Tuesday, January 24, 2012

Is This the End of the Road for the Rally?

The “dumb money” indicator has become extremely bullish (bear signal), and this is what one would expect with rising prices. The higher prices go the more bulls that are recruited. But is it the end of the road for the rally? Not necessarily so. In 1995, 2003, 2009, and Q4 2010/Q1 2011 we saw the phenomenon that I have dubbed “it takes bulls to make a bull market”. It is a market characterized by rising prices and excessive bullishness. In the case of 1995, 2003, 2009, the excessive bullishness and multi-month rally seem to be warranted as the markets were bouncing back from steep losses or a prolong period of consolidation (1995). The Q4 2010/ Q1 2011 version of this phenomenon was a QE2 induced feeding frenzy. With investors taking their cues from the Federal Reserve and European Central Bank, the current market environment resembles Q4 2010/ Q1 2011. For now, we need to respect this dynamic as we could be witnessing another melt up. The bulls have the ball in their court and are on the cusp of turning this recent price move into a multi-month barn burner.

The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator shows extreme bullishness.

Figure 1. “Dumb Money”/ weekly

Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Insider trading volume was seasonally thin last week, the result of most insiders being locked-up and prohibited from trading until after their companies’ Q4’11 earnings announcements, as well as the market holiday.”

Figure 2. InsiderScore “Entire Market” value/ weekly

Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 65.09%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops.

Figure 3. Rydex Total Bull v. Total Bear/ weekly

Let me also remind readers that we are offering a one-month free trial to our Daily Sentiment Report, which focuses on daily market sentiment and the Rydex asset data. This is excellent data based upon real assets and not opinions.

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Dow Dogs Starting Strong In 2012 : AA, BAC, HPQ, JPM

Every year, the worst performing stocks in the Dow Jones Industrial Average (DJIA) are bestowed the moniker Dogs of the Dow. And to some market observers a decent investment strategy is to pick stocks from the Dogs of the Dow list for the following year with the hope being last year's worst performers will outshine the following year.

Checking in
Back in December of 2011, I identified the worst performing DJIA stocks as a fun way to follow the Dogs of the Dow Theory in 2012. While the DJIA was up about 4.7% in 2011, that performance was hardly an indication of the representative performance of the constituents within the index. The worst Dow performer in 2011, Bank of America (NYSE:BAC) dropped over 50%, vastly underperforming the overall DJIA. JP Morgan (NYSE:JPM) was another victim of the financial sell-off in 2011 and declined over 20% in 2011. (For related reading, see An Introduction To Stock Market Indexes.)

Thanks to some corporate mishaps, tech bellweather Hewlett Packard (NYSE:HPQ) was the second worst performing DJIA stock dropping some 40% in 2011. After the plunge in shares, many notable investors including value investor Seth Klarman took the opportunity to load up on shares. Industrial aluminum giant Alcoa (NYSE:AA) rounded out the top four list as one of the worst performing Dow stocks in 2011, falling over 40%.

A Strong Start for the Dogs
While it's far too early in 2012 to make any calls, the Dow Dogs are having their day so far. Bank of America is up 20% so far in 2012, as investors seem to think this year may the beginning of the end of a terrible cycle for financials. Last week's earning report confirmed that Bank of America continues to wind down risky assets and improve its capital ratios. Following along the rally in financials, and JP Morgan shares are up over 10% so far. Both names are vastly outperforming the S&P 500 which is up around 3% so far. Even Alcoa is up nearly 10% so far despite an earnings report that was neither encouraging nor discouraging. And with a 2% year-to-date gain, Hewlett Packard gives the Dogs of the Dow Theory a perfect record for these top four underperformers in 2011.

The Bottom Line
It is far too early to claim victory for investing in the Dogs of Dow. At the same time, stocks like Bank of America and Hewlett Packard have been viewed as deep value plays by many investors throughout 2011. While 2012 still has a lot of time left, 2011's Dow Dogs could be 2012's gems.

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Is Silver the Great Trading Opportunity of 2012-2013?

By John F. Carlucci

Silver tends to form a very periodic, predictably shaped asset bubble. Silver is also relatively volatile compared to most assets like large cap stocks and gold. These two factors – predictability and volatility – offer a potentially very lucrative trading opportunity for silver. I believe that window is opening right now. In this article, we will examine silver's predictability and volatility in great detail so as to prepare for this trade. Figures 1 and 2 are a side-by-side comparison of the two most recent silver asset bubbles in 2007-2009 and the current unfinished cycle that began in August 2010.

Figure 1: Silver - January 2007 through December 2009

Figure 2: Silver - June 2010 to January 2012

You'll notice corresponding points on both charts numbered 1 to 13. These tie in with the date and price tables below. In Figure 1 above (Silver, January 2007 through December 2009), there was a sloping increase from points 1 to 5 after the bubble first started to form. At point 5 the asset bubble burst, dropping sharply down to point 6. The price fluctuated somewhat up to point 11. From there it dropped sharply again to point 12, recovered to 13, then on down to the bottom during late 2008.

In Figure 2 (Silver from June 2010 to January 2012), notice how closely the points match those of Figure 1. The similarity is striking, and while they are not identical twins, you can see that they belong to the same "family". The odds of this particular pattern repeating itself by random chance must be virtually nil. For our purposes, that pattern suggests predictability, which equals great profit potential for traders.

To get an appreciation of that profit potential refer to the data tables in the appendix below. The left side of the tables is labeled SLV Silver 2007 – 2009, "SLV" being the symbol for the popular silver ETF. Referring to the table under SLV Silver 2007 – 2009 you see the words Date, Point, Price, Long, Short. "Date" is self-explanatory. "Point" refers back to the 1 – 13 points shown in Figures 1 and 2. "Price" is for one share of SLV corresponding to the date. "Long" and "short" trades are self-explanatory. Under the Long column is the percentage profit for various trades. The same percentage profit figures are listed in the Short column. Green indicates long trades, red indicates short trades.

Let's look at a specific example. You can see that on 17-Aug-07, the price of SLV was $11.66. That date was also point 1 on the Figure 1 chart. Assuming you bought SLV on that date for $11.66 and sold at point 2 on 9-Nov-07 for $15.29, you had a 31.11% profit. The entire trade from start to finish is highlighted in green since it was long.

Following down the table you see that the long trade from 14-Dec-07, point 3 to 14-Mar-08, point 5 had a 48.62% gain. Directly to the right of that you see the first short trade. It began 14-Mar-08, point 5, $20.42 and ended 21-Mar-08, point 6, $16.70. In this case, the profit was 22.28%.

This will give you an idea of how profitable an asset bubble can be and especially how lucrative trading silver has been recently. To save you the math of calculating compounding profits, if you had just traded long, bought $1000 of SLV at point 1 and sold at point 2 for a 31.11% profit, bought $1311 worth of SLV at point 3 and repeated the entire process to 20-Nov-09, your total compounded gain would be 548% over 2 ¼ years. If you include short trades the gain would have been 1,440%.

These are maximum potential gains, of course, under ideal circumstances with perfect trade timing. No investor will execute every trade perfectly for maximum gain. However, it does illustrate how much potential there is trading the silver asset bubble. You could have a very substantial profit by taking advantage of just half or one third of the potential.

Now consider SLV versus AGQ, the leveraged silver ETF. While SLV had a 71.57% gain from 20-Aug-10 to 31-Dec-10 (right side of first table), AGQ had a gain of 258%.

What will the near future likely hold for silver? In my opinion, the conservative signal to begin buying silver is when the MACD crosses (Figure 2), which will happen shortly. The more aggressive or early warning indicator is when Slow STO crosses, which has already happened. I anticipate that silver should rise over the next 12 months to the $40 level before pausing in advance of the next asset bubble in 2013 – 2014, at which point it could top $100 / oz.

There might be a steady rise from today's price up to $40. However, I think there could also be a near term drop to the $20 to $25 level before the rise to $40. It all depends on how the price of silver is influenced by the stock market and economy as a whole. A comparison of the charts for silver and the contemporaneous charts for the SS&Pamp;P do not indicate any type of direct correlation. The only tentative conclusion that might be drawn is that sharp declines in the SS&Pamp;P and silver will generally occur in close proximity. If we experience a sharp near term drop in the SS&Pamp;P expect silver to drop to $20 to $25 as traders liquidate to raise cash.

Keep a close eye on silver. It could provide an incredible trading opportunity over the next couple of years.

Precious Metals Stocks: Diversify, Seriously

Gold and silver mining stocks will be the dot-coms of the second half of this decade. Yet most of the people who bet on them will lose money because they ignore the first rule of speculative sectors, which is that no matter how well the sector does, most of its constituent companies will fail.

This rule applies wherever hot money is chasing untested concepts, but it’s uniquely valid for mining, where reserves are uncertain until actually dug up, mines can cave in without warning, local laws can change in unfavorable ways, and managements frequently make dumb acquisitions. These risks make even the most attractive mine something of a crapshoot. Two recent examples:

Hecla’s Hangover
January 11, 201. Hecla already had a headache, but now it’s suffering from a full-blown hangover.

The series of unfortunate incidents that plagued Hecla Mining’s (NYSE: HL ) mile-deep Lucky Friday mine during 2011 attracted the scrutiny of the Mine Safety and Health Administration, which has now ordered the mine’s primary shaft closed until it can be cleared of debris that has accumulated over the years. Hecla estimates that the maintenance work will keep the mine shut through early 2013, leaving embattled silver investors to wonder whether someone spiked their holiday eggnog.

Hecla shares plummeted by more than 26% this morning, essentially mirroring a 26% reduction in the miner’s 2012 production outlook from 9.5 million ounces to 7 million ounces. Despite a strong price environment that saw the average price of silver in 2011 surge by 74% over the prior-year average, Hecla’s stock has lost some 54% of its value over the past 12 months. Though shareholders may wish to avert their eyes, the following image captures the devastation:

Kinross in Play After Paying Too Much for African Gold
Jan. 20 (Bloomberg) — By paying too much for acquisitions in western Africa, Kinross Gold Corp. is now turning itself into the cheapest gold-mining target in the world.

Kinross, Canada’s third-largest gold producer, fell the most in almost two decades after saying this week it will write down the value of its Tasiast mine in Mauritania. The company sold for 76 cents per dollar of net assets yesterday, versus the industry median of 2.5 times, according to data compiled by Bloomberg. Writing off the excess $4.6 billion it spent on Tasiast would still leave Kinross at a 50 percent discount to its competitors, the data show.

Hecla and Kinross are big companies which have been around forever, and they still hit common speed bumps. They’ll both survive, though, which is more than can be said for some junior miners with similar problems. Without money in the bank or other projects to share the load, an operating or cash flow problem can be fatal for a junior.

So why bother with mining stocks when you can just buy the metals? Because in the aggregate mining stocks will probably outperform the underlying metals (the fact that they haven’t lately just means they’ll outperform by an even bigger margin in the future), and the best miners will do two or three times as well as the metals.

So consider them, but show them some respect. Don’t buy just one, no matter how much of sure thing your broker or brother-in-law says it is. Instead, buy five or eight or ten, even if it means owning just a few shares of each. Or buy a mutual fund or ETF and let them do the diversifying for you. GDX holds a basket of major gold miners, GDXJ a basket of junior gold miners, and SIL most of the silver miners. One transaction and you own the sector.

The sector, of course, contains winners and losers, so the real prize goes to whoever has more of the former than latter. As mining guru Rick Rule likes to say, most junior miners aren’t viable, so all the gains in that sector come from the remaining 10 or 20 percent. So if you really want to be part of the coming mania you have to be a stock picker.

One low-stress way to do this is to piggy-back on the work of established analysts. They’re not always right but they do spend their days trying to separate solid properties from holes in the ground guarded by liars. Their best ideas go first to subscribers and/or investors, but they can’t keep everything to themselves. In media interviews, mining experts like Sprott’s John Embry frequently name a few of their favorites, and the funds managed by people like Tocqueville’s John Hathaway are required to report what they’re buying and selling. Once that information is public, it’s fair game.

Last but not least, keep some free cash available for opportunities like Kinross and Hecla, which are now takeover candidates.

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Martin Armstrong: Gold & Near Term Outlook for Gold

Gold & Near Term

Outlook for Gold

* Roman Coins for Purchase

click here to read pdf

Can Technical Resistance and Excessive Bullishness Break Up Side Momentum?

The S&P is up 4.6% year-to-date. Momentum is clearly positive, but if the S&P kept going at this rate, it would end the year up 80%. Obviously this is impossible and some sort of correction is inevitable.

The question is how long it will take before technical overhead resistance and increasingly troublesome bullish sentiment reel stocks back into reality.

Better than it Looks

As of Friday's close, the S&P has gained 58 points year-to-date. 48 of those points occurred overnight with the gains being reflected in the first hour of trading. There's been no follow through during Wall Street's regular business hours.

Talking the Talk but Not Walking the Walk

Investors are getting excessively bullish (more in a moment) but the conviction behind this rally is non-existent. Average trading volume for the first 12 days in 2012 is less than half of what it was in 2006, 2007 and 2008 and is 42% below the 8-year first 12 days of the year average. The chart below shows just how anemic trading volume is.

Bullish for Better or for Worse

The CBOE Equity Put/Call Ratio dropped to 0.47 last Thursday. This is the lowest reading since February 7, 2011 and means that more than twice as many options traders bet on rising prices than falling prices.

Concerning sentiment, the April 6, 2011 ETF Profit Strategy update warned that: 'The percentage of bearish advisors and newsletter-writing colleagues dropped from 23.1% to 15.7%. Stocks' performance 1 - 2 months following such a spike in bullish sentiment was substantially below normal. This is consistent with our outlook for a late April/May market reversal. According to sentiment, stocks are ripe for a decline.'

Less than a month later, the S&P rolled over into a wicked summer meltdown. About two weeks ago, the percentage of bearish investors dropped to 17.18%.

Of course we can't talk about sentiment without mentioning the VIX (Chicago Options: ^VIX). As the S&P (SNP: ^GSPC - News), Dow (DJI: ^DJI - News) and Nasdaq (Nasdaq: ^IXIC - News) have moved higher, the VIX has dropped to 18.28, the lowest reading since July 22, 2011.

The S&P lost nearly 250 points the 12 trading days following the July 22 VIX low.

Momentum vs. Technical Resistance

The markets relentless rallies of 2010 and 2011 have taught us that it 1) sentiment can always become more stretched and 2) it is dangerous to bet against strong up side momentum.

The 20% meltdowns starting in April 2010 and May 2011 on the other hand, have taught us that it is dangerous and nave to ignore the warning signs of a weakening market.

To profit (or prevent getting burnt) from this tricky situation, investors cannot afford to become complacent and need to be balanced about their decisions. Knowing important support/resistance levels and understanding how we got to where we're at will be a huge asset.

Dead Cat Bounce or New Bull Market

Is the rally from the October 2011 (or from the March 2009) low a dead cat bounce or the beginning of a new bull market?

A few days before the S&P hit its 1,075 low, the October 2, 2011 ETF Profit Strategy update stated that: 'Based on the studies discussed in August 14, I've been expecting new lows followed by a tradable bottom. I define a tradable bottom as a low that lasts for a few months and leads to a bounce that (in this case) should propel the markets around 20%. From a technical point of view, this counter trend rally should end somewhere around 1,275 - 1,300.'

Keep in mind that the prediction of a 20% rally seemed absurd at a time when Wall Street had already proclaimed the next bear market as the headlines below show:

Oct. 4, 2011: 'S&P enters bear market territory' - Reuters

Oct. 4, 2011: 'S&P 500 falls to the bears' - TheStreet

Oct. 3, 2011: 'Think the economy is bad? You haven't seen anything yet' - CNBC

The chart below, published in the October 2 ETF Profit Strategy update, outlined the S&P's journey back to about 1,300. Even though seen as impossible at the time, here we are at S&P 1,310.

Picking a top is always more difficult than picking a bottom, and it takes just as strong of a contrarian stand to sell into a top as it took to buy at the bottom.

Many indicators show that stocks are overbought and ready to roll over. However, relentless momentum and the possibility of QE3 could make it difficult to take a bearish stand and trade accordingly. How can you reduce risk?

Reducing Risk

The S&P responds to support/resistance levels like a car to traffic lights. A traffic light doesn't guarantee the car will stop, but if the car is going to stop, it will usually do so at a light, not in the middle of the road.

Knowing of important support/resistance levels is almost as valuable as exclusive insider information. The S&P's May 2, 2011 top for example occurred within points of the Fibonacci resistance at 1,369 (the April 2 ETF Profit Strategy update stated that: 'The 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions.') and the October 4 bottom was carved out within points of Fibonacci support at 1,088 (the October 2 ETF Profit Strategy update stated that: 'The ideal market bottom would see the S&P dip below 1,088 intraday followed by a strong recovery.')

The S&P is once again getting close to a combination of Fibonacci and trend line resistance. If the S&P is going to turn around, it will probably be there. Alternatively, a break below key support will signal that a turnaround has occurred.

The ETF Profit Strategy Newsletter outlines the target range of this rally and the one support, that once broken, will likely accelerate selling pressure. Updates are provided at least twice a week and include short, mid and long-term forecasts.

Last Time Bullishness Hit These Levels…

Goldman Tells Clients to Short 10-yr Treasurys

As of a few hours ago, Goldman’s Francesco Garzarelli has officially told the firm’s clients to go ahead and short 10 Year Treasurys via March 2012 futures, with a 126-00 target. While Garzarelli is hardly Stolper (and we will have more on the latest Stolpering out in a second), the fact that Goldman is now openly buying Treasurys two days ahead of this week’s FOMC statement makes us wonder just how much of a rates positive statement will the Fed make on Wednesday at 2:15 pm. From Goldman: “Since the end of last August, we have argued that 10-yr US Treasury yields would not be able to sustain levels much below 2% in this cycle. Yields have traded in a tight range around an average 2% since September, including so far into 2012. We are now of the view that a break to the upside, to 2.25-2.50%, is likely and recommend going tactically short. Using Mar-12 futures contracts, which closed on Friday at 130-08, we would aim for a target of 126-00 and stops on a close above 132-00.” As a reminder, don’t do what Goldman says, do what it does, especially when one looks the firm’s Top 6 trades for 2012, of which 5 are losing money, and 2 have been stopped out less than a month into the year.

What is Goldman’s rationale for shorting 10 Years?

At this stage of the cycle, growth expectations are in the driver’s seat: The value of intermediate maturity government bonds can be related to expectations of future policy rates, activity growth and inflation, and a ‘risk factor’ highly correlated across the main countries. These simple relationships are captured by our Sudoku econometric framework for 10-yr maturity yields. In coming months, we expect effective overnight rates to remain close to zero in the main currency blocs (US, Japan, Euroland, and UK) and retail price inflation to hover around 1.5-2.0% – consistent with the forwards and central banks’ objectives. With policy rates and inflation ‘dormant’ at this stage of the business cycle, bond yields (and the 2-10-yr slope of the yield curve) will likely react mostly to shifts in growth expectations.

Bond valuations are already stretched relative to consensus growth expectations: Around the turn of the year, the outlook on economic activity was buffeted by cross-currents reflecting the adverse credit conditions in the Euro area on the one hand, and the upward revisions to US GDP growth on the other. Our Sudoku model, which helps us trade-off these shifts, indicates that 10-yr government bond yields are currently trading too low (to the tune of 50-75bp) when mapped against prevailing macro expectations. Taking into account the cumulative impact of the Fed’s security purchases, the degree of mis-valuation of 10-yr bonds is roughly the same across the main regions.

Bond yields are lagging the improvement in industrial activity seen since late 2011: The momentum of our Global Leading Indicator (GLI) for the industrial cycle bottomed out in the fourth quarter of 2011, although the revised series after the latest data show it steadily improving through the second half of last year. The sequential improvement has extended into this year. We observe that, since policy rates have been floored in early 2010, intermediate maturity yields have tended to lag improvements in the GLI by around 2-3 months. With central banks on hold providing ‘carry’, fixed income investors may have been wary to trade on early cyclical signals until these received validation in the early ‘hard’ data.

Real rates (and the 2-10 curve) could play catch-up with cyclical stocks: We have identified a relatively tight positive relationship between the relative performance of US cyclical stocks vs. defensives (as captured, for example, by our US Wavefront Growth equity basket), and the 2-10-yr slope of the Treasury curve. The departure from this relationship since the turn of the year is now eye-catching. Cyclical stocks have strongly outperformed the broader market, a move probably amplified by positioning, while bond yields have barely moved, underpinned by US domestic investors’ continued attraction for ‘carry’ strategies. At a closer inspection, yields out to the 5-yr maturity have continued to decline in real terms, and are now in deeply negative territory (-150bp in 2-yr and -100bp in 5-yr, near the early November lows), while 5-yr 5-yr forward rates are barely above zero. Our estimates suggest that forward rates (5-yr 5-yr forward) are now too low. Incidentally, the fact that a potential rise in yields would come from a depressed base and mostly in response to an improvement in growth prospects (which should also influence earnings growth expectations) means that a fixed income sell-off should not pose a threat to the equity market.

The FOMC statement could provide a near-term catalyst: According to a client survey by our US trading desk, around half of those polled expect the Fed announcement to ease financial conditions further, with only 12% expecting a tightening. Around two-thirds of participants believe the mid-point of the ‘central tendency’ range for the Fed funds rate at the end of 2014 will be 75bp (the forwards) or below. Finally, 72% of respondents expect the FOMC will announce a long-run neutral policy rate of less than 4%. These results are consistent with our impression that Wednesday’s announcement is now largely discounted to represent an ‘easing event’. With the data improving, treasury yields below ‘equilibrium’, current coupon 30-yr mortgage yields at all-time lows, and discussions on policy easing shifting to ways to support the improvement in the housing market more directly, such expectations may be disappointed, in our view.

Got a Strong Gut? We've Got a Trade for You :MT

Price action in the broad market has been so strong over the past month, even the "down and out" steel sector is making headway...

In late August, we noted how companies that produce steel to build skyscrapers, cars, bridges, and power lines are among the greatest "boom and bust" assets in the world. They soar and crash as the global economy fluctuates. The thin profit margins these companies sport add to their extreme volatility.

Today's chart displays the steel sector's volatility and sensitivity to investor sentiment toward global economic growth. It shows the past two years of trading in the world's largest steel producer, ArcelorMittal (MT).

Like most all assets, MT was hammered in late 2011. Shares fell from their summer level of $35 to $15 (a 57% haircut). But the broad market action has become more bullish... and MT has bounced off its lows. It's now close to staging a multi-month upside breakout.

Should the world simply "not end," volatile ArcelorMittal and the beaten-up steel sector could stage a big "bad to less bad" rally... and gain 50% in the coming months.