Commitments of Traders 101: When commercial players – the smart money – are on the move, it is prudent for investors to take note. History tells us that commercials tend to be on the right side of the market the majority of the time. They also tend to control the majority of the open-interest in any given market, and are consequently large enough to create trends.

When the stock market tanked on February 27, many investors were caught off-guard. The mainstream blamed the earlier decline in the Asian markets as well as the technological glitch at the NYSE. These are what I call triggers; they are not in and of themselves the reason why the market sold off. Instead, the market declined because it was setup to decline from a commercial perspective. In other words, in the months leading up to the decline commercials were sellers. They sold into strength, as all the trend-followers and the dumb-money were buying near the top. When there is evidence of commercial distribution, that means that the floor or support for the market is waning and a trend-reversal is forthcoming. (Assuming that the market was in an uptrend while the commercial distribution or selling was taking place)

Notice the word ‘forthcoming’ from the above paragraph. We are not trying to predict when the market will turn, instead we realize that there are a set of conditions present that typically lead to a trend reversal. Just because a market is setup one way or the other does not mean it will turn when you expect it to turn. In fact, it will turn when it is ready – regardless of your expectations or perceptions. The markets are a living-system; at any moment there are a thousand pieces of information – also known as chaos – that influence millions of investor’s decisions. The key that I am trying to get across is that we do not exactly know when we will see that ‘trigger’ or ‘spark’ that will get the ball rolling down the track a.k.a. trend reversal. We saw it on February 27, but we could have just as easily witnessed it the week before. I cannot say that I was not surprised by the market’s swift decline, but on the same token, as evidenced from the COT reports, it was a foreshadowed event. It is also important to be aware that the decline was forecasted (by COT data), but not the specifics: such as the extent of the decline, duration, trigger etc.

Volatility Index

VIX [ http://www.buythebottom.com/vix.html ]
Commercials are notable sellers of the VIX as it broke out above key resistance near 13. This market is setup/setting up for a decline. What is very interesting right now is that a decline in the VIX is normally associated with a rise in the stock market, while the stock market – in large part – continues to remain setup for a decline.

Broad Markets

Russell 2000 [ http://www.buythebottom.com/rut.html ]
Commercials are stepping up and buying this index at the current levels: 760 – 790. This setup looks more neutral to me than anything else. From the price-chart, we tested the reaction-low at 760 last week, where the market found support and formed a double bottom. This is positive as long as we hold above 760: because if we break below this level it would signify a continuation of the down-trend. On the upside, there is resistance at 790 and 800; if we do not break above these levels while holding support at 760 that would translate into a range-bound or sideways market for the near term.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Here once again, commercials are buyers of the recent decline. The COT setup is neutral to slightly bullish, as the net-commercial position (orange line) was range bound between -40,000 and -50,000 for several months and is now finally moving up above -40 000 representing commercial interest on the long side. Watch for a price-confirmation of breakouts / breakdowns, with near-term support at roughly 1,372 and resistance at roughly 1,410.

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
While the RUT and SPX look like they are ‘improving’ from a COT point of view, the Nasdaq is at the opposite end of that scale. After February’s decline, net-commercial position decreased even further to -16,678: a level not seen since March of 2006. This is as bearish as it gets in regards to COT setups, and I just do not see anything to be constructive about with respect to this index. On the price-chart, a close above 1775 might make me less bearish, but it is still hard to argue with this commercial-setup to the downside. Critical support is at 1,710.

Dow Jones [ http://www.buythebottom.com/indu.html ]
The Dow Jones looks much more like the NDX than the SPX and RUT. Net-commercial position is virtually unchanged after February’s sell off. In other words, the setup remains unchanged, and continues to point to the downside. Critical support is at 12,000. (Resistance is at 12,330)

Overall, the stock-market looks vulnerable: I would pay close attention to the Nasdaq-100, as this was the lagging index prior to the sell-off in February and right now the NDX is the weakest looking index in terms of its COT setup. The SPX and the RUT are somewhat constructive while the INDU remains negative. And finally, the VIX looks like it is setting up for a decline…and a declining VIX corresponds to a rising stock-market. So there is no shortage of mixed signals here, I would watch key support/resistance levels for clues until we see some sort of development either in price or COT data.

Commodities

Crude Oil [ http://www.buythebottom.com/wtic.html ]
While oil has been in an uptrend over the last 2 months, commercials were sellers in the market.

Last week oil reversed to the downside and decisively broke below support at 60. The COT setup is more bearish than bullish right now, and the trend is down in the short-term (unless we break back above 60), while in the intermediate term this market is range-bound between 52 and 64. I do not think that we will see oil breakout above 64 until net-commercial position rises above 20,000. On the flip-side of the coin I do not see a breakdown below 52 unless we see net-commercial position decline to -60,000 to -80,000. It looks like we will see more short-term weakness in this market…watch for future COT data to determine whether commercials are buyers of this dip and to what extent.

Gold [ http://www.buythebottom.com/gold.html ]
Commercials were big buyers of gold last week, and now the market is range bound in the short-term between 635 and 660; this market is setting up for a move up.

It is interesting to note that from early 2007 till March, commercials were sellers of gold. This was a clear sign – to me at least – that this market is setup for a decline. We got a breakdown in late February, which was followed by a huge reversal to the upside. Yes, this was a sign of strength in the short-term, and the market rallied for several more days. But the COT setup was unchanged; this market remained setup to the downside. After a failure to close decisively above 690, gold reversed down and declined until finding support at 635. This is a great example that shows how price alone does not reveal the entire picture. Yes the trend was up, yes there was a big upside reversal following a false breakdown, but at the end of the day the smart-money was getting out and that is worth paying attention to. As for the reversal, it is important to note that it supported the existing trend versus being a counter-trend reversal which tends to be more of reliable signal.

Currencies

US Dollar [ http://www.buythebottom.com/usd.html ]
When net-commercial position hit 12,000 two weeks ago, this market was ready for a rally. In the week that followed, the market started to move up, only to break down. What happens within the next few weeks is going to be critical. The COT setup is bullish, and we are near support at 82.5 on the price-chart. Over the last year, the USD has been – for the most part – in a down trend (lower lows, lower highs), so if we can make a double bottom at 82.5, we may potentially see a significant leg-up.

What I found very interesting in late 2006, is that commercials were (or at least I think they were) supportive of range-bound trading for the USD. When this index tested 87-87.5 for a second time in October, commercials were very big sellers. And when the index declined to 82.5 commercials were very big buyers. On a longer-term basis this index is range-bound for over three years now, between 81 and 92.

Ok, I may be exaggerating, but Monday is crucially important as it is when the Canadian parliament reconvenes and the budget is to be tabled. First a little background: last October, Finance Minister Jim Flaherty surprised investors (and contrary to campaign promises made by his party) by proposing a new 31.5% tax for Canadian Royalty Income Trusts (CanRoys). The ensuing loss of 20-30% in many CanRoys as well as Cdn $35 billion in total market capitalization has been dubbed the “Halloween Massacre”. Early this year, I wrote about political developments in Canada that may induce change in the tax proposal as it now stands. On Feb 28, The Finance Minister promised to include this legislation in the upcoming budget.

Canadian Association of Income Trust Investors (CAITI) is an organization formed in the wake of the “Halloween Massacre” to “to preserve the ongoing viability and sustainability of the Canadian income trust market”. It has organized letter-writing and billboard campaigns aimed at influencing the legislative outcome.

The Standing Committee on Finance in the Canadian House of Commons has made several recommendations, including, 1) to release the detailed calculation with which the government claim the income trusts result in a tax leakage; 2) to table the proposal as a separate piece of legislation rather than part of the budget; and 3a) to reduce the proposed tax rate from 31.5% to 10%; or 3b) to extend the proposed transition period from 4 years to 10 years.

I admit that I was trying to be dramatic in the title (got you to read, didn’t it?) In fact what the Canadian government does matters little to my view on this sector. We live in a world increasingly hungry for energy while world oil supply may be peaking or already peaked. The oil/gas CanRoys own assets in a politically stable part of the world and will be valued accordingly. It has been argued that if there is advantage to convert these trusts into regular companies then it will happen. They can easily be acquired by private equity firms which will structure the deal with high levels of debt. Since interest payments are deductible, the government of Canada will see some real “tax leakage” then.

Disclosure: I own several names in this space.

When I had a forex trading account, there is one thing that I’ve learned about yen. Japanese companies close their accounting book at the end of March for the fiscal year, and it causes profits to be repatriated back home, creating temporary demand & strengthening for Yen.

I think the headline news about yen carry trade blowing up the stock market is most likely a big smoke screen. Why? Such yen strengthening has happened several times in March of the past years. You can read more about March repatriation in this link.

There are probably just two kinds of people in the forex. One is short term traders who trade in & out where 0.1% change in exchange rate can be 100% of their profits/loss. The other kind is hedger. These people don’t really trade, but properly hedge their currency positions through currency exchange swap/futures. They don’t care that much about rise and fall because they are mostly properly hedged in the given long timeframe. For these yen carry trades to work, they must be hedgers. They cannot possibly borrow lots of money for a long term, and rely on the currency market to stay the same.

Why is that when Yen strengthened some 30+% from year 2002 to year 2005, and no one said anything about yen carry trades? Such yen carry trades have been going on for a long time even before I opened my forex account back in year 2001. And a 30% change in currency exchange rate would have generated 15X loss for someone in currency forex, leveraging 50X (which is probably on the conservative side for forex traders. www.mgforex.com where I opened my account allows retail investors to leverage 400X. Institutional trades can probably go higher.). Here is the Yahoo chart of Yen vs $US for the past 5 years:

I think either there is something else bigger that is lurking behind, or the news media simply grabs whatever exotic but explainable things to confuse the regular folks further. Most likely $US will strengthen against Yen after April 1st if the history is of any guide. Does that mean that the stock market & news media will be “manipulated” upwards once $US starts to strengthen after April 1st?

Let us wait and see.

Yesterday’s reversal was quite intriguing. Both the Dow and S&P pierced last week’s lows (e.g. 12040 on the Dow) before making a “V” bottom and finishing positive. I was shorting several investment bankers and home builders and did not get out quickly enough. I ended up closing those trades first thing this morning which meant I gave back half the profits. It was a dear lesson: I needed to set tight trailing stops to secure the profits and trade against extreme emotions in the market.

In the very short term (read: days), the market has taken a stand. Let’s take a look at HUI below. I chosse HUI because of my commitment to PMs. The fact is, HUI has moved in tandem with the major indicies and the divergences are visible there as well. [By divergence I'm referring to the fact that yesterday's price was approximately equal to last week's low but the momentum indicators did not drop to the previous low. This is called a "positive divergence" which usually foretell higher prices to come.]

So does this positive short term outlook in any way alter my bearish views on the economy? None what so ever. Short term market gyrations are usually associated with trader’s emotions and rarely with the underlying economy. For that I urge you to read up on alt-A mortgages, collateralized debt obligations (CDO) and the like (e.g., at CalculatedRisk as I have always suggested). I still see risk aversion as the theme for the next while. As someone once said, the idea is to reduce your risk exposure before everyone else.

This is just a short message.

In my opinion, be prepared to go short. Opportunities coming. Just need to watch out for the reaction to the Bernanke talk.

Best luck.

The stock market needs a Fed assurance/action that the subprime woes will not spread. The best way to convey such is an interest rate cut.

Here is what I am guessing for the upcoming Bernanke script coupled with market reaction:

1. March 20/21: Change the bias to cutting interest rate. Market rallies for 1 hour, and start to plunge due to disappointment. This is the second major leg down if it has not happened already. If Bernanke cuts 0.25%, market will probably rally with more strength. But I’m guessing that Bernanke will be too proud to cut the interest rate.
2. mid-April: Bernanke may come out and surprise the market with an interest rate cut, due to markets imploding.
3. May 9: If Bernanke haven’t cut interest rate by this date, markets probably will be down close to 15% or more in my best guess. He should be cutting at least 0.25% after May 9.
4. If there is no interest rate cut yet, I believe when Fed takes action, they will be cutting 50 basis points in a single step at some point in time (or multiple times?).
5. In any case, whether the markets get the interest rate cuts or not, I believe markets will be in the rough water for the next 4 to 6 months until Aug/Sep. There may be strong counter-rally (let’s hope so). Again, I advise you to sell into the rally. In all likelihood, markets probably cannot exceed the recent peak by the end of October.

Is this the beginning of the big bear market? I tentatively think not. I agree with Jim Puplava’s thinking: pain and then (inflated) gain (from reflation). Unfortunately, the pain will be quite painful and longer this time around than last May for the general stock market.

I have been looking at the following stocks but have only shorted a couple of them. The weakest sector goes down to the drain first, and obviously they are housing sector at this point. The next sector I believe would be restaurant and consumer discretionary stocks. Some of the stocks have fallen so much that I am not sure if they are good candidates to be shorted anymore.

Housing/Mortgage related stocks:
FMT
FED
NDE
IMH
LEND
NEW
NFI
MTG
GM
WM
CFC
FNM
FRE

Restaurant stocks (with restaurants between high-end and median most susceptible to slow downs):
CAKE Cheesecake factory
DENN Denny’s
RRGB Red Robin
IHP IHop
APPB Applebee
MSSR McCormick & Schmick’s Seafood
PFCB P.F. Chang’s

I have been too careful about taking my short positions. My best short has returned 50% in less than two weeks, but I simply have not shorted enough given my portfolio size.

You can come up with your own sequence of falling chips, and short them as they counter-rally. With the home equity drying up, I fully expect a slow down in housing and consumer discretionary sectors.

I have not taken a short position against the general market simply due to my reservation with the ending of the bull market run since 2002. The bull market always seems to have nine lives, and calling a top is dangerous. The record put over call volume is helping the bullish case.
In any case, I do believe that the recent low will almost for sure be broken before 2007 ends. With the upcoming Fed meeting in another 9 days on March 20/21, I hesitate to do more shorts except the weakest housing sector. I’m certain that Bernanke will give out some candies for the permabulls under such circumstances.

`Tis the question on many people’s mind, after one of the most horrific weeks in years and apparent stabilization this past week. A number of respected sources argue from history and market internals that what happened on Feb. 27 was not the start of a bear market. For example, Chris Pulplava from FinancialSense quotes the venerable Paul Desmond from Lowry’s:

In the present case, there was no evidence of a prolonged deterioration of investor psychology. Past experience shows that 90% Downside Days occurring near the market highs with no warning signs of a major market top, are typically part of short term corrections, and thus eventually provide an opportunity to buy stocks with strong Power Rating patterns at the time of the next short term buy-signals, for a resumption of the primary market advance.

That may indeed be the case. But it is also undeniable that “risk” has been again thrust into the forefront of investor’s consciousness. While many a market pundit has been chanting “the fundamentals have not changed”, a slew of the latest reports paint a different picture:

• Durable goods order down 7.8%
• Consumer confidence down
• Retail sales weak
• The February non-farm payroll gain of 97k as well as a reduction in the unemployment rate to 4.5% was well received by the market. However, even a little digging reveal some worrying
  • In order to keep up with population growth, approximately 150k jobs per month need to be created. This is well ahead of the February number. Further more, gain in February was entirely due to contribution from the birth/death model totaling 118k.
  • The reduction in unployment rate was due to the reduction in the workforce participation rate – in February, the civilian labor force is deemed to have shrunk by 190k.
  • Bleeding in goods-producing sectors of construction and manufacturing continues, as is the gains in service sectors. Construction jobs decreased by 62k. CalculatedRisk has predicted loss of 400-600k real estate related jobs this year (construction + other RE services). We seem well on the way.
  • Government jobs jumped by 39k last month, 40% of the headline increase.

Just a little digression on the topic of conversion of manufacturing jobs into lower paying service jobs: Optimists have cited US’s successful transition from an agriculture economy to a manufacturing economy as a reason not to worry. Peter Schiff, in this weekend’s interview with Jim Pulplava, very eloquently picked that argument apart by pointing out that the US did not then, nor now suffer from a trade deficit in agricultural products, but the same cannot be said about the manufacturing sector. The loss of manufacturing jobs is a part of the global imbalance that doesn’t have any easy fixes. I won’t even pretend to know how it will be resolved, but in almost all scenarios I see some reduction in American’s consumption level and depreciation of the US dollar.

No back to the market at hand. Arguably, the “grey Tuesday” started with emerging markets. Below is a chart of EEM. Although the stochastics are bouncing from oversold levels, it seemed to have stalled in the past two days as it approached the 50 dma.

EEM represents one of the stronger indices. QQQQ ($NDX)’s behavior is more common. It could be construed as forming a bear flag which upon breaking down would herald a date with the $40 level. I didn’t draw the Fibonacci levels, but for QQQQ and others the 38.2% retracement level had been reached; for EEM, the 61.8% level. Now, the market doesn’t have to follow just because I drew a couple of lines on the chart. Currently all indices are showing positive momentum from oversold levels so I’m not aggressively shorting here. At the same time, any break from here would be a nice entry point.

So rather than answering the question posed in the title, let me again talk about the positions I’ve taken. Aside from some core holdings (mostly PMs and energy), I have moved significant parts of my portfolio into hedged equity (HSGFX) and high quality bond funds. I hold no short positions currently. The violent responses in the subprime sector amazed me — not so much at the precipitous price drops, but at the timing on a philosophical level. For weeks, information on these subprime loans was publicly available as several popular blogs wrote about them. So was the market really efficient? If we’ve been witnessing a major change in market perception, what would happen when the market suddenly “discovers” the weakening economy?

My current game plan is to react to market trends while reducing risk exposure. The day before “grey Tuesday”, I wrote Caution is warranted based on the technical behavior of the broker/dealer index. At least in the next couple of weeks, I’ll weigh TA evidence more heavily than economic fundamental or market sentiment.

Best luck and be safe!

A couple of months ago, Absolute Mortgage was offering really cheap purchase mortgage at the rate of 0.25% to 0.375% lower than MOST cheapest companies offered on the bankrate.com. It was so amazingly cheap that now it’s not available anymore. I guess they are done with enough “publicity” from bankrate.com. They no longer advertise their rate there, but also adjusted their rates to be about 1/8 % cheaper than the lowest ones at bankrate.com. Great deals don’t last forever. The rates advertised on their site are only for purchase. Refinanced terms may be 1/8 % higher, depending on the borrower’s qualification.

Well, if you are purchasing/refinancing, it doesn’t hurt to check Absolute Mortgage out.

Here is the comparison of two internet mortgage companies that I’ve found to be the most economical:
Click here for the current rate at Mortgage Capital.com:

Both are zero points, $1250 lender’s fee.

Click here for the current rate at Absolute Mortgage:

Both are 0.125 points, $399 lender’s fee (lower interest and/or lower fees). When you make a loan as big as 680K (exceeding conventional conforming loan of $417K already), the 0.125 point will cost you more fees compared to MtgCapital. Therefore, Absolute Mortgage should be cheaper in all cases.

The above rates are quoted when 10 year treasury yield was at 4.509% and 30 year treasury was at 4.65%

Best luck. And if you can find a better rate, or you can beat this fixed rate on a zero point, fee ~ $1000 (and preferably less than $700), please don’t hesitate to leave a comment here.

Posted by “Frugal” at My 1st Million At 33.com

For the month of February from 2/1/07 to 3/1/07,

1. Net worth is up by 2.61%.
2. Value of my company holdings (stock options, ESPP, etc.) is up by 12.55%.
3. Everything else excluding my home and cash is down by 4.83%.
4. If including cash in #3, it’s down by 3.80%.

I didn’t expect precious metals to go down much harder than the general market. My portfolio took a beating. In any case, the market finally has woke up to the subprime lenders’ woe. Although people may attribute the fall to China, or Greenspan’s recession speech, I believe US market is really the core of the problem in the global markets. They can get Greenspan to come out 10 more times to correct his words on recession odds, but it will not change the downward spiral in the mortgage market.

The downfall in the mortgage market is fundamentally very positive for PM. That is only the first shoe to fall. If Fed does not control the blow-up properly, we can see the long-waited $US fall sooner than later. If Fed starts to lower interest rates to arrest the downward spiral, it will also be positive for PM.

I believe the secular bear market in stocks may have resumed. The unfolding of such secular bear market however does not necessarily mean a fall in the absolute price of the stock market this time around. Rather, the stock market will fall on an inflation-adjusted basis, and also against gold. There is also a chance that Fed stops the downward spiral in time, and create a bigger bubble in everything going forward. The most likely timeframe is in 2008/2009 for next (potentially higher) peak. In fact, the stock market can put in a higher high in 2009, but not necessarily beating the accumulated inflation since 2000. I do expect the stock market to go lower than the low on 3/5/07 this year. I also expect the general stock market to put in less than 3% gain for the entire 2007 year.

I’m liquidating most of my non-PM/oil positions which were worth less than 4% of my entire portfolio. Due to the leverage that I can get, I still have not sold much out of my stock options. I am retaining my bets in PM/oil for a continual debasing of the currencies and bull run in commodity market.

Best luck navigating in the dangerous water.

Special note: returns were calculated by subtracting 3.00% APR return of my cash position.