The following is part of Pivotal Events that was published for our subscribers May 19, 2011.
Signs Of The Times
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The markets have, indeed, had a change in character as speculators became fully leveraged for soaring prices, and suffered plunging prices. Quite likely this has started another phase of "de-leveraging".
One of the most damaging has been silver's crash. More than something to trade, silver's fall relative to gold is one of the indicators that the speculative surge has completed.
Highs for hot commodities were sequential, with agricultural prices (GKX) setting the high in early March, base metals (GYX) in early April and precious metals at the end of April. These now appear as cyclical peaks in prices.
Stocks (SPX) set the high of 1370 at the end of April. The decline has been modest, but equities are vulnerable to forces of financial gravity as well.
Corporate bond prices and spreads have also participated in the party that arose out of the panic that ended in March 2009. This sector is again becoming vulnerable to a seasonal turn to widening that often makes May the month to "go away".
Momentum Peak Forecaster
This proprietary indicator went straight up the fall suggesting that speculation would run to excess. Called the Forecaster, it reversed in early January which signaled buying could reach a frenzy some two to three months later. This would center around March as all items would not peak at the same time. Other methods suggested that precious metals could run as some commodity groups lagged and crude oil could rally through April.
As it turned out, the action climaxed as crude completed seasonal strength at the end of April.
Other than anticipating a surge in speculation and its conclusion, the Forecaster has also made the call on the start of the recession – particularly when the speculation focuses on commodities.
The model is updated below:
Commodity Speculation and Recessions
Ross has enlightened technical research with some illustrative titles. The August 24, 2010 ChartWorks (CW) boldly headlined “BYE-BYE BONDS” as in goodbye bonds, or sayonara, or get out! That week set the top of the treasury bond market at 136.84.
The decline was 10 points to 117 in early February when the ChartWorks headline was "BUY-BUY BONDS". This requires no interpretation and though coincidental was timed with some of Pimco's most bearish comments on the long bond.
On the latest rally, the obvious target as commodity speculation lost momentum would be the 125 level and this has been reached. There is a fair amount of resistance that could force a trading range for a while.
Higher bond prices with lower commodities seem possible.
Over in the credit risk side, the action in corporates has been good on the fabulous rebound out of the crash. Since year-end the high-yield has declined from 7.51% to 6.66%, as the spread narrowed from 418 bps to 354 bps.
This is vulnerable to a change in sentiment, which could be followed by the discovery of risk – again – in the sub-prime. This week the issue (AAA-02-02) we thought would be the indicator has taken out the previous low. This was the "sell" for us on all spread products in 2007 and it is now.
This is backed up by Ross's "sell" (CW, May 18) on municipals. Munis (MUB) have rallied from 94 on disaster headlines in mid-January to 104 yesterday.
Often seasonal forces will narrow spreads into May and then reverse to widening. This and the Forecaster worked very well for us in 1998 when LTCM self-destructed on the bizarre notion that European spreads could be narrowed by government edict.
Historically, a dramatic plunge in silver relative to gold has anticipated the next liquidity crisis. It is inevitable that this will appear in all risk markets.
But to look to the brighter side, it could prompt a brief "flight to quality" move into longer-dated treasuries.
It is essential to understand that as with any recession, this one follows over-speculation and is not due to policymakers tightening. Quite tediously, the establishment could soon lay the blame upon "talk" of ending QEII.
Shorted-dated rates are still declining. Dealer commercial paper rates have dropped from 0.54% last summer to 0.23% in April. The number is now at 0.20%. This could be reflecting extreme accommodation by financial adventures at the Fed and Treasury.
Similarly Libor has declined from 0.539% to 0.260% today.
In May-June 2007, these rates increased when troubles started and liquidity began to vanish. Could happen again.
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