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EURUSD/AUDUSD – SHORT, PREC. METALS – SHORT

October 18, 2010 Leave a comment Go to comments

The reflation trade of the past several weeks has unquestionably taken its fair share of bears out to the proverbial wood-shed. The rally has been broad in nature as we experienced sharp rises in global equities – most notably in EMs, FX pairs, metals, treasuries, and recently energy joined the party as well.

The rally's synergy has pushed many of these markets to extremes proceeding pullbacks and/or consolidations. To say the least, it has been futile to be short any of these markets, but now from a short term standpoint, it doesn't look like a bad time to "get in the way" a little bit with stops closely at hand of course.

Sentiment has risen sharply. In the case of precious metals it has risen to a feverish pitch. Silver short-term sentiment, as measured by Daily Sentiment Index (DSI), has recently demonstrated on a few occasions that 95% of traders are loving the shiny metal.

Commitment of Traders reports (COT) show that large speculators have been piling into the futures markets, sending total position size in several markets into the upper levels of historical extremes.  Gold (255,874 contracts) and Crude Oil (129,326) are both sporting near record positions. The Euro Large Spec. position has made a complete round turn from the depths of a net short position reaching nearly 120,000 contracts back in June to a net long position of 41,511, which is just shy of the position size back towards the peak in late 2009.

Daily momentum indicators, such as the 14-period RSI, have become extremely stretched for an extended period of time.  I never rely on this indicator for stand alone signals, but my interest is piqued when the indicator stays in the nose bleed section for an extended period of time or begins diverging away from price. Silver 14-period RSI has been above the 70 line since the end of August, while the Euro has been above for nearly a month now. Both rarities, especially in the case of silver. (It should be noted, Silver can be a dangerous instrument to get in the way of given its history of really sticking it to the shorts before knifing lower.)

Recent price action suggest that we may see a price reversal very soon. The EURUSD closed below the prior days low for the first time since 9/7, or 28 days ago. I liked Friday's wide range reversal bar as a first entry, but upon taking a closer look (240 minute chart) one can see a possible head-and-shoulders pattern taking shape. The AUDUSD is flirting with a breach of a narrow channel extending back to late August. The GBPUSD has been the weakest of its foreign brethren and has rolled over more than 200 pips since Friday, where it failed to hold a breakout above the August high.

Gold and especially Silver have significantly expanded their daily trading ranges in the month of October. The 5-day ATR (Average True Range) for December Silver has increased 56% since 9/30. The speculative fervor is spooking the shorts, and drawing in the "Johnny-come-lately" crowd causing wild overnight and intra-day action. Often a sign that a sharp reversal is not too far around the corner.

In equities, I think the lagging nature of financial stocks will be tested. I have continued to wait for them to play "catch-up", but they have failed to do so yet. Should the stock market retrench a bit, it will be important for this sector not to fall apart if the market is to have a shot at heading higher later.

In after hours, Apple (AAPL) and Big Blue (IBM) are trading down over 5% and 3% respectively on the heels of earnings. This might be enough to spur some selling in the coming days, helping to bolster the "risk-off" trade and my near term bearish bias.

In the event that a retracement unfolds we will have to take another look at any technical damage done and assess whether we can continue to march higher into year end. The bull's case is for QE2 and lagging fund performance to keep markets trending higher. The bear's case is that QE2 is baked into the cake, and the myriad of structural issues and stalling in the economy will begin to weigh on investor's minds once again. At this juncture, I am still leaning towards markets staying propped up into year end.

Audusd daily

  EURO ABC

Eurusd 240


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