BigTrends

Several times over recent months, GLD has tested the 122 area.  This area marked resistance on rallies in May and June, see the following chart.  We actually had a couple breaches above this area before reversing lower.  Now we are again testing the 122 level on GLD after a nice rally that's been in place since late-July.

Today it looks as if we're backing off from this level yet again.  However, given the strength in Percent R and the steady uptrend in place for a month now, I would anticipate that we would hold on a pullback around the Middle Band (yellow line) and 20 day Exponential Moving Averages (red line).  Twice in August we pulled back to here before rallying higher.  In that case, one should look at a pullback to the 120 or 119 area as a good entry point to bank on a possible bounce in GLD.

GLD Daily Chart

There's been a clear asset allocation into securities such as Government Bonds (TLT) and Gold (GLD) as investors & traders look for safe harbors in this uncertain economic environment.  With less attention, however, the Japanese Yen has gained significant ground versus both the Dollar and the Euro.  Take a look at the chart below, which tracks Dollar/Yen forex (USDJPY) and Euro/Yen (EURJPY).  You can also utilize FXY etf for tracking the Yen.

Dollar/Yen and Dollar/Euro Chart


First, you can see that the decline of Dollar and Euro vis-a-vis Yen has basically been in tandem -- indicating a clear safety preference for the Asian currency.  Also note the big decline in late '08/early '09 -- this was in line market weakness -- however, there was not a corresponding selloff in March '09 when the market panic bottom of SPX 666 occurred.  This was a sign that the stock selloff was overdone.

Another factor to consider is that Euro and Dollar have actually breached to new lows below the 2008/09 levels ... meanwhile the stock market is far above those levels -- even if you throw out the 666 bottom, we're still fairly high above the 800/900 SPX levels reached in late 2008/early 2009.  If the market follows suit, keep an eye if SPX 1000 is breached in the coming days, we may then go as low as SPX 900 (881 is also a Fibonacci level) in September.  At that point, we may then see a strong market rally as mid-term elections approach/occur -- but that's for another article.

For most of 2010, there was an interesting performance correlation between Gold (GLD), Bonds (TLT) and the Dollar (UUP).  The three securities were moving mostly in tandem, which is somewhat unusual historically.  There is no 'set in stone' relationship between these, but quite often Gold and the Dollar will go opposite directions, for example.  And one could conceive that a weak Dollar makes our Government Bonds cheaper for foreigners to buy, etc.

The inter-relationships and connections between large areas of the financial markets such as Bonds, Currency and Commodities is fairly complex and can be obtuse.  Here's my take on the story with these 3: 

Certainly in this case, we've seen Bonds rally as economic growth looks slow, the Fed is pumping liquidity and buying Treasuries, and investors are looking for any safe return (even ridiculously low ones).  Gold is another safe haven in times of turmoil and is often an inflation hedge -- the bullish move in Gold raises the question of whether so-called deflation is in fact present.  My view is that we have deflation in some areas of the economy but also have had significant inflation in others, especially those that affect the base middle-class (and below) consumer.  The Dollar ... well, UUP had a pretty big downtrend in 2009 and rebounded in 2010 with the Euro weakness (when debt problems spilled over to Europe in a big way).  And while a low Dollar will theoretically help our exporting, in general I'm a big believer that a strong currency is a positive thing for a country/economy in the long-term.

So each of these markets has its own story, yet they are related at the same time.  Now taking a look at the 2010 performance of these 3 ETFs, below:

TLT, GLD, UUP Performance Chart


So you can see that they moved in tandem for most of this year.  That relationship broke down around July, and has since widened.  I wouldn't expect the performance correlation to resume as strong as it was earlier this year any time soon.  If you are looking at paired/hedged trades, you would want to consider whether this performance divergence will widen, narrow, or stay the same.  Traders could consider playing the UUP against either the GLD or TLT in a paired trade.  If you have a strong conviction (such as that TLT will eventually correct to the downside from its near parabolic uptrend), you could go Long UUP/Short TLT.  Just a hypothetical example, I'm not recommending that trade at this time.  Or if you see GLD breaking upwards even further, you could consider a Long GLD/Short UUP.  These paired hedged trades can be done through options, ETFs, futures, etc.

I noticed a fairly unusual pattern on the S&P 500 (SPY) hourly chart in terms of Percent R.  We had a real spell of whippiness through Wednesday.  Take a look at Percent R at the bottom of the first chart below, you can see we quickly cycled through extreme bearish, then bullish, and back into bearish readings.  It's not unusual for an hourly indicator to give strong bullish or bearish readings, but the quick 3 turn cycle is fairly unusual.

Current SPY Hourly Chart


We haven't really seen this type of pattern recently, so I looked back with an eyeball test at recent data.  A similar pattern caught my eye.  Then the dates of when it occurred really piqued my interest ... it was a couple days before the infamous Flash Crash.  This also was right at the beginning of the 2 month market downtrend we saw through June.

Recent Similar Percent R Pattern


Something to keep in mind for your trading, especially given that we've just had the VIX pop with increased volatility and the market sell off.  There may be more bad news or events coming ... either way a strong trend may be likely to emerge soon.

Well, it's official -- China has now overtaken Japan as the world's 2nd largest economy, according to a CNBC.com article.  This is after overtaking Britan and France in 2005 and Germany in 2007.  China is projected to pass the U.S. to become the world's biggest economy around 2025.

China's per capita income is only $3800/year -- if this can grow by multiples of 2x, 3x, 5x, etc -- imagine the size of their consumer buying power, as Chinese citizens upgrade their purchase quantity of "luxury" items such as computers, cars, vacations etc. Not to mention that China already has the world's largest stockpile of currency and asset reserves at $2.45 Trillion.  Hence they are becoming or have become the leading world power in commodity demand as well.

The CBOE Volatility Index (VIX) is showing some interesting price action recently.  The market in general has mostly been fairly quiet in it's action with a bullish bias.  Yet the VIX is somewhat stubbornly hanging in and refusing to drop much below the 23 level (see the following chart).

This is now the 3rd time we tested the 23 area, and we have yet to breach below this area.  I would normally expect the VIX to drop down to test the 20 area in this kind of market environment -- sure there is uncertainty, but we've also seen big news events recently that should alleviate anxiety, such as the oil spill being capped and financial reform/Goldman settling.  Also, earnings season is winding down.

There is fairly heavy open interest in the August 22.5 and 25 VIX Puts, which could be helping to keep the index in that range.  But in general, there is definitely some skepticism and negativity about the market out there, as seen in the VIX -- is this a contrarian bullish sign (price action has certainly been bullish in July) or "smart money" anticipating another volatility spike?  I lean to this being contrarian bullish, but would feel more comfortable for the bullish case if we do finally move down to the 20 area.  Additionally, band width indicator on the VIX (bottom of the chart), basically a simple measure of VIX volatility, was actually rising a bit recently, something to keep an eye on.

VIX Daily Chart

We've noted throughout 2010 that the small cap Russell 2000 index (RUT) (IWM) has been a relative outperformer versus the other major indices (QQQQ (DIA) (SPY).  Especially when the market rallies recently, the IWM gains ground quicker.  Take a look at the following 2010 performance chart -- IWM is blue, QQQQ is yellow, DIA is red, SPY is green.

2010 Performance Chart


You can see the IWM has steadily been above the other indices -- it also "spikes" higher in general when the market rallies.  On the flip side, it also looks to come down quicker when we sell off, but still maintains a net edge in yearly gain/loss.

This increased leverage/movement/volatility is priced into the IWM options, so you do pay for the potential gains.  For example, my data currently shows the IWM at-the-money August options are priced around a 27% implied volatility.  By comparison, QQQQ is around 22%, DIA 19%, and SPY 20%.  Some of this increased option premium pricing can be alleviated by buying deeper in-the-money options -- but also of course premium will dissipate as we get closer to expiration.

Gaps on an index daily chart are a fairly rare occurrence, due to the wide range in a day's trading that normally occurs.  However, we've seen 3 recent significant daily gaps in the major indices.  Let's look at the DJIA etf (DIA), known as the DIAmonds.

DIA Daily Chart


In each case, the gap move was quickly "filled in" by a reversal move within 5 to 7 trading days.  This is something to keep in mind if you see this formation occur again in the future -- it is likely that the gap direction will be reversed and filled in fairly quickly.

I mentioned yesterday to our premium subscribers that we were likely to fill in this DIA gap today, which has occurred.  Incidentally, we've just made 2 strong profitable trades on the DIA based on 30-minute charts with a modified RSI based system.  Index Options Timer clients bought DIA Puts on June 28 and bought DIA Calls yesterday morning July 7th.  If you are interested in participating in these trades, please call 1-800-244-8736 for information on subscribing to Index Options Timer. 

An interesting story came in from England this week.  Apparently a trader, whose job was only to execute client orders and whose firm did no proprietary trading, took it upon himself to make some big trades in the very early morning on Brent Crude Futures.

This occurred June 30, 2009 and the trader moved over 7000 futures contracts representing 7 million barrels of oil.  These trades on the ICE Futures Europe Exchange (different exchange than the ISE) apparently caused chaos in the oil markets and sent global prices higher (oil subsequently went sharply lower in the following days).  He made no money on his actions, but did try to cover up and lie about his actions when questioned.

While to some degree this is a bit of a comical, "shake your head" type of story -- it also shows the risk of "rogue traders" to individual firms, markets, and public investors.  One would expect that companies would put strict limits and systems in place to prevent internal risk parameters from being violated.  And we can assume that more and more internal regulations are in place at companies since the massive financial mishaps of recent years.  Also, government regulations can be expected to strengthen in the wake of recent events (if they aren't watered down too much and also if government can actually get something right, which isn't certain at this point).

However, these types of events have been going on for years.  Remember Nick Leeson, the famed Rogue Trader of the 1990s, who basically broke a bank?  I was a partner in an option trading firm in London in 2000 and 2001 and I can tell you that at that time, the internal financial accounting at our clearing firm was shoddy, at best -- this was just my personal experience, but the level of professionalism and accuracy there was bush league when compared to the Chicago firms I had previously dealt with.    Hopefully things have improved since that time.  There would seem to be simple ways for these firms to place limits on employee trades, sophisticated real-time risk management, etc, so that these types of things do not continue to happen in the future.

George Soros, the famed trader/philanthropist/muckraker, said during a speech in Berlin that the Euro currency and in fact the European Union (EU) may be in danger.  He basically attributed Germany's economic tightening policy and unwillingness to bail out fellow European countries as a possible cause of a breakdown.

Soros is an interesting  and polarizing character -- raised in Nazi-occupied Hungary, he then became of the world's most famous and rich traders (known for "breaking the bank of England" in 1992), and in recent years has leaned to becoming a strange mix of libertarian/socialist/pacifist activist that has confronted many world leaders and governments.  Many Americans don't like the very opinionated politically-oriented pronouncements that come from Soros in recent years.  But the complex nature of his beliefs can be seen by the fact that in the 1970s he garnered huge profits in a hedge fund with Jimmy Rogers, who is a vocal free market, limited government spending advocate.

This attack on German fiscal policies by Soros is a bit complicated, as is the entire worldwide Debt and Currency Crisis.  But he basically seems to be saying that Germany should be increasing public spending in order to stabilize Europe and keep economies from slipping off the brink.  And to some degree he may be correct in the short-term, as massive spending in America has helped to temper our recession (long-term effects are a different story).

However, by bringing in the concept of Euro/EU failure and saying "Democracy itself could be at risk", he basically is raising panic and fear -- and not in a responsible manner in my view.  I would assume he is doing this for political reasons, not personal trading/financial ones -- but he can shake world markets with talk like this.