The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, February 1, 2016.
The Fed appears to be increasingly delusional. It appears they are lost in their own bullshit story. The net result of this confusion, which is seated in their desire to 'normalize rates' before they have to respond to the next financial / market(s) collapse, is they have essentially abandoned the stock market. Thing is though, the speculators (public) don't understand this, which puts the stock markets in a precarious position. They think because it's an election year the Fed still has their back. This is why open interest put / call ratios on the major indexes (see here) have been trending lower with prices as they continue to buy the dip, and the demand for portfolio insurance is on the decline - because they are out of touch with reality - whatever that means in America these days.
Out of touch? Perhaps that's putting it politely, but we will leave it there. Of course what's coming for most investors over the next few years should remedy this, because it's going to be brutal. Most American's have not benefited from the reflation since 2009, however they will feel further pain in the next collapse to make things worse. With any luck this will prevent them from voting another idiot into the White House because it matches their desires for a 'fairer and better America' (think Sanders - America doesn't need more socialism), but this might be too much to ask of America. But I digress; let's stay focused on the markets, which is enough to worry about - no?
One thing is for sure; this year just threw off one of the worst January Barometer signal's ever - where the talking heads on CNBC won't be able to put lipstick on that pig - especially if stocks keep falling - and irrespective of Friday's month end moog-fest. (i.e. desperation window dressing.) And based on how speculators are reacting to this (see above), which is being confirmed in the charts (ratios below), this is in fact the expectation, that prices should indeed keep falling this year - an election year. Because the American public is expected to do something intelligent, like vote wisely, however in this, and the investment world, they remain woefully inept.
Stocks went up Friday predicated on the concept negative rates will force (steer) more money into stocks, and this might in fact be correct for a short period of time. And of course if Japan is doing it now, the US will follow - right. Only thing is, none of this matters, because the amounts of money we are talking about in the big scheme of things won't be enough to make up for what comes out once the stars are aligned, which again, is completely dependent on speculator betting practices. It's all about how the gamblers react to all this. Make no mistake about it, because if they had not been shorting from 2013 through last year, stocks would have collapsed long ago.
So, if broad market speculators get bearish again like they did in 2013 after the last election, based on the supposition price managers wouldn't have their backs like in 2012, then guess what - stocks will go up. And if they don't, and open interest put / call ratios remain low / declining, then stocks will fail - it's that simple. So don't let any of the idiots on TV / Internet confuse you - it's completely dependent on how the speculators react to the negative rates. As you can see below, the pattern allows for a fall to broadening top support, and if it does in fact touch this support (as put / call ratios remain contained), then the prognosis for the stock market remains terminal. (See Figure 1)
The idea here is if stocks remain strong, they won't need gold anymore, and the Dow / XAU Ratio will go shooting higher again, perhaps touching resistance on the megaphone. (i.e. broadening top.) Speaking of patterns, you will remember last week I posited the pattern this year is similar to the year 2000, which would mean February should go sideways to up with a possible surge higher in stocks during March, even if new highs are not vexed. The monthly outcome on Friday greatly increases this possibility, where even if it's not a perfect match, stocks still look to have further gains ahead. However this does not preclude the Dow / XAU Ratio testing megaphone support first, before correcting higher. In fact we need to see that in order to get the proper count (in 5's) on the nominal indexes - we need to see a lower low soon. (See Figure 2)
If this were to occur, it would mean trouble might return to stocks sooner than March, more like the pattern in 2008, where February became the key turn month. Just the slide in the Yen can make the machines assure such an outcome if nothing else happens to destabilize the markets. (i.e. think Yuan devaluation to counter the Yen slide.) What's more, while they will be giving away 'free money' to hedge funds in Japan to speculate with, the only problem is they gotta pay it back at some point, which could act as a double edge sword considering the Yen is at decade(s) lows. Such a set-up will only exacerbate the volatility when it finally arrives, which according to the Dow / Gold Ratio (DGR) plot above should be sooner rather than later after a small correction higher. (See Figure 3)
The window for further strength in precious metals this cycle (monthly) is this week, because as we get closer to expiry on the 19th, the more likely ETF open interest put / call ratios will matter, which should keep prices contained. Certainly if COMEX goes cash only between now and then all bets are off on predicting what will happen to in the sector, however the crazies in New York are in for a full pound, so you can count on them to make like nothing is happening until it does. This is why the Fed is reluctant to let up on its bullshit story, as evidenced this past week. Because once the genie gets out of the bottle this time, there will be no stuffing it back in so easy. This is the message in the Gold / Silver Ratio.
It wants to decline, but its being held back for the final blow-off (to 2008 highs) caused by a collapse in the equity complex, which is what needs to happen now in order to keep prices contained with COMEX potentially about to blow. Again, if China devalues this week in response to negative rates in Japan, we could see this play out sooner rather than later. If not, the counter-trend bounce in stocks likely has further to go on the upside, where as warned last week, we find 'exponential rounding top resistance' on the S&P 500 (SPX) in the vicinity of 2020. Sentiment and seasonals point to a continued bounce, so don't be surprised if the large round number at 2000 on the SPX is tested at some point in coming days.
Again, the Dow / XAU Ratio needs to swoon soon in order to establish the larger bearish impulse lower, however this doesn't mean stocks need to see new lows. Most of the work in this equation can be accomplished by rising precious metal stocks and only minor losses in stocks, after which (after an interim low is established) stocks would have a wind at their collective back while the Dow / XAU Ratio corrects higher, likely still within the confines of the broadening top (see above). So if you are shorting stocks, one would be well advised to be patient in terms of establishing positions because it could take weeks or even months to digest all that must happen before a lasting turn lower in stocks materializes.
This view is confirmed in looking at Figure 2 above, where it's apparent the DGR could conceivably rally for four more weeks if history is prologue before turning lower again. Of course if you look at the monthlies, you get a completely different view. (I will post the monthlies in my Monday commentary next week.) Stock average monthlies are crashing with the economy now that ETF / index bearish speculators are exhausted, so any bounces should be modest. For the SPX, this means anything over the large round number at 2000 should be viewed as a gift. That's the thinking right now based on the ferocity of the rally Friday, contrived as it was.
Thing is, everybody thinks the market is going higher here, so it will be interesting to see how the put / call ratios reacted to Friday's trade. In that regard, we will not know for certain until tomorrow. In checking updated ratios this morning (see here), the word 'flat' comes to mind, meaning this time around, US price managers won't be getting much help from the options market in sponsoring another short squeeze. Actual short positions might help this cause, however as we get closer to options expiry on the 19th, gravity associated with the options market will do its work, putting pressure on stocks. Certainly opening indications in stock futures and the European markets this morning can't be inspiring for the bulls, making Friday's jam job looking questionable. (i.e. because after all, stocks are being distributed.)
So, it looks like we might just get that lower low in the Dow / XAU Ratio discussed above this week (or next?) before a more lasting counter-trend correction higher emerges. We will obviously know more by Wednesday, so leaving it there for today appears appropriate, because anything past pointing out the possibility is just guessing. Because who knows what the animals in New York will do after Europe closes later today.
And we obviously know now what has happened since. For educated and useful intermediate-term trade analysis of implications associated with the volatility over the past few weeks, see below.