SPXU to UPRO. A further study of the chart will show that both the MACD line and the slow stochastics have turned over and are heading down. This is a very bearish chart, which is all the better for SPXU.

In conclusion, I expect the S&P to bottom at 1030 within 3 weeks. When this happens I will switch to UPRO as I ride the S&P up to the 1200level. This is going to be a very exciting month.

By George Maniere

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Gold and Silver collapse as the crowd rushes to the Exit

by the trader

It never is different, especially when the crowd does the same thing….Silver and Gold collapse. We are awaiting the first casualties after these moves.

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The Yield Spread Is Lying About The Coming Recession

by Lance Roberts

You are being lied to. There is currently more than sufficient evidence that indicates that we are either in, or about to be in, a recession. The last time I made that statement was in December of 2007. In December of 2008 the National Bureau of Economic Research stated that we were correct. I don't make statements like that lightly and, honestly, I hope I am wrong as this is a horrible time for the economy to relapse.

However, the reason that I bring this up is that there have been numerous analysts and economists stating that the economy cannot be going into recession due to the spread between various sets of interest rates. (For the purpose of this report we will focus on the spread between the 1-year Treasury bond and the 10-year Treasury note.) Historically speaking they would be correct and I will explain why.

The steepness of the yield curve has been an excellent indicator of a possible future recession for several reasons. First, the spread is heavily influenced by current monetary policy which has a significant influence on real activity over the next several quarters. When there is a rise in the shorter rate this tends to flatten the yield curve as well as to slow real growth in the near term. This relationship, however, is only one part of the explanation for the yield curve's usefulness as a forecasting tool. The steepness of the curve also reflects the expectations of future inflation. Because economic growth is affected by the level and trend of both interest rates and inflation it is not surprising that the spread has historically been a good predictor of future recessions.

This time it could be wrong.

The issues with the spread between interest rates today are twofold. First, the U.S., via the Federal Reserve, has embarked upon an unprecedented series of policies to deliberately suppress the yield curve. Through outright purchases of treasuries through Permanent Open Market Operations (POMO) and Quantitative Easing (debt monetization) programs have been implemented to specifically target areas of the interest rate curve. Even the recent announcement of "Operation Twist" is specifically designed to flatten the yield curve to "help promote the demand for credit". Therefore, since abnormal and artificial influences are being applied to the bond market to manipulate interest rates it removes the usefulness of the yield curve as a forward indicator of recessions.

Secondly, and most importantly, the economy is currently not operating under a normal economic environment. As we have discussed in recent missives the U.S., for the first time since the "Great Depression", is undergoing a balance sheet recession. During the "Great Depression" beginning in 1929, the Total Credit Market Debt as a percentage of GDP rose substantially before eventually collapsing. We saw this phenomenon begin again in the 1980's as total debt began to expand dramatically until the Total Credit Market Debt hit 380% of GDP in early 2009. We are now experiencing the deleveraging of those credit excesses which creates economic drag as money is diverted from savings and consumption to the repayment of debt.

Japan has been struggling with the same reality since the bursting of their real-estate/credit bubble and subsequent balance sheet recession. The government of Japan has implemented many of the same policies that Ben Bernanke has been foisting upon the US economy but to no avail. As a result Japan has been mired in a stagnating/declining economic growth environment for the last two decades with frequently recurring recessionary downturns.

The yield spread between Japanese bonds, much like we expect to happen here in the U.S., has remained positive due to government interventions since the beginning of their economic malaise some two decades ago. As far as a recessionary indicator goes - the yield spread has failed miserably.

Japan has been struggling with the same declining employment to population ratio, stagnating wages, an overburdened pension system and weak economic growth enviroment that currently faces the U.S. today. If that is the case then the economic future that has been laid out before us is not a bright one. The coming deleveraging of debt which will result in a needed cleansing of the excesses from the system will result in continued weakness in economic growth as consumers and businesses remain on the defensive. This defensive posture leads to deterioration in the demand for credit, stagnation of wages and lack of productive investment.

If the recent history of Japan is any reflection of the path that we have been set upon then we will likely enter a recession by the beginning of 2012. Of course, it will confound, confuse and surprise the mainstream analysts and media as the yield curve will most likely remain positive. As I stated before, I sincerely hope I am wrong, and that everything turns out for the best. Deep down I am an enternal optomist and believe in the innovation, ingenuity and passion that has made this country great. However, "hope" and "optimism" are not investment strategies by which we can successfully navigate the finanical markets today or in the future.

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When Hope Fades

by Tyler Durden

At the end of a dramatic week such as this, when clearly the hope of a civilized world of buy-the-dip monetary policy-to-the-rescue 'investors' was somewhat dashed, we take a look at the decimation. Friday appeared a day of rest for everyone but margin clerks as 'safety' was sold but nothing appeared to be bought. Financials managed to hold their heads above water as hope remained that someone would do something this weekend but as we scan the asset classes - we note that investment grade credit was the best performer of the day - hardly a signal of strength - as volumes in equity markets dropped significantly.

UPDATE 1: The fact that the CME hiked margins after-hours seems to be as much a driver of the weakness in gold, silver, and copper and we note that after the equity close, we are seeing both silver and gold up around 1%. They also hiked 30Y which helps explain the coordinated sell-off we discussed earlier.

UPDATE 2: Here they come - Trichet: We Stand Ready to Supply Unlimited Liquidity (well that should help the USD?)

IG credit outperformed on the day as can be seen in the chart, followed by HY, and then a close-to-close marginally unchanged equity market. While all were well off their lows of the day/night, the moves in IG and HY were more driven by the macro-to-micro hedge rotation we discussed (as well as some light re-risking in quality investment grade (which saw decent net-buying today). Over the course of the week, there was a very obvious shift up-in-quality and up-in-capital-structure and while bond volumes in HY were nothing to write home about (we have talked about this dearth for a long time with the view that managers know to start to sell into this cash market is likely to start a rather nasty ball rolling down-hill rather quickly), we did see very modest net-buying relative to significant net-buying in IG bonds. The greatest net-buying was focused in the 3-7Y maturities with the twist helping as longer-dated corporates were net bought more than shorter-dated.

On the week, investment grade credit widened significantly with a long-run-based two standard deviation shift that is the largest since May of last year (and before that March of 2009). HY also widened notably on the week but had been moving before the week began so its relative shift was not as impressive. We do note that equities remain significantly expensive relative to credit still even though we have collapsed the relative-value significantly this week.

All stock sectors ended the week lower. Even dividend-heavy safety plays such as Utilities were unable to hold gains (though they were the clear winners losing only 1.7% on the week). Materials and Energy were the worst hit (which might surprise some given the constant chatter about Financials) which might help explain the dramatic drops in emerging market and commodity-producing nation stocks, credits, and sovereign spreads this week.

In terms of magnitude of move, TSYs were the initial choice as winner (though see further down for the Silver move!!) with the shifts post-Bernanke both shocking (given how telegraphed the 'twist' was) and violent. Making new records all over the place, 30Y (long duration) bond yields were smashed lower.

It is interesting though that not only did we see a relatively significant (for a normal day) sell-off in TSYs today, but 5Y shifted lower (yields higher) than pre-Bernanke and even the pivot 7Y started inching back towards unch. It was perhaps evident from our earlier discussion with regard TSYs and precious metals that today was more a liquidation of whatever you had left for some funds (or selling of the winners because noone likes selling losers eh DeltaOne).

Precious Metals, more specifically Silver, were the hashtag trending topic of the day. It seems when looking at stocks and sectors (and credit) that whatever caused this sell-off had the definite feel of forced liquidation/workout post a significant margin-call from the previous days. The moves in stocks/other-risk-assets today were simply not large enough to trigger such obviously forced selling and the stabilization - albeit at massively lower levels into the last hour or so suggests this was the case also.

The move this month in Silver is over three standard deviations from very long-run norms and is the largest since March 1980 on a percentage basis (on an absolute basis this month's sell-off is over 10 standard deviations from the norm!).

Of course, the losses in commodities and precious metals were not helped by the strength of the USD this week - which gained over 2% but can hardly be blamed (not even on a levered basis) for this pain. FX markets were very volatile but followed the similar chaos-pause pattern we see in the equity market with most of today/late-yesterday relatively stable (we say relatively because on a normal day a +/-0.5% shift in DXY is news).

All-in-all an incredible week that seemed to catch many unhedged and off-guard as we discussed was possible given options and credit skews implications. The market remain comfortable at this pivot point but we suspect that if we do not get any real action this weekend then Round II will start Sunday evening as it becomes increasingly evident that global growth is grinding to a halt and credit crises are once again spreading (having gummed up all monetary transmission channels).

UPDATE: The fact that the CME hiked margins after-hours seems to be as much a driver of the weakness in gold, silver, and copper and we note that after the equity close, we are seeing both silver and gold up around 1%.

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