The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, Monday May 16, 2016.

Wouldn't it be nice if precious metals go sideways and consolidate this month - giving us our positive Fibonacci monthly count set-up. That wasn't a question - it was a statement. Such an outcome is looking increasingly possible (but not probable) as the dollar($) corrects higher, keeping the shorts in precious metals placated. Because if we don't get this, which, as you will see below is likely based on several important technical signals, the metals might need to go to sleep for several months, and the correction will be more severe. Because that's what happens post record-breaking moves - it's the nature of the beast.

Unfortunately the nature of traders today is not to follow the natural path, meaning actually selling some in overbought conditions, but to hedge (a Wall Street construct that gives them enormous fees and trading advantages against their 'clients'), which could still distort the better path. (i.e. a rest now would signal better sustainability, increasing the chances of a bigger bull market.) But we can't fight it, because it's the world we live in and we had better make the best of it while we still can. (More on this sad subject matter next week.) Of course either way the prognosis for precious metals is still positive - in theory.

In terms of sentiment then, precious metal speculators are unwavering in their nervousness about the rally thus far, seen in still high and rising open interest put / call ratios (see here) in precious metal shares (due to hedging), where as long as this is maintained post options expiry this Friday, significant downside past a 'normal' 20% correction is highly unlikely. Again, we in fact would like to see such a correction this month, because it would recharge the shares, so keep fingers crossed. (i.e. we don't want new highs in May, a historically significant 'pivot month'.)

Concerning sentiment in the stock market, again, as measured by key open interest put / call ratios (see above), it should be noted we had a marked turn lower in HYG last week, the chief high-yield ETF, leaving only VXX (VIX) and IYT (Transports) providing firm support, which could be an increasing problem if this trend persists even with the Fed painting the tape daily. And then one must wonder what will happen post options expiry. Generally, directly post expiry we see at least short-term reversals in previous direction, but I'm sure no general rule applies these days with the characters we are dealing with here.

In terms of aiding us in estimating probabilities then, we will now turn to the charts. But before we go to our own charts, I would like you to look at these courtesy of Zero Hedge (ZH). Again here, as is all to often the case with posts on ZH, anybody going out and acting on information presented here is likely to regret it not long after, because let's face it - they are in the business of selling sensationalism to industry professionals and traders, who in turn become 'the ball' in becoming party to consensus. Be that as it may, while there is every reason to be bearish on stocks at this time, not the least of which being a supposedly rising dollar($) (not the case), with this many long volatility it would be quite surprising to see stocks substantially declining from here, which is of course contrary to the author's view, and ZH propaganda.

In total then, looking at the 'big picture', although we are not anticipating 'big gains' in stocks by any means, at the same time, given the speculative position in the VIX (VXX) is a record, one would likely not go too far wrong expecting grinding / sideways price action as opposed to sharp declines until excesses are burned off. Even if the head and shoulders patterns (H&S) on the indexes are traced out early this week, the losses would be minimal - another 50 SPX points (the large round number at 2000 is the target) Post options expiry next week could bring in some volatility, however it's always a good idea to look at the post expiry options distributions before jumping to any conclusions.

Turning to the charts now (finally) in order to gauge probabilities moving foreword, first we'll look at the Dow / Gold Ratio (DGR), which looks like it's making a three-wave correction lower, consistent with the view a major decline in stocks cannot commence until the VIX derivatives hedge fund roach motel is vacated. Further supporting this view, we have the fact the precious wave higher off the February lows was a five-wave affair, raising the need for at least one more just like it even if the next impulse turns out to be the c-wave of a corrective zigzag, which is my preferred count. Such an outcome would provide the time and squeezing necessary for hedge crazy funds to cease VIX call buying, setting the stage for some real fireworks in stocks as the lazy days of summer arrive. (See Figure 1)

Figure 1

The next chart we want to look at is the weekly Dow / XAU Ratio (DXR), where as you will see below, the view stocks should have a wind at their back for at least a few weeks (probably longer) is also apparent. It's not hard to see why of course, where even if precious metals make one more push higher in a bout of relative strength, the next thing that should happen is a major correction relative to stocks. And that usually means higher stocks knowing the boys from New York spend every waking minute attempting to deliver just that by any means. So again, it would be surprising not to see a meaningful bounce in the DXR develop soon, also meaning precious metal stock investors should be careful over the next fortnight (four weeks) at least as well. (See Figure 2)

Figure 2

Of course such thinking could be off base if this view is correct, the view credit and hot money from China is slowing, and we should all be very afraid. Even the mighty Goldman Sachs is pulling back on its perma-bullish view these days, however it should be noted they are essentially selling volatility insurance here, and we know what that means - they get their clients to buy VIX calls and stocks remain stubbornly strong until VXX put / call ratios begin to rise. For the very near-term one should watch the dollar($), and whether the inverse H&S pattern plays out, or whether the bounce is over, which would help both precious metals and stocks. Another relationship you want to keep an eye on to aid in calculating probabilities in this regard is the Gold / Silver Ratio (GSR), where the bounce is either done and it's about to fractal lower, or a H&S pattern is forming. (See Figure 3)

Figure 3

If it's the latter scenario, this would bring into question the entire rally in precious metals these past months for some people, so completing a five-wave impulse lower sooner rather than later is important. This means one more rally sequence for precious metals is on deck, with silver leading. The latest COT report for silver, seen here, saw Small Speculators tack on 3000 puts last week, so who knows, maybe they get squeezed. Certainly a close below the 'trend definer' and Fibonacci resonance support seen above on the weekly would remove any doubt what's happening. So let's keep our fingers crossed in this regard. With ETF speculators still very nervous about the rally, as reflected in key open interest put / call ratios, one needs to remain bullish, putting the odds of a GSR plunge higher than most might think. (See Figure 4)

Figure 4

That said, one cannot ignore the signals coming out of China, and potential implications for stocks, commodities, and precious metals given their apparent positive correlation (see Figure 2) when it suits the algo programmers. For this reason many are watching Dr. Copper right now for a reliable global macro signal if it breaks below the large round number at $2. If it does this, then even though the funds are long a boatload of VIX calls, this will not stop stocks from becoming considerably more volatile for a short period of time. If this happens before an options expiry, like next week, expect the reaction stocks to be muted. If it occurs after however, the reaction could be far more violent for a few weeks before the next options cycle could stabilize things, assuming the funds keep their VIX calls of course. The copper ETF - JJC is neutral sentiment wise at this time and is not a factor. (See Figure 5)

Figure 5

Again however, the same cannot be said for the VIX, VXX, and all related derivatives. It's important to understand that this volatility matrix mess is essentially the only factor strong enough to keep stocks from imploding right now, that, and the $ if it begins to head lower again (not the most likely outcome.) It's important to understand this is why the VIX remains below the very important and key large round number at 20, and if this were ever to change on a monthly closing basis - all hell could break loose in stocks. What's more, in addition to all the other fundamental reasons for lower stocks we have covered here throughout the weeks, months, etc., at some point the growing lack of capital / investors is bound to become a factor - see here and here - you've been warned.

In the meantime, with options expiry this coming Friday, open interest put / call ratio influence will be at its highest, meaning if a majority of broad market ETF's are low and declining (except VXX), this means the influence of the VXX in the larger formula could be trumped, allowing for some volatile losses, but sharp snapbacks. As outlined last week, our target for such a sell-off is approximately 1965 on the SPX, where it would not be surprising to see this vicinity vexed, followed by a weekly close back above 2000. This possibility is found in the charts above, even in copper. Therein, if copper were to fall below $2 in Chinese trade over night, recent strength in North American commodity related ETF's and stocks would suggest a quick snapback here too, because we can't forget about the gamblers, Fed, and election States side. What's more, put / call ratios don't allow for much weakness in precious metals this week either, yet another supporting factor in the larger inflation trade.

That's all for today folks.