Oct. 17, 2016, Weekly Summary: Weather Report
Weather Report
Weather reports are probability statements about the future based on the historical patterns of various indicators such as air pressure, the position of the jet-stream, and water and air temperatures. Market analyses are not much different since they also are composed of probability statements about the future based on historical patterns traced-out by various indicators.
There is a crucial difference, however, between weather and markets; weather is purely a physical phenomenon, while markets are driven by emotions, as well as physical factors. Even in today’s machine-driven markets, emotions remain as part of their fabric because Humans write the code that directs the machines to learn trading methods based on past historical patterns. Machines learn how to trade by studying how markets moved historically when Humans where making all the decisions, so it is not surprising that machine-traded markets continue to behave as if they were human-run (emotional).
The ‘physical’ factors that affect market performance, are what fundamental analysis concerns itself with. Indicators such as revenues, earnings, interest rates, PE ratios, cash levels, book value, etcetera often correlate with market performance, but not all of the time. If they did, then predicting the market would be easy which, of course, it is not. When markets are not trading in-line with fundamentals, we tend to consider them as ‘irrational’, which means emotional and not based on the ‘facts’. Technical analysis, or charting, concerns itself with patterns which historically correlate with the way markets are priced and makes no attempt at explaining ‘why’ the market is behaving the way it is. In other words, it does not provide causes since correlation is not causation.
Often, fundamental and technical analysis are in agreement, but the times when they are at odds, seem to be times of emotional imbalance in the markets. The most ubiquitous emotions are fear and greed (‘irrational exuberance’) which can drive valuations off-the-fundamental-curve in either direction. This is the stuff that bubbles are made of; extreme valuations without fundamental under-pinning.
We have been pointing out for months now, that there is no fundamental reason for these lofty equity valuations, other than a desperate search for yield. We have also stated that these bubbles (bond and equity) are not a result of ‘irrational exuberance’ in the same way as other bubbles in the past, since the general public has not participated this time around. These bubbles are, and continue to be, the exclusive purview of the financial industry; money managers, pension funds, and banks. And that may be why the Bull Sentiment Indicators, which normally serve as contrarian indicators, no longer do. The independent investor sentiment is normally low after a significant drop in prices, indicating that the average investor is emotionally (and financially) spent just before prices turn around and start to rally, thus acting like a contrarian indicator. What we are seeing now is low bull sentiment readings after a significant rise in prices which is not a contrarian indicator since in the past, when this happened, market corrections followed, not rallies (chart below).
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If we look at the put:call ratio directly ( the VIX is an option ratio also, but with higher averaging), we see that a minimum in the VIX correlates with a maximum in the SPX 80% of the time (chart below).
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When we isolate the Rydex Bear/Bull ratio (chart below) we get a picture that implies a higher market in the future, and which goes counter to the evidence we have presented so far.
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GOLD
We had expected a bounce in the price of gold this past week because of the over-sold RSI, but the best it could do was finish down a few dollars. This shows more weakness than we expected and may mean that lower prices will materialize sooner. The chart below shows the RSI rising slightly, and the MACD arresting its fall, but gold managing only to move mostly sideways during the week.
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The commitments of futures traders shows reductions in both speculator long, and commercial short positions, but the positions on both sides continue to be historically high which correlates with further downside for gold (see chart below).
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The Hui Gold Miners index and the Gold Miners Percent Bullish Index continue to correct.
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Regards,
ANG Traders
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Source: Nicholas Gomez