The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, March 18th, 2010.

Within the space of 24-hours we discover the Fed is still scared stiff (of deflation), the ECB is bailing out Greece (because deflation is already occurring), and the Japanese are doubling recent monetization efforts (because they have been deflating for decades), all pointing to a continuation of a highly accommodative stimulus disposition world wide. This is a large part of the reason stocks are enjoying a record advance, where now we also know why bonds look precarious moving forward, with US Treasuries center stage given a breakout from long-term resistance (see Figure 2) is in the making. Here, it appears the reason this will be occurring is not just due to exploding government deficits; but also, continued strength in stocks aided by bearish speculators who don't seem to be able to get enough puts in their portfolios as well.

Just give these people a reason to buy more puts and they will, with a constant flow of bad news and other reasons (historical, technical, etc.) to speculate on a top in stocks. For this reason then, we would not be surprised if bearish speculators / hedgers buy more index puts next month (for the April cycle), with the reason being they decided to fade the rally (which is really a squeeze) into the March expiry, viewing it as a repeat of year 2000 timing. As you know from previous discussions on the subject, such an outcome would take us into a potential Presidential Cycle mid-term timing top in April, along with bearing an interesting parallel to the top in stocks that ended the post crash bounce in 1930. If this is not the case, stocks are blowing-off right into options expiry on Friday, as anticipated; raising the possibility the post crash bounce ends prior to the mid-term Presidential Cycle target next month.

Of course if the market is nothing more than a faulty and fraudulent casino these days however, which happens to be the case, largely controlled by the betting practices of delusional speculators forced to 'play the game' because all other employment is being exported to cheaper jurisdictions, then shouldn't this post crash bounce end when nobody is expecting it, making a top next month just as unlikely given many will be betting on such an outcome as well. While only the shadow knows for sure at this point, from our perspective, we will not guess in these matters. No, we will watch put / call ratios and other sentiment gauges to aid us in assessing probabilities in this regard and act on this analysis in a logical fashion. As you will see below, right now, with open interest put / call ratios for tech stocks (NDX, QQQQ, etc.) so high, the word remains up into next month. (See Figure 1)

Figure 1

That is to say, with the open interest put / call ratio for both big (see above) and small (see below) NASDAQ traders so high running right into expiry this month it's unlikely they will decline enough within the space of a month (the April cycle) to sponsor a turn from up to down within their respective indexes, creating a likelihood stocks could even remain firm into May. What's more, if the technical message in the monthly NASDAQ / Dow Ratio (see Figure 2) plot is correct, where RSI has broken out of a massive diamond, successfully tested that breakout, and is now poised to head meaningfully higher, then in what would be a surprise to most, further gains in stocks would be of the mania variety, to some degree re-entering bubble measures indicated on the chart attached directly above. (See Figure 2)

Figure 2

And while unlikely to reach 'extreme bubble' dimensions within the present sequence, as this has never occurred previously within the same generation, still, it appears some degree of bubble dynamics will need to be experienced in coming days to finally discourage bearish speculators enough to stop buying these index puts, which will make the job of identifying a top accurately somewhat more daunting. Now, with this knowledge, and assuming our suspicions are confirmed next month, we can speak of the S&P 500 (SPX) reaching trajectories in the 1300 to 1400 range, which should blow a few circuit breakers in the brains of the bears. Of course the larger process should also see the put / call ratio for the SPX (and SPY, OEX, etc.) generally continue to work lower during this period as well, where when NASDAQ measures do the same on a lasting basis, the post crash bounce from last year will finally have exhausted itself. (See Figure 3)

Figure 3

So please, just because the market generates bullish signals by default, which is the fault of bearish speculators / hedgers attempting to capitalize on collapse, like the Dow Theory confirmation signal yesterday, don't go believing any foolish talk the stock market is in a new bull market, or any other hair-brained theory you may hear. The reason stocks will rise here is because stubborn bearish speculators will create their own self-fulfilling prophecy (their biggest fear), where increasing put / call ratios combined with all the money coming out bonds will need to find a home, and at the beginning that home will be in the broad measures of stocks. (i.e. this is why the Dow / Gold Ratio and others of this variety are breaking out higher.) And later on, this money will increasingly flow into precious metals. Right now precious metal share speculators remain overly optimistic, a usual condition for these people, which accounts for the inferior performance of gold stocks against the broads. (See Figure 4)

Figure 4

What's more, this also accounts for their lack luster performance against gold too, where as you can see below, speculators have been far less optimistic about prospects for the metals themselves. So how should the pattern for precious metals develop in coming weeks? Next week, a post expiry week, should see the broads weaken, but not fall apart if our analysis above holds any water. (i.e. potentially filling the gap on the SPX at 1120.) This should have the effect of triggering weakness in precious metals too, which is being telegraphed by the outside down week gold had last week. So don't think GATA going to see the CFTC will send prices soaring, although I would be a buyer on weakness associated with a reaction to selling in the broads next week none the less. (See Figure 5)

Figure 5

This would put you in position to enjoy a nice surprise during the next week, one of the strongest of the year from a seasonal perspective. So what about money supply growth in the larger equation given it's falling off a cliff, making bullish prognostications somewhat counter-intuitive? Again, in case you missed it, it's all the money coming out of bonds looking for a new home that will provide the liquidity. And it's the bearish stock market speculators fuelling a squeeze higher that will enable such a sequence. When this notion first crossed my mind, which was sometime back, while being the only logical outcome (aside from paying down debt [which won't happen]) when thinking about it, still, it was difficult to swallow given I though historical precedents associated with the stock market would not allow for such an outcome.

Why was this thinking insufficient? Because this is minimally a Grand Super-Cycle Degree event (the 1929 to 31 crash was only Super Cycle Degree), which means the post crash bounce can go even higher than in 1930. Why is this? Because, as alluded to previously, prospects moving forward are so dire (worse than in the 30's), and we as a society are so spoiled (and wishing to maintain this condition), that those who contemplate such things remain compelled to attempt preserving their lifestyles, which is why they buy puts.

And believe it or not, along with a good dose of greed for some, it's as simple as that.

See you next week, where we will discuss this further, as well as implications for the downside later on as well.

Special Note: Figure Source: Schaeffer Research