Cotton Candy, If You’ve Been Short

On November 10th, I highlighted my opinion that the Cotton party might be over and a sharp 15-20% correction was in the cards. Indeed, Cotton has gotten blasted by 23% as of this morning in only 9 trading sessions. Limit down has become a daily event. As we are approaching the 50% retracement mark from the July trough and 50 day ema/sma, it wouldn’t be  a bad time to ring the register if you were fortunate enough to catch this monster short.

‘Risk-off trade’ Likely Has More Room

Markets, across all asset classes (risk-on, risk-off trade), suffered sharp losses, with modest bounces taking place during the last few days. We are now left with the question – was the downdraft just another “buy-the-dip” opportunity, or could the sell-off be the beginning of a trend change? There are indeed several sentiment measurements published by different folks which point to the possibility that we might be in the process of forming an intermediate top. One of the more notable polls, in equities, the II (Investor’s Intelligence), recently reached up into levels seen at previous peaks, including the one made in 2007. Commodities such as Oil and Gold saw record levels in speculative holdings in their respective futures contracts.

Recently, there were several great short opportunities, especially in the commodity sector where obvious signs of speculative fervor were prevelent. One needs to look no further than silver, sugar, ags and cotton to see this. Now is the time for the ‘risk-on trade’ to prove its worth it’s salt, or fail.

At this juncture, one of a couple of scenarios will likely play out. a.) Markets will settle out and form a basing pattern, allowing market participants to gather their breath for another leg higher. Or, b.) we will see volatility in the form of see-sawing price action, whereby the buyers and sellers duke it out before seeing the bulls succumb to selling pressure. Furthermore, if we are in the process of forming a top, then we should see many of the high correlations between assets demonstrate reversion to the mean; this is not to say they will completely diverge, but rather dance to slightly different beats. The first correlation, or ‘anti-correlation’, which is likely to see the biggest correction to the mean is between the Dollar and equities. During recent months, equity traders have in effect become currency traders, and vice-a-versa. However, it is still very possible that the correlations will break down, whether we are amidst a top or simply digesting recent gains before thrusting higher.

Bottom line; be patient, opportunities of significance will, as they always do, rear their pretty heads. My biggest focus right now lies in the FX/Commodity sectors. The Dollar bullish trade looks like, from where I’m sitting, to be the best opportunity on this small pullback. Last week, I touched on this trade in a bit more detail, click here last weeks commentary. Technically speaking: EURUSD – weak bounce, looking for uptrend line going back to June to get tested in the 1.33 area; AUDUSD – head-and-shoulders pattern forming (should it trigger, .9275-.93 will be the target; GBPUSD – trying to maintain a a trend-line extending back to early September – trust until broken.

Precious metals also look like they will experience another leg lower, as the speculative excesses, particularly in silver, have not likely been purged enough to warrant bullish bets at this time. Gold appears to be forming a head-and-shoulders pattern, which may have a very weak right shoulder should the next push lower begin shortly. Stay tuned for further updates.

Dollar Could Pullback, But Intermediate-term Prospects Remain Positive

The Greenback, thus far, has experienced a solid 4% bounce off its two-year trend support, with the strongest move taking place in the EURUSD. The bearish excesses, built up during the weeks leading into the FOMC meeting, reached an extreme consistent with trade-able lows. In the two days following the meeting, there was a final thrust lower as the ‘johnny-come-lately’ crowd piled into the ‘risk-on trade’ one last time. This pushed price down into a strong support level where a clear divergence in momentum was also present; creating a low-risk opportunity to initiate a bullish campaign in the Dollar.

Extremely Bearish Sentiment + Long-term Price Support + Momentum Divergence = Low-risk Entry

Today’s trade took the Dollar Index (DXY) up to the 50-day sma/ema, which resides just under a trend-line extending back to the June high. I expect some weakness to develop on the initial test of this resistance area, however, as long as the low created on November 4th holds I will remain constructive looking out over the intermediate-term. At the moment, in the absence of an immediate technical pattern or overtly positive fundamental driver, I am leaning on the notion that a correction in the imbalance of market participants’ positioning will eventually fuel further price advancement. The potential for a bullish bottoming formation is also in the cards should the Dollar experience an orderly pullback in the sessions to follow. (See chart below)

Silver Update: C-Wave In Progress

Silver beginning next leg lower — looking for $25-25.50 in the near-term.

Cotton No 2: The Bonanza Might Be Coming To An End

Yesterday, we saw a huge reversal on big volume in precious metals after the CME raised margin requirements on the Silver (SI) contract. Today, we saw another gigantic reversal, this time in Cotton, parallel to the move made in the Silver market. This type of price action after such a parabolic run is indicative of a trend change at hand. Last week, when I first mentioned a trade was brewing in Cotton it was trading nearly 20% lower. There were no reasons at that time to get in the way of the freight train, however, in light of today's reversal I think risk now favors the bears. This trade, like the one in Silver, is not for the 'faint of heart', and needs to be managed diligently. I could see a 15-20% correction occurring in rather short-order. There is the distinct possibility of an assault on today's high, but should be short-lived and ultimately unsustainable.

 

Dollar Rallies, Equities Retreat, And Silver Implodes

On Sunday, in "Weekly Preview: Nov. 8-12",  I expressed a strong bias towards establishing Dollar bullish positions while taking a bearish stance on equity indices. Also, in addition to these core ideas, in recent days, I pointed out three individual stock ideas (one bearish & two triangle set-ups without definitive biases, click here and here), and another triangle set-up in USDJPY. So far, the Dollar has rallied smartly off the LT trend-line, equity indices have begun pulling back, the stock ideas are in a holding pattern, and USDJPY — after making a head-fake lower this morning — joined the Dollar rally by breaking out above the top-side trend-line of the triangle.

Today, what really grabbed my attention; the precious metal sector, more specifically – Silver. The volatility seen today has very few precedence.  This afternoon, silver experienced an 11% reversal from high to low in less than three hours. Gold — not having garnered the same degree of speculative fervor — was much tamer with a daily range of only 3%. What ignited the post-market sell-off in Silver was a letter sent out by the CME outlining higher margin requirements; so it seems. However, interestingly enough, upon closer inspection, the S&P, and the 'risk-on trade' in general, was under pressure all afternoon. During much of Silver's (SI) sell-off, the price movement correlation to the S&P 500 ranged between 60-100% on a 5 minute intra-day chart.  The fact is — reactions with so few historical precedence — do not occur on news of this type, which, in my opinion, demonstrates just how grossly overbought Silver is.

Back on 10/18, I felt we were upon a decent short-selling opportunity — SI pulled back quietly, touching the 20 day ema — but, today's action created the type of reversal that spawns extended periods of volatility and price weakness. Due to Silver's volatility and wild swings often associated with inflection points, it shouldn't come as a surprise if we see a retest of today's high, 29.34, before rolling over. With that in mind, it would be prudent to consider this possibility when devising a trading plan.

Interest rates are already presenting an interesting 'fade-the-fed' trade. I know this contrarian idea is at odds with the age-old axiom, "Don't fight the fed". However, when 5-year rates  decline from 2.75%, as they were back in April, to last week's low of just above 1%, I am left wondering how much more down-side is left in this move. The 10-year rate could be carving out a bullish inverted head-and-shoulders pattern. I will continue to monitor the situation for any low-risk entry points.

Summing it up: From where I'm perched, at this time, the most explosive opportunities are in the FX markets and precious metals. Specifically, I am focused on Dollar long positions expressed through shorts in the EURUSD, GBPUSD & long USDJPY, AND Short positions most heavily concentrated in Silver, with some Gold. Additional set-ups: Long SPY & QQQQ puts; short LVS. Pending trades: NFLX and BIDU. (Trade Update: EURJPY needs to hold above 111.25 ,at this time, for me to remain constructive.)

BIDU: Triangle

BIDU's (Baidu Inc.) stock price has been constricting for over 2 weeks now, forming a nicely shaped triangle for the second time since the end of September. The previous triangle broke out, retested the breakout, and then shot higher on the heels of its earnings release. Since the prevailing trend is up and a sturdy 2-month  trend-line resides just under the bottom of the pattern, I anticipate another leg up. However, one can never rule out the fact that this type of pattern, which generally holds no bias, could lead to a breakdown. The stock is extremely overbought on the long-term and major market indices could use a rest, so maintaining flexibility, as always, will be prudent. The width of the pattern points to a minimum measured move of $8.50 in either direction.

 

 

USDJPY – Triangle Forming

The USDJPY is in the process of carving out a triangle and should breakout within the next 2-3 days. Given that the prevailing trend is down and the wave structure, at this time, another thrust lower looks most probable – with a target of 79.25-50.  However, one can't rule out the possibility of a breakout to the upside with a target of  82.75-83. Stepping back, glancing at the big picture, I still remain optimistic that a low of significance is in the works in the not too distant future.  Bullish sentiment, along with price,  is near historical levels creating a potentially explosive opportunity.  But, for now, I will remain focused on the short-term set-up at hand.

 

 

 

 

Weekly Preview: Nov. 8-12

Equities:

Heading into last week, despite bubbling optimism for stocks, consensus had grown widespread amongst market participants, even in the bull camp, that profit taking would set in once the FOMC outlined their intentions for QE2 (sell-the-news). Indeed, thus far, this has not been the case. Financial stocks have benefited the most, shooting up over 5.5% during the two days following the meeting. The size of the LSAP program was within market expectations, however, the average maturity of the new purchases was not. The average maturity will be between five and six years; thus putting the curve steepening trade back in play, helping boost bank's profitability.

At some point this week I expect weakness to develop in the 'risk trade'.  I am by no means calling for THE top to take place, but risk appears to be strongly favoring a pullback. On two prior occasions during the month of October I anticipated a pullback in equities, but to no avail. This time, however, the market is demonstrating signs of "blowing-off" with the most recent surge appearing to be coming from capitulating bears and panicky bulls. The S&P may hold below the top-side of the multi-week rising channel, providing a backstop for bearish bets. Once markets pullback, we can access the damage and get a better idea as to whether the pullback is the beginning of a larger reversal or simply a healthy correction.

Commodities:

Commodities have been the hottest game in town. Both industrial and precious metals have been racking up huge gains while agricultural sectors have been acting simply outrageous. Cotton and Sugar have been leading the speculative frenzy with price charts bending back to the left – registering multi-month percentage gains in the triple digits. For those with the intestinal fortitude, a high yielding short set-up is in the making.

In the months to follow, it will be interesting to see how much of an impact the rising cost of raw materials will have on profit margins. To what extent will businesses be able to pass through rising cost to a consumer stuck in a balance sheet recession? This will be, to say the least, an important development to pay to attention to. If the economy can take the torch from the Fed and grow on its own, then this may turn out to be a non-issue, however; if the economy continues to muddle along then an unintended consequence of QE2, squeeze on profit margins, could rear its ugly head. As they say – only time will tell.

Currencies:

On Friday the Dollar Index (DXY) bounced off a long-term trend-line. My bias since mid-October, based on historically extreme pessimism, has been that the downtrend in the Dollar is closing in on a reversal, however, price action — the final arbiter — has yet to cooperate. From a pure risk/reward viewpoint, establishing a long position off the long-term trend-line makes a lot of sense; regardless of the outcome. Presently, I am leaning towards short positions in EURUSD, GBPUSD, and long positions in USDCHF, and possibly USDJPY. I will follow up with more details surrounding these pairs as the action unfolds.

Interest Rates:

I don't see a particularly strong edge in making any moves against the short to intermediate term maturities, however, a rally in rates would be consistent with the before mentioned biases. The 30-year could become an interesting trade in light of the fact that the Fed isn't going to be focusing their purchases on the long end of the curve. A bearish topping pattern is in the cards for the 30-yr futures (US) which will further support this idea.

Bottom Line:

Dollar bullish trades look to hold very favorable risk/reward opportunities as long as the long-term trend line holds. In addition, purchasing puts in Index ETF's, considering how inexpensive volatility is, looks like a solid risk/reward play off the upper band of the rising channel. Also, on the radar are a pair of short set-ups in individual equity names –NFLX, LVS — click here for the NFLX trade outlined late last week, and check out the chart below for details regarding LVS.

 

 

 

NFLX On The Radar: Gap Fill In The Cards

Netflix (NFLX) reported better than expected earnings on October 20th,  sending the stock up to new all-time highs. However, since breaching the old high made in September it has fallen back below, and underperformed the Nasdaq considerably over the past week. Equity markets, as a whole, look pretty rich; any correction in the near-term is likely to tip NFLX over the edge.

In addition, and more importantly from a technical standpoint, NFLX is forming a head-and-shoulders pattern with the neckline residing just at the bottom end of the range created post earnings announcement. A firm break below 165 will put NFLX under the neckline and 20 day, squarely in the gap. Some trend support might come in around the 160 level. The projected target for this quick-hitter is for a fill of the pre-earnings gap –153. The 50-day ema/sma is ~154 and rising, so this will be another area of support to watch as well.

There is the alternate possibility of a bullish triangle. If this comes to pass as the dominating pattern, then the recent relative weakness was just a breather and the rotation effect will be in play. At this time, however, the first scenario looks most likely; but, as always, I will let the price action be the final arbiter.