Sage Weekly Letter – 3/10/2012

Last weekend I published my weekly letter on Sunday morning as I needed an extra day to think things over and collect my thoughts. Sometimes my weekly letter is influenced by articles or research that I have recently read, however, more often than not it is 90%+ derived from my own thoughts, work, and experiences from the prior week. Last week’s letter was one of those in which I had very few influences which made it all the more interesting on Monday morning when I read several other notable market observers/researchers also calling the market environment as being particularly unfavorable to new longs.

This morning Barron’s is out with a piece which reads a bit stale given what transpired last week in the markets. Nonetheless, Barron’s cites fund manager John Hussman and technical strategist Walter Zimmerman both of whom view current market conditions as being unusually unfavorable for long exposure, although they arrive at this conclusion through different approaches. Hussman wheels out his usual cautionary line stating that the current market condition is characterized by an “overvalued, overbought, overbullish, rising-yields’ syndrome”. Although Dr. Hussman has used this line repeatedly over the years, perhaps to the point that it has become trite to some – disregard it at your own peril.  Meanwhile, Zimmerman cites “the high level of bullish sentiment, plus waning relative strength and a negative formation on the charts called a rising wedge” – there is nothing special in this. I (along with many others) have pointed out the RSI divergences across many charts along with bullish sentiment which has remained elevated for two months.

Last Tuesday’s sell-off stopped just short of a 3% correction for the S&P 500 ($ES_F $SPY $SPX) and perhaps more importantly the preeminent index found support two points shy of the 1338 level which I have been harping on for over a year:

Click to enlarge (notes on the charts)

The correction in small caps ($IWM $RUT) which began on February 3rd has been far more severe – At Tuesday’s low the Russell 2000 had declined nearly 6% from its high and more importantly the high-beta index closed below its 50-day simple moving average for the first time since December 19th (the last key inflection point low):


The weekly chart offers a potentially even more bullish look after last week’s candle formed a bullish “piercing pattern”:

Perhaps more important than chart analysis or the fundamental drivers of market action is market psychology and the positioning of market participants. Last Tuesday towards the end of the session and after the close I mentioned to several people that many longs were now “stuck” and a further decline to the SPX 1325-1330 area would bring out some substantial “weak hands” capitulating. In other words the path of max-pain was still lower, however, this did not occur as the futures ($ES_F) reversed higher immediately following the US regular session close. This highlights the highly forgiving nature of the current equity market environment – moreover, it is stunning how quickly the wall of worry grows after the first 1% daily decline for the S&P 500 in more than two months.

Macro Picture

During the last two weeks there have been two major market moves which have stood out above all others: The rise and subsequent rapid decline in precious metals ($GC_F $GLD $SI_F $SLV), and the significant top formed in $EURUSD:

The rally in EUR/USD fell short of the key psychological level at 1.3500 – the confluence of Fibonacci resistance, trendline resistance, and previous resistance from Nov/Dec 2011 proved to be too much. With EUR/USD still clearly mired in a powerful downtrending channel, another test of 1.3000 looms in the coming days.

Meanwhile gold & silver have been the site of a tremendous amount of action during the last three weeks:

Silver Weekly – Last week’s hammer closes near a price equilibrium point. Gold made an important low last Wednesday and finished the week on a high note roughly $50 off the weekly low:

Precious metals appear to have been shaken from their highs of two weeks ago by a combination of concerns about China’s growth and a possible end to QE3 speculation which happened to coincide with elevated bullish sentiment and speculative long interest. However, Friday’s powerful reversal combined with a significant divergence between metals ($GC_F $HG_F $SI_F) and the major US dollar pairs ($AUDUSD $EURUSD $GBPUSD) is noteworthy:

(h/t @P_Ambrus)

I would be willing to place a small wager that we will soon find out the driver behind Friday morning’s strong divergences among asset classes and markets. The three most likely candidates in no particular order:

Bloomberg: China has largest trade deficit since 1989 – more easing on the way from Premier Wen?

WSJ: FOMC announcement this Tuesday – Sterilized QE on the way? 

WSJ: Draghi Defends ECB Balance Sheet Expansion – More balance sheet expansion coming?

I will leave you with a powerful anecdote that I learned of on Friday morning: I have two long time contacts who are precious metals bullion/coin dealers, they both mentioned to me that earlier in the week (Tuesday/Wednesday) they were flooded with large orders for gold coins and silver bars by unusually large, and previously unknown, cash buyers. This tidbit combined with Friday’s price action made me stand up and take note.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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