The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, December 9th, 2010.
The markets are so manipulated these days that it's becoming increasingly difficult to gauge just what effect increasing interference is having, knowing in general all unnatural stimuli have decreasing impact the longer and more they are applied. Perhaps the best example of this at present comes from the bond market, where in spite of QE2 and a generous POMO schedule (every day now) that looks set to run in perpetuity, bond prices are falling. In this regard you should know US long bonds (and 10-Year Treasuries) are in jeopardy of signaling a secular trend change with a bearish five-wave pattern lower, which is why so many are now looking for another crash in real estate. We will let you know when such a signal in the bond market is triggered.
But lack of monetization is not the only reason bonds are falling. They are also falling because fundamental market sentiment is shifting as more and more people put two and two together on the increased deficits an extension of the Bush tax cuts will lead to, putting the US government on a collision course with bankruptcy only a few years down the road. So it looks like it's do or die time for the bureaucracy. It's either austerity or higher interest rates due to the inflation increasing monetization will create - and bond markets around the world finally appears ready to recognize this reality. What's more, with Bernanke still running the Fed little doubt exists as to what he will do (monetize more), making it almost a forgone conclusion the bond market will actually need to blow up before one can ever expect to see responsible policy.
And the manipulation doesn't end there, with stock futures jammed higher every day, and commodities (especially precious metals) suppressed. Trade over the past few days tells the story in this regard, where like clockwork the bureaucracy's price managers take advantage of the optimistic idiots who must buy banker derivatives in greedily attempting to maximize profits from an anticipated move higher in gold and silver. (As opposed to buying physical, which I have been a proponent of for many years.) This is naturally why open interest put / call ratios across the sector remain in the tank (discussed in our last commentary), which enables price management of precious metals to be effective. It should be noted the ratio for SLV has started to move back up again however, which could give price managers and bears some unexpected angst next week as expiry approaches.
This is of course the mechanism the bureaucracy's price managers use to keep gaming the stock market(s) higher, where elevated US index open interest put / call ratios are a sign sufficient numbers of traders are short and bearish, making them vulnerable to a squeeze no matter how many times this has occurred previously or how overbought technical conditions may be. If you are a trader and are stupid enough to be short or long puts going into an options expiry with open interest put /call ratios at generally elevated levels, as is the case right now, you can rest assured a squeeze play will be attempted, given when conditions are as overbought as they are now (and ratios mixed), the sustainability of such actions become increasingly fleeting. Therein, the squeeze play overnight right into the face of an intensifying bond market rout and Chinese rate hike rumblings could witness a nasty reversal.
Be that as it may, and although chop in stocks could last into next week, based on a look at the trade pattern in the CBOE Volatility Index (VIX), pictured below, any such weakness should be temporary. As per the US index open interest put / call ratio analysis attached above, enough shorts likely exist to arrest any such weakness as we push into next week. And if that's not enough, the week after is a Christmas holiday shortened week where price managers are sure to take advantage of low volumes to jam prices higher, so whatever you do, don't go into the holidays short or you might be run over by Santa Claus and his reindeer as they rally stocks into year's end. Here, we will be looking for both the VIX and VXO (I used the VXO as you can see the diamond structures better) to hit 15 over the Christmas holidays, and then volatility should pick up in the first week of January, just like in the year 2000. (See Figure 1)
Figure 1
In support of this thinking, the monthly VIX plot from the Chart Room pictured below shows good support should be found at 15 as well. So again, barring a hyperinflationary sequence that takes stocks to the moon and causes 15 on the VIX to crack on the downside, the theory is one should fade the market aggressively when the VIX hits 15, not that efforts on the part of the bureaucracy's price managers won't produce violent swings during the first quarter of next year, possible entailing new price highs, again, as was the case in the year 2000. Therein, if enough shorts are in the market running into the March options expiry, you can bet on such an outcome, especially if the dollar ($) remains vulnerable. (See Figure 2)
Figure 2
The fact the $ is not rallying more now with US yields rising the way they are is testament to the bureaucracy's determination to keep things glued together over the Christmas holidays, in line with our thinking above. Again, come next year however, this will all change and volatility will pick up, likely starting in the first week of January. So short sellers / traders get ready, because if we get a supportive sentiment shift post options expiry this month, of which you would promptly be appraised, next year could offer some excellent opportunities.
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Good investing and best of the season all.
