Bulls At The Ten Yard Line

It’s week two of football season and I had this ephiphany about making my second favorite sport the theme for today’s post. Not just on a whim or to be funny, mind you, but I actually think that using a different paradigm may lead you to detach yourself from your own mental traps and hopefully to take a new perspective on what’s going on:

The gist of what I’m trying to convey today is this: It’s the fourth quarter – the bulls are sitting at the ten yard line and have possession. The score is 21:7 and the bears’ defenses are in turmoil. There have been several fumbles – moral is at all time lows and the bear’s offensive has not been getting out of the gate. The bulls are getting tired but have Ben Bernanke on the sidelines handing them cool drinks and energy tablets. Meanwhile certain bearish pundits keep running to their bookies to put large bets on the bears scoring three touchdowns and taking the game.

What gives?

Now miracles can happen – maybe Schaub gets sacked and half of their offensive falls into a sudden coma. And yes, individual bullish fans outnumber bearish ones by about 2:1 right now. But let’s not forget that big drives often happen in extremely overbought conditions – which is exactly what the bears keep referring to when it comes to big drops in oversold conditions.

However, my momo charts continue to look like a tossed salad, leaving the door open for the bears to finally score a few touch downs. But let’s always remember Jesse’s mantra: The tape will usually go the direction of least resistance. Right now we are sitting at a formidable horizontal resistance line – yes – but what happens when we actually breach it?

So what are the odds here? Is a fourth quarter miracle in the cards? Let’s look at some charts and then you’ll be the judge – today I’m going to cover the entire gamut:

Let’s start with the simple charts first: Copper has clearly been leading equities and I don’t expect this to stop right now. Look at those beautiful divergences in March 2009, and in January, July, and August 2010. What is it doing right now? Pointing up – and that does favor equities.

Similar situation in junk vs. treasuries. It’s pointing up and I do not yet see anything resembling a divergence or weakening in demand.

You may remember the gold/silver ratio chart I plotted against the SPX. Now, my beautiful channel/triangle formation was shot to hell in late August and I was stunned to see such fast drop. This now puts us in a completely different POV – one that requires us to zoom out a little to appreciate what’s going on:

Same chart – but going back to late 2006. As you can see the ratio roughly moves inverse to equities – as it should. Strong silver in comparison with gold suggests that economic conditions are improving – falling silver means falling demand as it is an important industrial material in addition to making cheap offerings to appease pre-menstrual female companions.

Now, the blue line connects points on that chart that seem to be important to precious commodity traders for some reason (I don’t know why – no). And we are right on it – just now. The question I have is this: If we bust lower – will this lead to an acceleration in the ratio? Meaning – will gold finally take a plunge to the downside – or will silver keep pushing up further? For the record – it is very strange to see the ratio plunge while gold is pushing up so hard. Nobody out there seems to be looking at this strange phenomenon.

Confused about the chart above? Well, here’s silver in gray against gold in gold. Silver shorts have been taking it up the rectum in the past two weeks and yes, we may be looking at buying exhaustion here any time soon. But we are also close to making new highs in silver, so if there’s a breach, expect the ratio to drop even lower per the chart I proposed above. Now, always remember, currencies and commodities move a bit different than equities. The trend remains the trend until a meaningful reversal stops it in its tracks.

On the momo indicator side we are far from ‘reversal territory’ – sorry. What is encouraging is that we turned right where I expected us to in late August as the SMA on the put/call ratio touched my resistance line on the very top. Now, most recently we have been turning back down at a diagonal dropping support line (not marked on the chart but clearly recognizable). Will this happen again? Maybe – but if it does not then we have a long long way to go.

This obviously also supports the ‘now or never’ scenario I have been proposing shortly before I head out to Korea. As I’ve quipped above: The bulls are literally on the ten yard line – and unless they lose possession yet another touch down appears imminent.

My ‘lie detector’ does however leave the door open. If you’re a Zero sub then you know that the recent push higher had no meat behind it and we could be looking at healthy reversal here. But let’s not forget that we have seen that game before – sideways or slow up tape with no momentum/participation followed by a sudden push higher. The door is open but the bears have to walk through it and force the bulls’ hands. Thus far I have seen no indication that sellers are ready to step in here. Maybe next week – but the path of least resistance seems to be sideways right now. And that means it could represent a sideways correction before a final push higher. The bears need to show us that they mean business.

But what’s really been driving equities is the FX carry trade in the AUD/JPY. If you don’t have access to FX tickers then the FXA:FXY pair is the next best thing.

Last week there has been a disturbance in the force on the Yen side. The BOJ attempted to intervene by dumping massive amounts of Yen as 120 is a major threshold and had to be averted. Question is whether or not it will succeed – I have grave doubts they will as they have failed in the past. But then I’m not an FX pro – maybe someone here could shed more light on this.

But back to the carry trade story – as you can see the AUD/JPY has enjoyed significantly greater capital inflow than for instance the EUR/JPY. So, if we start seeing a reversal in the Yen (due to BOJ intervention or regular buying exhaustion) then I expect the AUD/JPY to get sacked in a big way. Nothing is as fun to watch on the FX side as an unwinding of a carry trade. Remember what happened late last year when the Dollar finally turned. Those moves are big and scary – when they finally happen. Usually it’s a lot later than anyone thinks – when it comes to currencies and commodities the trend the trend is your friend.

Bottom Line:

As you can now see: We are at an inflection point on several fronts. But the bulls are in possession and they know that a fumble here would be catastrophic. If they land another score they will probably take the entire quarter. After all, this is crash season and thus far equities have been leading the bears by the nose, much to their chagrin. If a drop into Primary {3} happens then it most likely happens now – next week or by the end of the month at the very latest. The odds of that are very mixed and I frankly do not see anything that clearly suggests that we drop lower here. The daily Zero is flat as well, leaving the door open to both sides. I would have loved to see a divergence on that end but nothing thus far.

We have been trapped in a range for months now and everyone just wants ‘out’. Whatever move will happen will be big – when it finally happens. But we may just move sideways for a few more weeks – thus faking out everyone and causing even more theta burn on both sides. Thus here is a possible trade that may work for either scenario – yes, maybe we can have our cake and eat it too. It’s a strategy we covered a few weeks ago – if you didn’t pay attention: shame on you and go back to read it.

You may want to click on that to size it up a little. If you are bullishly inclined then the bear call ladder is for you. I am considering a three month window here as the tape may slow down in the November/December cycle right after the election and ahead of X-Mas. As you can see you are immune to theta burn as it’s a credit spread and your downside is fully covered.

Now if you’re a bear this is the bearish equivalent – the bull put ladder. Little tip: To add those legs in TOS as a spread hold the ctrl key when clicking on the bid and the two asks.

Here is the SPY chart with my twisted logic on why I picked those levels on both ladders. I think my thinking should be clear but of course option strategies can be peeled like an onion. If you guys have any better ideas I’m all ears – hey that rhymes!

One final note – does the chart above remind you of anything? Exactly – the football grid I posted! Who ever said that watching sports didn’t teach you anything? If you like football stats then trading options may just something that’ll come natural to you – the game is not too different. We have theta burn (i.e. the clock) we have offensive/sideways/defensive plays – the odds – the players – the teams. Come to think of it – the game is similar – and in the end the only thing that counts is that you score touchdowns. Hopefully my post will help you to do just that.

Cheers,

Mole