Tuesday, January 17, 2012


Although at times I am in this crew, or feel like I am, the dumb and dumber, this is the Sunday night shorters in the emini S&P 500. I have seen more people lose more money selling this market in the early night sessions on Sunday night just to have it reversed against them seemingly 80% of the time, it makes me wonder as Seinfeld said "who are these people?" If this is you take a breath and stop doing this until we get into a bear market. When you have a strong short term uptrend like what we currently have, you are just throwing money away shorting the openings on Sunday nights. If I had one trade to make without researching it at all, it would be to buy the ES when it falls 8 to 10 points on a Sunday evening and exit when it hits unchanged. Just anecdotally, I think this would win 8 out of 10 times if not more. Maybe just throw in that we are trading above some moving average, and it might be even better than that.

Since my Gold comments are once again apparently ruffling some feathers,  I will make one last attempt to make my point clear. I have felt this way before about bubbles and I have chronicled those prior instances in here over the last couple of years. Maybe it was my lack of success in 2005 trying to convince people to sell their real estate that keeps me coming back to this topic. One thing I try to do is make things as simple as I can. I do create all kinds of funky indicators to try and give me an edge, and some actually do. However, it is the basic common sense aspect of things that I think often gets lost in our world of high tech trading. In every bubble in history, there have always been arguments about why there is not a bubble and why prices should continue upward. The tech bubble was a new world created by the internet, where all these fabulous ideas would change the rules of business. Then of course we had real estate, with similar arguments about why what we were seeing made sense and would continue on indefinitely. There was T Boone Pickens when Crude was at $140 saying it was a lock for $200. He of course was such a wizard he neglected to tell us it was going to $32 first. Now we are seeing those types of arguments with Gold. All of these things I have never heard of are being bandied about as to why this has to continue.

Who in the world ever studied closely the percentage of people that own gold? People do now because it is low and supports the theory that as more people buy it price will continue to rise. Perhaps even though the percentage is small, it is still much higher than before effectively making it overbought? I have no idea but the point is this is a theory. Who would report they owned it? I sure as hell wouldn't if I did. I would not want the government to know I had it so they could choose to come take it if they felt like it. The idea of fiat currencies. You talk about a Depression, wait til you see the one that is created by limiting the financial world to the supply of Gold. The whole world would instantly collapse. Talk about shrinkage, as a guy I don't have to jump in a cold pool to experience shrinkage, I could get my max dose right in this scenario. It has never been zero. Really, seems to me most things have never been worth zero? It is a store of value. Study the charts, that is just plain not accurate. At times it has been, at times it has been a store of diminishing value. I heard Marc Faber say he would rather own Gold and have it drop 50% than have his money in cash since that might go to zero. Has this guy ever hit a ball out of the infield? I don't recall ever seeing any proof that he had made any money trading? Who the hell would be willing to lose 50% of their money just to prove a point they were being too stubborn on? I would not take investment advice from anyone who was that inflexible.

What we have now is something that is just very simple, a commodity market that has gotten into favor and has had a tremendous rally. It is nothing more than that. We know that from studying the past price movements of commodities, that these types of boom and bust cycles happen quite frequently, and they all end the same way. One thing we do have going on today that may be a bit different, is the hedge funds and how they accelerate price moves. They have been part of this craze, and they will be blamed when it ends in flames. When you get these large funds, they get limited in where they can go to trade just based on pure liquidity considerations. They can trade Bonds, Stocks, Crude, Currencies, and Metals. Many of the other markets just don't have enough volume to handle the large orders they place. This is why you see these huge sharp moves in Gold. You have hedgies piling in and out very quickly. At times when we get stock declines, they have to liquidate other positions like those in Metals, to cover margin calls and redemeptions. This makes for exciting price action to say the least.

As I get into this I need to make something perfectly clear. I am neither a long term bull or bear of this or any other market except stocks. I am a long time bull there. Why? This is a very simple point which leads into my discussion on this topic. Look at the chart below, tell me what is different about it than any other market?

This is pretty simple, you can see it just has a never ending up trend, over 100 years old at this point.The reasons for this is it basically just tracks human evolution, the advancement of our society. As time goes on we figure out new and better ways of doing old things, and we also come up with new things. All along the undercurrent is just perpetually moving us forward. I expect this to continue for as long as I am alive and well beyond. There is every reason to believe human kind will continue to evolve so this will likely in spite of set backs, be a net upward path. We still we have declines and some of them will be large, but this is not a mean reversion market. It has not historically been and I don't expect it to become one.

Now lets look at the next chart, Commodity prices. This chart is quite busy, but I think it is easy to get the point I am trying to make. It has Gold with several other commodities over layed on top of it. The take away here is that Gold is the only one that has had this massive spike up without a significant reversion. The point I am trying to drive home, and it is my sole basis for having the longer term view I have here, is that this market is doing something that has never been done before. Commodities due to the fact that they are a known supply item, tend to go in and out of favor in terms of demand, therefore they see saw up and down. Yes there are new stashes of things found here and there but not enough to materially effect the basic premise. The arguments about limited supply were made with real estate, and we saw where that led us. My favorite was always, "they are not making any more land." One of the few constants in life in the non constants. We can be sure of very few things, but one of them is change. Markets measure collectively human emotions and desires. When something is hot everyone chases it, then they tire of it and chase something else.

Prices decline not because sellers enter, it is because buyers leave. This is an important point to remember. Sellers can always be there to sell, and as long as there are enough buyers, prices of anything will rise. The minute the buyers leave, that is where price declines take place. This is why fading Sentiment works so well. Sentiment basically tells us how many people have bought, once the levels get above 80%, most of the people have already bought and the numbers of buyers is going to decrease. I have nothing against Gold, I could care less if it rises or falls, my life changes not one bit either way. What I do have something against is buying something that has already risen this far, when I know the history of commodities is that they are mean reverting. That is the genesis of my argument. It has nothing to do with this fiat currency discussion, inflation, the US deficit, the European debt crisis, et all. It is purely based on the mean reverting nature of commodities.

One other thing that always bothers me is the lack of common sense that is used in investing. If someone told you God himself would promise that Cattle prices would rise 100% if you bought them tomorrow, I would be willing to bet the majority of people once faced with that gain, would hold on then hoping for another 100% and wind up losing all of the profits as it reverted back down. They would not be willing to take the double and run. They would cry out some reason as to why the Cattle market would be forever in strong demand and there were just not enough cows to go around. I would love to think that at some point I would make one trade that made me $10 Million Dollars. The largest trade I have ever made was buying a house in 1999 and selling it in 2005 for a $1.1 Million profit. That was during the housing bubble. However, when I think about the odds of that versus having a stable approach that I know makes me money year after year, versus trying to catch one thing perfectly that is a home run, I will take the former every time. For those that are in from $400 or $500 I do not understand why you have not taken profits you already have a once in a lifetime gain? Are you really prepared to watch all of that money go poof? I sense most of you have no exit strategy at all, and you will buy it all the way down if it comes down, and wind up with nothing to show for your brilliant investment. You should not blindly exit just because some dude like me is popping off in a blog about it, but at least develop an exit strategy just in case by some minute chance you are wrong.

Now as to why I think now is the time versus some other time for the big decline to occur. If you look at just a basic regression channel, you can see the blow off top we had that extended so far out of this channel it was a mathematical lock that we would come down. These are the types of patterns you see at tops that last for many years, not just pauses in trends. Had we not had that huge blow off, I would not be nearly as bearish. I also have one of the cycles that is pretty decent for this market, the 2 year drawn in with vertical lines. We did hit a top right about when that was calling for one, hmmm.... There are other cycles of longer durations one of which is coming due about now, that call for a top. The next chart shows the Large Traders and Commercials and what they are up to.

There are a few things to make note of here. First, when we made that high, there was a failure of the Large Spec position to make a new high. Since they often pyramid positions, they generally can increase their longs during rallies like this. In this case, their buying was exhausted and we see the net decrease in buyers I mentioned earlier. This was an ominous sign at the time. The other thing to make note of is the Commercials and their critical position sizes. If you look at the last two large rallies the long size was about the same, I have drawn vertical arrows as well as a horizontal line going across those numbers. You can see now on this recent dip, we are far below that net position for them. In other words, this decline has not attracted anywhere near the buying that the last two did from the commercials. This tells me the big guys are unwilling to step in front of this yet. If they were much more bullish here, I would have a different view. They aren't. We can't always stake our whole view on the COT data, but when I see something this significant in the data, it needs to be heeded. Maybe on the next break they will bring their long position up to the prior levels. If they were to do that and price had not broken too much, I would become bullish at least in the near term. The trick with COT positions is where they occur in the price structure. If a big break is accompanied by big buying that does not mean much if the trend is broken. If the trend is intact and it happens, like in the two examples I have the arrows at, you have a great buy setup.

If I take all this together here is what I come up with. An extremely over due mean reversion in markets that always mean revert. On top of that, a blow off top of significant proportions that took place right when the two year cycle called for a top. I then add the seasonal top tendency which is right about now give or take a couple of weeks. This is the basic reason I am bearish on this market from a larger perspective. I also do not see any significant Commercial buying which I would normally have expected on a decline of this amount. We have also broken the weekly uptrend and are bouncing up in a down trend now. If I also add mechanics to this, Steve Briese's study of commodity bubbles objectivity measures this as one and gives it a very high probability for a significant decline if it is to sync up with historical price movements. It has absolutely nothing to do with any opinions I may or may not have about all of these new age arguments being made about why this has to triple from here. I don't invest my money on opinions about such things, they are just too arbitrary. This does not mean they are wrong, they are just not what I use to make trading decisions.

I realize I stand almost alone in this view, and perhaps that makes some people think I am just some moron who does not get it. Maybe I am. I do look at this just like anything else. I use my tools and experience to the best of my ability. I do not always get everything right, and I never will. I do get the majority of things right which is why I am a profitable trader. Perhaps this is one of the markets I will get wrong, but I view at as I would anything else. This is my reasoning, it is just another trade to me. I am not currently long or short this market, and will trade whichever side my short term tools tell me too regardless of what my long term view might be. I don't strive to find that one trade that I will hold for years to make my whole life's fortune in. I do plan on trying to hold shorts when I do them longer than I normally would because I think the potential down side here is enormous. That is about the only influence at all that my larger picture view will have in my actual trading.

I won't dispute other people's arguments on this but what I will ask is this. In discussions on this in here, if you have an argument to put forward they are all welcome with one asterisk. They need to be accompanied by a chart showing in the past where they have caused the price moves you claim they are going to cause in the future. I will upload these to the blog if I get any that meet this criteria. Just saying Fiat currency blah blah blah, is not an argument unless you can show me on a price chart where that caused the price of gold to reliably rise. Without that arguments are theories and are not objective.

I know at this point I have readers from all over the world so if you wish to submit a chart email it to me at mktwzrd1@gmail.com. Please make it plausible and not something like percentage of ownership of Gold. It has to be something that is measurable over time, not some new age graph that was created to support the argument. Those are theories. Maybe we can find something that will change my mind, nary a day goes by that I don't examine some way of looking at things differently. Maybe this is a case of someone just getting through my thick skull.

This will be the last big picture discussion I have about this market, I am burned out and my conscience is now clear. All my future commentary will just be short term trading opportunities that I am trading in both directions.



John M said...

Brilliant. Thanks. I think I'll print this out and make copies to hand out to everyone I meet who believes gold is going to infinity and will never come down more than a couple hundred bucks.

Chris Johnston said...

Funny, of course I could be wrong but at least I am willing to go out in this open forum and state why I think what I do about this

Anonymous said...


Here is how the new Euro carry trade works with 10 yr. notes. Wonder what happens to rates when this carry trade is off??

Anonymous said...

Well said and I believe you are correct. And I have two observations: One, is the 22 yr chart of gold seems to look a lot like the 100 yr Dow chart with its parabolic move etc. What's missing in the gold chart is a swan dive like the Dow took in 2008, so it is probably close at hand as you point out.
Two, while I agree that the Dow Index tracks human evolution and economic growth, the Dow itself is part of Wall St hype and has never done that well in reality. It is continually being changed supposedly to "better reflect the makeup of our industrial economy". Truth be told there is not a single stock in today's Dow that was there 100 years ago, maybe even 75 yrs ago. In fact had you purchased all the Dow stocks back around that time you would have lost 100% of your money because all of the companies that made up the Dow then have gone out of business. Over the years the American Motors and Woolworths of the Dow have been replaced by the higher profile IBM's and Microsofts of the world and the index itself never reflects those losses by companies that went belly up. Granted the charts would still have an upward curve but I doubt it would look anything like what it does.
The Dow is like what the government does to the CPI and the employment numbers - they cook the books to make themselves look good.
Don in Virginia

Mingoman said...

Thanks Chris.
Excellent post.

Chris Johnston said...

good point on the dow chart I was just trying to keep things simple here so I did not want to get too tied up in a discussion of the dow

Anonymous said...

I agree with your Gold ideas. But what about other markets like corn, etc? They have had huge rallies, not as impressive as Gold but can we expect them to mean revert as well?

Chris Johnston said...

mean reversion is just math, it applies to everything. The key to it is to look for extremes, not sure Corn qualifies there yet

Anonymous said...

Have you ever thought about writing an e-book or guest authoring on other websites? I have a blog based upon on the same subjects you discuss and would really like to have you share some stories/information. I know my viewers would enjoy your work. If you are even remotely interested, feel free to send me an e mail.

Chris Johnston said...

there is no email address for this prior comment. I might be interested in that if you want to email me