Natural Gas Explosion

Stocks opened lower this morning, following a 2 day rally, but were lifted temporarily after today's Fed Beige Book report of regional economic conditions. The report showed slowing growth in the economy, and the market interpreted this as another indication that the Fed will pause or even cut in August. However, I keep stressing that the bottom line of that report, including Bernanke's comments last week, is the fact that the economy is slowing. A slowing economy is not good for stocks. I wonder when this Fed rate bias will end and bad economic data will start sending stocks lower, instead of higher. With respect to yesterday's new short position on BIDU, the stock opened in the red, but rallied hard to close at a gain of 2.5%. Similar to PHM, I took this opportunity to build more shorts on BIDU. Tomorrow we will see earnings from both BIDU and PHM (also new home sales figures).

We expect this week's 3 day rally to have come to end, as evidenced by a very weak closing today accompanied by light volume. This is supported by the doji that formed today in the S&P and Dow.


We are re-entering our short in the Nasdaq 100 (NDX). Although there is a possibility that there may be a follow through rally until the end of the week, the technicals for NDX do not agree. Today's internal technicals showed just 65 new highs compared to 125 new lows in the Nasdaq. One factor that concerns us is the NDX making a new low on 7/23, while the RSI failed to follow suit, indicating divergence. Our stop for NDX is at 1525, and our target is at 1400.


Today's most exciting activity came from natrual gas, which rallied very hard to close with a gain of nearly 9%! We feel very fortunate to have went long natrual gas futures yesterday as part of our relative value trade against crude oil. Frank Barbera's chart from Financialsense provides a great depiction of the historical relationship between natural gas and crude oil. As Barbera's indicator shows on the chart, a peak in the crude:natural gas ratio has coincided with important bottoms in natural gas. Indeed, today we saw natural gas break out of its downtrend, indicating that a bottom may have been forming.


Disclosure: Long BIDU, PHM Puts; Long NatGas/Short Crude; Short NDX Futures

Great Expectations

As I mentioned on yesterday's post, the data for existing home sales today showed further meltdown in the housing market. However, the drop in sales was small compared to expectations and forecasts. The market took this to mean some sort of stabilization in housing sales and real estate stocks rallied hard. But I do not buy this rally. We took this opportunity to build up our short position in PHM (Pulte Homes, Inc). Furthermore, we decided to hedge our long gold futures position by shorting a basket of gold stocks (NEM, AU, ABX). This hedge is supported further by a potential head and shoulders forming in gold stocks.

BIDU will be releasing its earnings tomorrow after the market closes, and I expect it to test the completion of a potential descending triangle. Today AMZN took a big hit due to poor earnings and I don't think the outlook for BIDU looks any brighter.


Disclosure: Long Gold Futures/Short NEM, AU, ABX; Long NatGas Futures/Short Crude Futures; Short BIDU

Will The Rally Continue?

Today we saw a sharp rally in all indices, while shorts scrambled to cover...boosting the rally further into the late afternoon. Of course, sharp rallies are not unusual during beark markets. But considering the overwhelmingly bearish sentiment within the mainstream, we take this as a contrarian indicator of a continued rally in equities. Therefore we have closed our shorts and will remain on the sidelines until further confirmation. Meanwhile, we expect oil producers to come out with strong earnings in the coming weeks due to the price of crude which hovered above $70 throughout this year. As for tomorrow's data, BP will be reporting its earnings and we are long BP calls. Furthermore, data on consumer confidence and existing housing sales will be released tomorrow. We expect both data to reflect the lagging drag of the Fed rate hikes, and we also expect the data to show further slowdown in the housing market. PHM has been forming a descending triangle, which is a continuation pattern of a downtrend. We took today's massive rally as an opportunity to build a short position. The falling volume indicates the near completion of the pattern and we expect PHM to break below $26 accompanied by heavy volume.

Disclosure: Long MSFT (Stop revised to $23.7), Long BP Calls, Long PHM Puts

Weekly wrap-up 7-21-06

This week saw a lot of action and clowns jumping up and down on CNBC with Wednesday’s “Fed-is-done” rally. Commentators took Bernanke’s claim that the FOMC expects moderating growth to contain inflation as a confirmation that inflation is under control and the interest rate outlook is benign, a view we do not endorse. Investors may have realized that slowing growth implies slowing earnings – so although second quarter earnings have been largely in-line with and even exceeding expectations, stocks were broadly not rewarded. We wonder how many of these “Fed-is-done” rallies are left… but would not be surprised to see more and more sharp rallies as this bear market really takes hold. We saw Wednesday’s action as a short-covering rally, motivated by the fears of short-sellers of missing the next leg up, perhaps triggered by Bernanke’s new seemingly dovish stance. The fact that buyers failed to materialize, as evidenced by the various indices surrendering most of Wednesday's gains, confirmed our view. The higher-than-expected core CPI number and the growing signs that Israel plans a full-scale invasion of Lebanon were mostly ignored.

The outlook for gold and silver this week is sunny with a chance of rain. We look for rallies off forming trendlines to confirm their importance. If those rallies successfully penetrate some resistance overhead, we look to get long these metals again. If no rally is mounted, however, we expect trading down to support and possibly 200-day moving averages. If those levels are seen we will be aggressive buyers. For now we are on the sidelines.


The Nasdaq 100 crumbled some more this week as tech industry bellwethers INTC, DELL, and AMD saw their stocks trampled, countering the mid-week rally that saw a test of 1500 above. In bear markets, oversold conditions are the norm, so the low RSI does not bother us that much. Excusing sharp intermittent rallies like the one we saw on Wednesday (which we used as an opportunity to add to our short), we expect the NDX to continue disintegrating for a test of 1400, and ultimately 1300. The SOX semiconductor index hit new lows, violently. We remain short NDX, and look to add to our position on large rallies.



We noted that copper has failed to make new highs on its latest rally. It is now below its 50-day MA again, which previously provided support. The 200-day MA remains far below. Our growing bearishness on copper, coupled with the PD chart, motivates our desire to sell rallies in that stock.

Important Earnings Tomorrow (7/20)

Today (7/19) the markets bounced back much stronger than I anticipated yesterday. This is because the market decided to pop the champagne cork to Bernanke's testimony today. Even though the core CPI came out higher than expected, Bernanke commented that he expects inflation to retreat due to a slow-down in the economy. It seems like the current upward bias in the market welcomed Bernanke's comment on moderating inflation, but missed out on why that may be: a recession? The Dow is near its 50-day MA and I don't expect it to break above that resistance. With major earnings being released tomorrow (Ford, Google, Pfizer, Microsoft...), it will be interesting to see whether equities will continue their rally. Looking at Microsoft, I expect tomorrow's earnings (after market close) to help confirm whether there is a head and shoulders bottom. Strong earnings and a break above the neckline would be a confirmation, and it should be accompanied by heavy volume. But given the current bear market, there is a chance that it may turn out to be a failed head and shoulders.

Rec: Long MSFT (Stop at 22.2)

MC Hammer

As trading began this morning, equities continued to bleed from yesterday's plunge. But as I mentioned yesterday, most indices are near very important long term trend lines, so it seemed too much to ask for the market to continue its relentless dive - a breather seemed to be in order. Then surprisingly (or I guess not so surprisingly), the markets started turning green around 2pm and managed to close above their open. Consumer staples (food, beverages, tobacco...) and non-cyclicals led today's afternoon rally. But, the H/L differentials of each index depicts continued interior weakness in the market, despite what the averages said today. The Nasdaq, for example, made only 28 new highs compared to 251 new lows today. However, I cannot ignore the hammer that formed today for NDX, and thus cannot rule out a mild bounce (although a similar hammer back in June turned out to be a false signal). Moreover, I expect the Dow to rebound as well from its support level (tested today) of 10700. However, looking at the very weak volume for the Dow today, I am not sure how strong the rebound may be. Moreover, there will be important data released tomorrow such as the core CPI and Bernanke's testimony at Congress that may depress many assets. Finally, I checked out the chart for Google and found that it made an Evening Doji Star (bearish reversal pattern, but based on weekly candlesticks) earlier this month. Moreover, it is very clear that the uptrend from the 340 level in March has not been supported by strong volume. Instead, a descending triangle has been forming (volume heavier on the downside and lighter on the upside), and while the descending triangle is a continuation pattern usually found at downtrends, they can also be found at market tops signalling a reversal. I can't see Goolge holding its 400 level for long (by the end of the week), and we may easily see a drop back to 340 or even 275 in the coming weeks. This breakout to the downside should be accompanied by heavy volume.

Rec: Short GOOG (Stop at 400)

Testing the Trends

This week will be a major test for the long term trend for the Dow, S&P, and Nasdaq. There will be key economic data released this week, such as the core CPI and housing starts. Moreover, Bernanke will be addressing Congress on Wednesday, and he will most likely explain his interpretation of the latest inflation figures. As the Fed made clear that they will be more data driven, this week's hearing at Capitol Hill and data release will be pivotal to guage how the Fed may move in August. As for today's broad selling in PM, it confirmed short-term technical weakness. Silver has failed to break above both its resistance level of 11.8 and the 50-day MA for over two weeks. Assuming a mild correcting for PM is in progress, silver, as with gold, will probably slide back down to the 200-day MA. Hopefully this is when I will get back into PM. Note: Tomorrow, look out for earnings from Coca-Cola and Intel as the market will probably react sensitively to their releases.

Bounce

As morning trading began today, it seemed like the broad selling in Asia and Europe was going to continue into the U.S. market. The bulls kicked in, however, late afternoon to enable the major indices to close in the green. The NDX failed to break below its support level, and the Dow maintained its short-term uptrend line. But all this could very well turn out to be noise as we head into earnings season. As for tomorrow, there are no major earnings release but the government will be reporting on the past week's crude inventory and the trade balance for the month of May. I am not sure how equities will react to tomorrow's data, but gold and silver are likely to use tomorrow's data to test their resistance levels. Note the bounce of gold and silver off the 200-day MA, compared to the Dow's diving plunge...

P.S.

While people are still finger pointing at Zidane for France's lost, I still believe that he is one of the greatest football players of our era. He should have received a yellow card, just like Figo did after he similarly headbutted a Dutch player.

Tech Weakness

Today (Mon. 7/10), the short-term trend line for NDX (Nasdaq 100) was broken. NDX closed just above last month's low of 1516. With earnings reports due, it wil be interesting to see whether NDX holds its current support level, which also marked the start of a major rally in October 2005. This week we could see a mild bounce off this level, but weak earnings can very well cause a break below, indicating a strong bear signal.

Sweet Crude

As the price of crude started cooling off from its post-Katrina high of $70, many people predicted crude to sink below $50. Indeed crude briefly fell below $60, but as we predicted at the end of last year, crude has climbed back above $70. Subsequently, the $70 level has become a very strong support for crude. While other assets, including precious metals, went under steep correction, crude remained resilient, consolidating within a tight range between $69 and $75. This week, as the Fed storm cleared away, crude is back to challenging $75. Until the next August FOMC meeting, at least, we expect crude to break out of its current range (maybe even beginning next week) and find a new high. We expect the ever-present global political fear and high summer demands to support crude's strength in the coming months. Clearly, the long-term trend in crude is still very much intact, bouncing off the 200-day MA.

Divergence

Since the broad correction across all assets began in mid-May, precious metals and equities have been moving in unison. Despite the traditional negative correlation between PM and equities, uncertainty of the Fed's interest rate decisions and fear of liquidity drainage affected both assets equally. As PM investors, we have been looking for indications that signal a break from this trend. The first indication came when PM stocks led the rally in response to the Fed's dovish meeting in 6/29. As Wall Street begins talking about the Fed game being over, we expect PM to stop being dragged by broad selling and buying in equities. Of course, we don't expect there to be perfect negative correlation between PM and equities. But today marked the first day since May when PM rallied against a poor performance in equities. Indeed, today's PM rally was supported by the missile launching of North Korea and a rally in crude oil past $75. But the importance of today's divergence lies in our expectation that the froth in PM has been cleared, setting the stage for a new uptrend.

As for technicals, gold is near a resistance level at $640, so a break above that level this week would be a strong buy signal. As for silver, we see a resistance at $11.5-$11.75 and we expect silver to rally quickly from it's current $11.4 and test its resistance level. If both metals fail to break their resistance, we could see a pull back to $580 and $11 respectively. As for equities, we continue to see whether the Nasdaq will break above the resistance level of 2200-2225. We expect economic data to begin showing clearer signs of stagflation in the economy (high energy costs, lagging wages, weak (and yes, even strong) employment, debt, housing meltdown...), so even though equities may break its immediate resistance levels, we don't expect them to make a new high past April's high. Again, we will keep our eyes on how PM and equities each react to future data. As for tomorrow, we expect a mild bounce in equities (as investors perhaps realize the empty threat of the "Type-Of-Dung" missile), and a continued rally in PM.