Silver posted a bearish reversal at a major pivot of 200 day MA

Source: Bar Chart (edited by Short Side of Long)

Several days ago, we published a post titled “Why Are Precious Metals Declining?” and stated that precious metals sector has just gone through “a rather sharp reversal in sentiment [which] usually tends to signal a correction during uptrends or a potential for another leg down during downtrends. This is unless of course, assets like Silver can continue a sustained rally with a break above the 200 day MA. We continue to track the overall sector very closely…”

We have been monitoring the price action with a magnifying glass. Interestingly, Silver did not manage to follow through. The metal posted a false break out above the 200 day moving average during the FOMC meeting, which was followed by a extremely sharp reversal at this important pivot level. To us, this signals an extremely bearish setup and therefore we have taken appropriate action over the last 24 hours.

FOMC continues to with hawkish stance, while funds pile into longs

Source: Short Side of Long

While the next Commitment of Traders positioning report will be released tomorrow, the current data we have available shows that hedge funds and other speculators are extremely optimistic on precious metals, and in particular Silver (NYSE: SLV). We are at record high managed money net longs (hedge funds), which must be very surprising to gold bugs. The fact that the price has not made a higher high nor cleared the 200 day moving average – and yet every Tom, Dick and Henry piled into this trade – tells us there is still room further downside.

Obviously we are wrong with a tight stop above the 200 day moving average, however looking at the dumb money positioning and various bloggers opinions, we believe there is a lot of potential disappointment coming.

Fastest quarterly build up in hedge fund net long positions

Source: Short Side of Long

In recent posts, we have been discussing a potential precious metals break out and a possible reversal in trend. After rallying pretty strongly for the last several weeks, the sector has now given up some ground. So what is going on and how will the prices behave in the coming weeks?

Hedge funds and other speculators have piled net long bets on Silver

Source: Short Side of Long

So far the 200 day moving average has acted as a strong resistance across the board in the precious metals sector. Gold (NYSE: GLD), Silver (NYSE: SLV) and Platinum (NYSE: PPLT) all stalled at this important pivot point. Same is true for Gold Miners (NYSE: GDX), Gold Mining Juniors (NYSE: GDXJ) and Silver Miners (NYSE: SIL).

From a contrary perspective, hedge funds and other speculators have piled into assets such as Silver over the last couple of weeks. This is a rather sharp reversal in sentiment and usually tends to signal a correction during uptrends or a potential for another leg down during downtrends. From a contrary perspective, current positioning looks pretty bearish to us. This is unless of course, assets like Silver can continue a sustained rally with a break above the 200 day MA.

We continue to track the overall sector very closely…

Source: Short Side of Long

In a recent article published at the end of September, we made a prediction that the Precious Metals had a decent chance of rebounding out of its short term oversold conditions. Our reasoning was linked to diminishing probabilities of a FOMC rate hike, which should support the sector, other commodity prices and also weaken the dollar (at least for awhile).

Technically, the price and pattern conditions haven’t changed all that much, despite our correct prediction of a short term rally. Out of four major asset classes within the precious metals sector, only Silver (NYSE: SLV) has recently managed to overcome its downtrend line resistance. Gold mining companies (NYSE: GDX & GDXJ) are still pressing against their downtrends, just like Gold (NYSE: GLD) itself.

Is Silver’s early break out signalling a change in trend or will this be just be yet another fake out? We continue to watch the developments closely and on daily basis for clues.

Silver’s break out from a downtrend might be an early bullish signal

 Source: Short Side of Long

Further evidence of pessimism as fund managers cut net long exposure

Source: Short Side of Long

Problems with VW and Glencore, poor seasonality, technical damage, slowdown in EM economies and a disappointing jobs report did not manage to knock the market down. Whenever an asset refuses to make new lows on deteriorating news and tape rallies strongly in the opposite direction (just like Friday’s technical reversal), it is a very bullish sign. On the 01st of October, we were discussing a possibly of a double bottom, which now seems to have above average chance of completely developing.

We have already discussed how breadth became washed out and sentiment dropped to extremely low levels. New data showed that yet another indicator registered an important buy signal late last week: National Association of Active Investment Managers. As we can see in the chart above, net long exposure by fund managers has now dropped below 20% for only the second time in the last four years. Only other time was October 2014, which also marked an intermediate bottom.

Traders have been busy purchasing plethora of put options recently

 Source: Short Side of Long

Furthermore, by late August, we saw how options trades pushed the VIX to the second highest daily reading in almost three decades, prompting us to call a capitulation bottom. These same trades have continued to load up on put options throughout majority of September, with the hope that the index will break towards lower lows. Assuming that the S&P 500’s double bottom  and Friday’s outside reversal (biggest in 4 years) holds, plethora of put purchases could end up being a strong contrary signal.

Finally, global fund managers are extremely worried and fearful of the Chinese economic slowdown and a potential for a full blown emerging markets debt crisis. I feel that whenever certain “investment mantra” reaches a boiling point as in being front page of every newspaper for several months, central talking point of almost ever fund manager interview and most popular blogging theme across internet… its most likely overdone with a reversal in the cards. The fact is, MSCI EM Index has refused to make lower lows despite continual bearishness ever since the emotional wash out occurred during the Black Monday 25th of August.

Global managers remain most worried about Chinese & EM growth

Source: Merrill Lynch

Commodity prices are approaching a major support level

Source: Short Side of Long

Commodities are now on track for their fifth annual decline in the row. This is an extremely rare occurrence for any asset class. In the case of commodities, prices have now declined below March 2009 bottom and have recently started to test the level of 185 on the CRB Index. This price dates all the way back to 2001, when the China driven commodity bull market began. Such a persistent decline has resulted in production and supply cuts, which will eventually saw the seeds for a strong rebound.

Sentiment on commodities is approaching rock bottom levels

Source: SentimenTrader

Sentiment in the raw materials sector remains at ridiculously low levels, relative to the historical mean. The chart above, thanks to SentimenTrader, shows that the percentage of bulls is now at the lowest level in over a decade and half. Contrarians should definitely pay attention to the prices in coming weeks and months ahead, as a major bottom could be forming.

Speaking of bottoming process, there is a high probability that the oversold Energy sector has successfully retested its crash low from earlier in the year. I would expect the bottoming pattern to continue for awhile still, as we build a complex base along the lines of a triple bottom perhaps. If the current price level persists for longer, production will be dramatically reduced ensuring a big bull market around the corner.

Crude Oil continues to build a bottoming base post 2014 crash

Source: Short Side of Long

Hedge funds have cut bullish bets on Gold very swiftly over the last 3 months

Source: Short Side Of Long

Precious metal assets such as Gold, Silver and Platinum have been in a rally mode over the last several days. While most investors are wondering what is the reason for recent strength, the most likely case scenario lays behind market participants positioning and overall sentiment. After falling for weeks, breaking to new lows and constantly being regarded as a useless asset (especially by Tom Kenee on Bloomberg Surveillance), hedge funds and other speculators have now completely left the sector.

Speculators dramatic reduction in Silver net long contracts is one for the history books

Source: Short Side Of Long

Observing the two charts above, one linked to Gold COT and the other to Silver COT, we should be able to notice the dramatic reduction in net long positions. In the case of Silver, bullish bets were unwound so quickly and by such a large margin, that we have a 2.5 standard deviation event. Last time we saw behaviour like this in early 2003, Silver was starting a huge bull market rally that lasted for several years.

Not only were overall positions cut sharply, but speculators also increased gross short interest on both Gold and Silver to yet another record high. Bearish bets climbed to over 280,000 gross futures contracts on Gold and Silver combined. In theory words, just above every man and his dog were expecting Gold to keep falling from here onwards. Or even better, as Mr Tom Kenee said it best: “Gold is classic textbook short.” Lucky for him, he has a job at Bloomberg Media and not as a trader who has to make a living from the markets.

Short selling contracts in both Gold and Silver have risen to new record highs in recent weeks

Source: Short Side Of Long

S&P is now on the verge of breaking its tight range and trading below the 200 day MA

Source: Bar Chart

Will it or won’t it? We have been discussing S&P 500 over the last few months on this blog and focusing on whether the US large cap index will finally drop below its 200 day moving average support. The index of 500 components has outperformed the rest of the global stock markets for awhile now, remaining the only game in town. But how long can this outperformance last, while rest of the global assets keep dropping with deflationary pressure?

Possibility of a 10% correction is high, with last one occurring almost 4 years ago

Source: Short Side Of Long

Readers should remember that the index has not suffered a 10% correction (on a closing basis) since October 2011, almost 4 years ago. This is now one of the longest historical stretches without a meaningful correction. Obviously, volatility is behaving due to artificial conditions, where major central banks remain engaged in QE.

Furthermore, as already mentioned in previous posts, S&P 500 has traded above its 200 day moving average for 183 out of the last 187 weeks, so it is definitely overdue for a drop and a mean reversion. Today’s price reversal looks likely to signal that bears could finally take control (for awhile). If S&P breaks lower, one can expect other global markets, such as MSCI EM Index, to feel even more pressure going forward.

If the global stock market correction continues, Emerging Markets will feel more pain

Source: Short Side Of Long

Chart Of The Day 1: Gold mining companies are trading more than 30% below 200 MA

Source: Short Side Of Long

The current bear market in Precious Metals companies is one of the worst ever in sectors history. Prices have declined so much, that we have now returned all the way back to the bottom in early 2000. If one was to ask Gold bulls whether such an event was possible only a few years ago, they would have laughed at you. Miners were seen as very cheap in 2012, 2013, 2014 and also in 2015. Eventually, they will become so cheap, that a bottom will be formed.

Let us investigate the price. Technically, gold and silver mining companies are approaching a major support of $41 in the Philadelphia Gold and Silver (NYSE: GDX) index. As already explained, this buying zone dates all the way back to the last major bottom.

Furthermore, the index is extremely oversold on technical basis. Consider that the price of the sector is now over 30% below its 200 day moving average. Such an even only happened only 3 other times in the last two decades. Moreover, on the quarterly performance basis, the price of the index has sold off by 40%. This is a 2 standard deviation event.

Finally, while the sector is oversold nominally, it is underperforming Gold in a disastrous way. Let me remind the readers of the blog that Gold (NYSE: GLD) is still trading around $1,100 per ounce. If we look at the chart below, we can literally see that miners are losing value in a raid fashion on relative basis. In other words, the ratio between Gold and Gold miners is going parabolic.

Chart Of The Day 2: The ratio between Gold and Gold miners has entered a terminal stage

Source: Short Side Of Long

Chart Of The Day: S&P 500 has managed to stay above its 200 day moving average

Source: Short Side Of Long

A lot of technicians have been following the price of S&P 500 very closely in recent days. After a 5 consecutive day decline towards its 200 day moving average, it was make or break for the US equity market. So far so good, as the index managed to stage a 40 point rally (at the time of writing this). After trading above the 200 day MA for 183 out of the last 187 weeks, the question is: does S&P 500 have the legs to carry it towards new record highs or is this a short term bounce? The key to answering that question and future direction of the market lays with market breadth participation. In other words, despite a seven month sideways trading range, there is a lot more going on underneath the surface.