Feb. 20, 2016, Weekly Summary: Something Interesting and Rare in the Market this Week

The SP 500 made a healthy 2.8% gain in the four days of trading this week. Unlike the bullish move from two weeks ago, where bullish sentiment increased along with the market, this week’s bullish move resulted in a decrease of bullish sentiment to a level (17.6%) seen only once in the last twenty years (green circle on the chart below). This much pessimism just increases the chances of a rally.

Also on the chart, the blue arrows demonstrate how downward spikes in bullish sentiment correspond to major lows on the SP 500– after which major rallies occurred. The blue oval indicates the one time that the resulting rally only lasted two months before dropping to new lows.

The probability continues to point to at least a short to medium-term rally. Few investors think that the market will be higher in six months, which means most have sold what they were prepared to sell. When there are fewer sellers, the market tends to rally.

On the monetary side, the CME FED tool is giving a zero percent probability for a rate cut, 97.9 % chance of no change, and only a 2.1 % probability of a quarter point rate hike on March 16th.

The FED and the rate futures market are singing from very different hymn books, evidenced by the fact that Yellen has not been unnerved by the market down-turn, which means a rate hike is not off the table according to her. In fact, she may even be pleased that some of the frothiness has been blown off of the equity markets. She is certainly happy with the cover provided for the FED’s December rate hike by the lower unemployment rate, increase in hourly earnings, and core PCE inflation.

The discrepancy between the opinions of the FED and that of the rate futures market, highlights a possible risk to the equities market. Any positive economic data that comes out between now and March 16th, could puff-out the FED’s confidence enough for them to declare a completely unexpected rate hike that would blind-side the equities, which are still reeling from a self-inflicted round of tightening. We are not expecting this, but we do think it carries more than a 2.1% probability.

We still calculate that the odds are on the side of a short-to-medium-term rally, but we continue to keep one eye on the FED.

We made no moves in this shortened trading week. Our short gold position (GLL), taken at the end of last week rallied nicely on Tuesday, and even though it dropped back over the next couple of days, we still feel comfortable being short gold and gold miners (DUST).

Notice in the chart below, that the RSI has started to move down and the HUI and GLD have backed-off their recent highs and are heading down toward the blue trend lines. We expect to have gold back to at least $1180 before we start covering our gold shorts.

The first chart below is of the positions held by gold traders on the COMEX: dark red bars represent the positions of the large commercial banks and dealers who are generally short (and correct): the grey bars represent the large speculators (usually wrong): and the short yellow bars represent the small speculators (also usually wrong). Notice how at the moment, the commercials are short a lot of gold, and the speculators are long the same amount.

Under the COMEX chart, is a chart of the gold price over the same time interval. Notice how the commercial traders are maximally short at the peaks of the gold price (blue arrows), and both large and small speculators are maximally long at the same time.

What follows is a drop in the gold price which allows the commercials to cover their short positions at a profit, while at the same time the speculators are forced to sell their long positions at a loss. The historic probabilities are on the side of a drop in the gold price over the next few weeks. Again, these are probabilities, not prophecies.