A Perfect Storm

It’s sunny in Los Angeles today – not a cloud in the sky and the temperature is in the lower 80s – very little smog – call it a perfect day. What do you expect – it’s summer in California and people are streaming to the nearest beach to pursue their weekend pleasures. Los Angelinos love to sizzle in the sun for that perfect summer tan (mixed with some early stage skin cancer), take a stroll down the strand, or take that Jet Ski for a spin, assuming they can still afford the gasoline that makes it run.

But little do they know that a perfect storm is brewing – not above in our skies, but in the domain of our economy and hence in our financial markets. If you are a trader and happen to be on the bullish side of the equation you would most likely disagree. After all, the Dollar is up up up – the Euro down down down – Gold has been beaten to death – the Nasdaq has been steadily pushing up for weeks – and Crude has been tanking. Life is good again, right? We’re back with a vengeance and it’s back on Easy Street.

Well, today’s posting aims at bursting that bubble – and no – we’re not sorry because the inherent profit potential is humongous. The last two weeks could be described as the proverbial ‘quiet before the storm’, which has given the permabulls plenty of confidence, signified by a sinking VIX, which is at last count has receded back into bull territory (19.58). But as the evil speculators that we surely are, our job is to look beyond the obvious which drives the herd of clueless investors from which we derive our ill gained fortunes. So, without further ado, let me paint next week’s picture for you:

Let’s start with my usual S&P futures chart:

S&P running out of steam.

Pretty similar to a few days ago. ‘Timid’ would be a good word to describe the last few days of trading in the S&P futures – ‘going out with a whimper’ would be a fitting label on this chart. As I indicated in my last post (and I will spare you the boring details today), as prices have been chugging higher, each step up has been weaker than the prior in terms of its momentum. This can be measured by the a/d ratio, the peak upside volume, or an indicator I recently started to appreciate, the force indicator:

Divergence between momentum and price.

As is blatantly obvious from the chart above, this push up is running out of steam as it is a textbook counter-trend rally. What’s fascinating is the lackluster performance of the financials and banks, which although having enjoyed every iota of relief action made available by the Feds, have been running into resistance, and since then have languished. Sometime next week I expect the triangle support line shown in the first chart to be breached with confidence, thereby initiating the signal for us hungry bears to circle in for our first feast. Things should transpire quickly at that stage and on our end it will represent the signal to start loading up on short positions. The astute reader will notice that I have swapped the ‘most likely scenario’ to down, although we don’t want to discount the possibility that by some unholy market manipulation (i.e. continuous Dollar loading by the ECB, the BOJ, and the Chinese), we may see one last push up to the 50% retracement area around 1320.

You can run but you can't hide.

The Nasdaq has been the darling of the bulls as of late, mainly lifted by the technology sector, but even it is running out of steam. A breach of 1920 will signal that the rally is over and the downtrend is resuming. However, I won’t lie to you – the Nasdaq has been a thorn in my eye. Then again, as the saying goes – a diverging market is an unhealthy market, and given the factors I will discuss below it seems that this rally is destined to end.

Dollar over-extended to the max.

Which brings me to the Dollar. Don’t let the ‘fancy chart’ confuse you – what you’re seeing is a Bollinger band set to 2.0 and 2.5 Std. Dev. Not surprisingly after such an explosive action, the Dollar has moved FAR outside the 2.5 Std. Dev. boundary – I even checked and it is actually bordering the 4.0 Std. Dev, which could be described as being ‘stretched to the max’. Incidentally, the same applies to the Dollar’s currency nemesis – the Euro. I have never seen a commodity, equity, or currency remain that far extended for that long, which is indicative of some artificial buying by some big players (i.e. the ECB and the Swiss Bank) – this kind of action does not occur ‘naturally’. In addition, EW theory also dictates that we need to see a retracement here very soon, probably starting early next week. So, expect the Dollar to start retracing and the Euro to start gaining over the coming weeks. In the long term the Dollar will continue its path upwards, but for now this wave seems to be in its final stages. Similarly, the Euro is destined to continue to depreciate against the Dollar, but in the short term we expect it to surge back up. More details on those targets once we see both currencies embark on their corrective waves.

Gold craters.

I have to admit, evil speculator or not, I feel bad for those poor gold bugs. This is a similar chart as the one I have shown for the Dollar – after yet another brutal drop Gold is currently stretched to the max and is bound to slingshot back starting Monday or Tuesday at the latest. Don’t get me wrong – the Bear isn’t done yet with Gold and in my last posting I predicted 720 as the next stop. However, I was a bit hasty to read the short push up to 840 as the completion of its consolidation, and after Friday’s precipitous drop we will need to see one more push up to around 840 to 850 before we will consider going short again.

Silver oversold to historic levels.

The other (now less) precious metal, Silver (ZIZ8 in TOS) , appears to have completed its 5th wave down after losing 11% overnight. I suspect that after the dust settles we will see some headlines that several large hedge funds have been forced into liquidation and had to blow out all of their positions. It is ready for a rebound VERY soon – most likely starting Sunday night. However, as commodities often tag on an ‘extension’ to their 5th wave, there is a possibility that we may see some further weakening. I do have some doubts in that respect however, as Silver has been shot to hell in my mind and is stretched like a rubber band. It is so oversold at this point that its disparity index has reached negative levels we have not seen for a quarter century. Gold is in a similar situation, but not as extreme. But the big picture here is that both precious metals are ready for a correction, so if you are holding short positions I would recommend exiting Monday.

Now, at the beginning of this posting I was talking about the ‘perfect storm’ that seems to be brewing. Now let’s put all the pieces together and see if we can’t project forward a little to see what the near term future will bring: We have a market that’s divergent and which is running out of steam. We have Gold and Silver – stretched to the max and ready for a rebound. We have the Dollar completing its wave up and ready to consolidate back down – and the Euro ready to bounce back from its oversold condition. And expect Crude to bounce back a bit as the Dollar drops and Gold is consolidating. Does that sound like the straw that might just break the camel’s back?

What I’m getting it is that we all know that this bear market is just in its beginnings and had it not been for the incessant but expected meddling by our esteemed ‘plunge protection team’ this consolidation period would have been short and sweet. But as I’ve said before – you can run but you can’t hide – the market is a cruel mistress and it ferrets out the weak whilst mercilessly imparting its justice. The entire financial sector is being held together by scotch tape right now and a tumble in the Dow and the S&P will be all that’s needed to rip off the band-aids and lead to a barish escalation. This is where we come in. What gives us scavengers of the financial world an edge in times like this is that we are ruthless realists who will have zero compunction about leveraging any unfair advantage. After all, the bulls had their month in the sun, but this summer vacation is coming to an end and hell just froze over. Oh, and before I forget it – remember that the VIX is in the teens right now and our put options are going to explode once volatility kicks back in.

Let’s have some fun next week and bank some mighty coin. When it’s all over and done by the end of fall, let’s all meet in Vegas for a Dow 10,000 party. Which reminds me – LVS, PENN, WYNN, etc. will be excellent candidates for short positions once things get rolling.

Cheers!