Bond Major Trend Shift Wreaking Some Havoc?

Last week we discussed how important the action in bonds and TLT’s was to watch.  Today bonds fell under the critical 89.6 support level in the morning and nearly closed below this support.  The bond action is already starting to wreak havoc with commodity and currency markets and the reaction of stocks to continuation down in bonds will be important to watch as well.

 
Chart 1:  Bonds starting to break down below critical support levels.  Courtesy Bloomberg

The big decline in bonds hit commodities markets hard today.  Gold fell over $25, copper and base metals fell sharply, grains got hit, and even the final holdout of the commodity complex, oil fell sharply.  Let’s take a closer look at oil here because it may well be at a critical juncture as well.

Chart 2:  Oil putting in a temporary peak after sharp runup of this year?  Courtesy Bloomberg

Oil has hit our upside target of 120-130 and is now not acting well.  Today’s big volume downside reversal actually helped lead commodities lower.  The big reversal in oil also came off of a bullish inventory report.  Whenever a market reacts negatively to positive news, your antenna should go up that the bullish case is potentially in trouble.  Oil has gone up nearly vertically, has hit the news media, we’ve had trucker strikes in England and France from higher oil prices, monthly and weekly overbought indicators are showing the upside overdone, and futures spreads have behaved bearishly recently.  As we’ve highlighted, the rest of the commodity complex has turned down and oil has been the only real holdout.  Oil is in a secular bull market and a trader should only go long, very long, or be sidelined in such a trend, but our suspicion is that oil is in for a correction here soon that should bring it back down to less frothy levels and may provide an opportunity to go long again later this year.  Let’s watch if the downside action continues.  Further downside in bonds may exacerbate the oil and commodity correction ahead.
 

Chart 3:  Dollar still not signaling new down-trend and bond decline is adding support.  Courtesy Bloomberg

Last week we also talked about how the dollar index needed to break under rectangle support to signal a new down-leg – otherwise the bias would be toward a continued trading range with support close at hand.  The dollar has gotten support from the bond decline and the trading range scenario obtains.   One of our favorites CNY is holding up quite well now that deferred NDF’s have stopped falling.  A good volume close over 40 in CNY would put in a Head & Shoulder bottom that should be watched for in the ETF on the Chinese currency as a potential signal to add or buy.

Last week’s column also suggested watching base metals closely  because nickel, lead, and zinc were all making new lows at the same time.  Unfortunately base metals have continued to weaken this past week, especially Thursday.  Tin, which was the upside leader in the base metals until Thursday, got creamed, as did copper.  Copper gapped down, while upside leader Tin collapsed under the 50 day ma.  The Ph.D.’s in economics are now pointing more clearly toward softer global economic growth ahead, and one has to wonder how long stocks can hold up if interest rates don’t stop rising pretty quickly here.
 
Chart 4:  Tin, former upside leader for base metals, broke sharply below 50 day ma today.  Courtesy Bloomberg

Meanwhile stocks remain in a no man’s land between the 200 day ma resistance levels that sent stocks reeling to the downside last week, and the 50 day ma support that has held up thus far.  As we suggested last week, we are now neutral with our bullish bias fading, and looking for a high volume and weak breadth close below the 50 day ma for our models to turn bearish once again – something that continues to bear close watching.  Conversely a strong volume and breadth breakout above the last two week’s highs would be positive and would likely signal that the bond rise is more economically benign than we have suggested in the foregoing analysis.

TLT’s are the central market to watch and to monitor the effects of on other markets.  A clear further breakdown under 89.6 could wreak further havoc and could even derail the economic stability that has developed off of intense Fed action in response to the credit crisis.  Could fear of inflation push bond yields up and prevent the Fed from responding to a renewed round of weakness that will push the economy more clearly into a recession that will have more global reach here?  Let’s watch the action with baited breath.

Since the mid March lows we have still NOT had a period of 5 trading days or longer when our Top RS/EPS New Highs list outpaced our Bottom RS/EPS New lows list by 40 or more each day – which would signals a good environment for adding net long exposure in leading groups and stocks.  As the chart below shows, now our Top RS/EPS New Highs have plummeted and are often below Bottom RS/EPS New Lows – which are still not rising enough to signal good consistent shorting environment either.  While Steels, E&P’s, natural gas, fertilizers, rails, and export oriented big cap techs have led the rally since March, they may be starting to breakdown here, and if the market falls sharply, this rally may be toast.  Thus we continue to suggest lower degrees of allocation and potential short-hedging to all net long stock exposure now.   If Bottom RS/EPS New Lows Expand further and move consistently above Top RS/EPS New Highs, this bear rally will likely be over, and either a substantial retest of the March lows or new lows will become likely.  We doubt that we’ll get a clearly negative enough market to lead to substantial net short opportunities, but less let the action tell the tale.  Our bias is to suspect that the Fed will act aggressively if new lows are made, but further bond rate increases could prevent this. 

Our long/short strategy is now long AGU (raise stops under the 50 day ma) and SID (raise stops to under 47 level to lock in profits), and we took profits on short CKR in the past few days as our trailing stops helped ups lock in profits.  Even if the rally ends here we will have made a bit on the move, something that is not always easy in a countra-trend situation.  There were not valid trades but close calls on NOV, EOC, SDA, WDC on longs and BYD for short side in the action of the last week. We now have to watch carefully to see if the leadership in our Top RS/EPS New Highs can recover and rebuild or if Bottom RS/EPS New Lows will begin to dominate and the market will rollover at the 200 ma resistance zone.  Next week’s action in bonds and stocks remain critical to watch closely therefore.

For those not familiar with our long/short strategies, we suggest you
review my book “The Hedge Fund Edge,” my course "The Science of Trading," my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call “upfuel," as well as rigorous criteria for potential short
 stocks that we call "down-fuel." Each day we review the list of new highs on our "Top RS and EPS New High List" published
on www.midasresourcegroup.com for breakouts of four-week or longer flags, or of valid cup-and handles of more than four weeks. Buy trades are taken only on valid breakouts of stocks that also meet our up-fuel criteria. Shorts are similarly taken only in stocks meeting our
down-fuel criteria that have valid breakdowns of four-plus-week flags
 or cup and handles on the downside. In the U.S. market, continue to only buy or short stocks in leading or lagging industries according to our group and sub-group new high and low lists. We continue to buy new long signals and sell short new short signals until our portfolio is
100% long and 100% short (less aggressive investors stop at 50% long
 and 50% short).

The chart below shows that Top RS new highs (available on www.midasresourcegroup.com) have plummeted and even fell under Bottom RS/EPS New Lows for a day.  This is disappointing action and the differential must grow to new high’s favor quickly for this market rally not to continue to deteriorate.