- Interim Update 18th November 2020
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Commitments of Traders
(COT) Extremes
Most of the time, sentiment
simply follows price (a rising price causes speculators to become more
bullish and a falling price causes speculators to become more bearish). As
a result, important price tops invariably coincide with a high level of
speculator optimism and important price bottoms invariably coincide with a
high level of speculator pessimism. However, upward trends generally don't
end due to speculators becoming too bullish and downward trends generally
don't end due to speculators becoming too bearish. This is evidenced by
the fact that it is not uncommon for a market to continue trending upward
after a high level of speculator optimism has been reached or continue
trending downward after a high level of speculator pessimism has been
reached. This implies that it is reasonable to view sentiment as an
indicator of risk or potential, but not as a causal factor in a trend
change.
In many of the markets we follow*, the COT data are the
most useful indicators of sentiment. It probably works this way because
the US futures markets are influential on the global stage and because the
COT data show what speculators in the US futures markets are doing with
their money (as opposed to what they are saying).
Currently, three
of the markets we follow and for which the COT numbers are good indicators
of sentiment have -- according to recent COT reports -- speculator
positioning that is at or near an extreme. We are referring to speculator
positioning in the T-Bond futures market, the euro futures market and the
copper futures market. Each of these is discussed below with the help of
weekly charts from goldchartsrus.com. In each chart the blue bars indicate
the net position of commercial traders, which is the inverse of the total
speculator net position (an extreme commercial net-short position
indicates an extreme speculator net-long position, for example).
Right now, the most extreme speculator positioning is found in the T-Bond
futures market. As illustrated below, within the past two weeks the total
speculator net-SHORT position in T-Bond futures hit a 9-year high. It
wasn't quite an all-time high, but it was close to this market's
largest-ever speculator net-short position. Therefore, it appears that
speculators, as a group, are as bearish as they ever get about the
T-Bond's prospects. Another way of saying this is that speculators are
extremely confident that long-term interest rates will rise over the next
few months.
This creates the potential for a significant pullback
in long-term interest rates within the next three months. To be clear,
such a pullback won't be set in motion by the current lopsided speculator
positioning, but if a pullback starts for some other reason then the
short-covering of speculators in T-Bond futures should magnify the move.
Turning to the currency market, in late-August the total speculator
net-LONG position in euro futures was much larger than it had ever been.
This implied that speculators, as a group, were as bullish as they ever
get about the euro's prospects. Since then the euro has drifted with a
slight downward bias.
Although the euro's price decline since
late-August has been small, it has been accompanied by a 30% reduction in
the total speculator net-long position. Speculators are still betting
heavily on euro strength, but the combined size of the speculating
community's bullish bets on this currency has shrunk by enough to reduce
the euro's short-term downside potential by a meaningful amount.
The total speculator net-LONG position in copper futures hit an
all-time high in 2018. The following chart shows that this high was
matched within the past few weeks.
The hefty speculator net-long
position in copper futures is a reason to be cautious about copper's
short-term prospects, but we doubt that it will result in a large price
decline. The reason is that the industrial metals, including copper, are
benefiting from macro-economic tailwinds that should persist until at
least the middle of next year.
*The markets for government bonds, the major
currencies and several commodities, but not the stock market.
Oil and Gas (O&G)
Update
Oil stocks are breaking
out
The stocks of oil production and oil services
companies have rebounded rapidly from late-October lows and in many cases
are trading comfortably above 200-day MAs for the first time in a long
time. For example:
1) Schlumberger (SLB), the world's largest O&G
services company, gained about 50% from its late-October low to this
week's high and has broken above its 200-day MA.
2) The Oil Services ETF (OIH) also gained about 50% from its
late-October low to this week's high and also has broken above its 200-day
MA.
3) BP Amoco (BP) was relatively weak during August-October and is yet
to move above its 200-day MA, but like SLB and OIH it has rebounded
strongly over the past three weeks.
The large-cap oil production/services stocks are now 'overbought' and
therefore are not good candidates for new buying at the moment. We suspect
that they will make 1-2 month highs soon and then correct/consolidate for
a while before resuming their upward trends. These
corrections/consolidations should create new opportunities to buy in
preparation for rallies to much higher price levels during the first half
of 2021.
Natural Gas (NG) has plunged
From
our perspective, short-term price movements in the US NG futures market
are not predictable and are often surprising. This possibly is because the
supply-demand of the physical commodity undergoes sudden shifts in
response to changes in the weather or expected changes in the weather.
The most recent surprise was a dramatic decline in the January-2021
futures contract (currently the most liquid contract) from around US$3.50
in late-October to around US$2.80 earlier this week. In late-October there
were no warning signs (as far as we know) that this price plunge was about
to happen.
The price plunge of the past three weeks could be quickly retraced due
to a colder-than-usual North American winter, but that's not something we
would bet on. We would, however, bet on NG trading at much higher prices
at some point over the next nine months due to the combination of reduced
supply (a result of this year's large decline in drilling activity) and
increased demand stemming from massive government spending and a temporary
economic revival.
The Stock Market
The financial markets are
looking beyond the current dismal economic situation involving
sky-rocketing COVID-19 cases and counterproductive lockdowns to the better
economic times that should arrive during the first half of next year.
That's why the S&P500 Index was able to close above it early-September
high on Tuesday of this week.
The optimism is linked to the improving ability to treat COVID-19
cases and the increasing probability that effective vaccines will become
widely available within the next few months. On the vaccine front, for
instance, there are now two companies/teams that claim to have developed a
vaccine with about 95% efficacy. Pfizer's vaccine success was announced to
great fanfare at the start of last week. This vaccine initially was
reported to have 90% efficacy, but that has since jumped to 95%. Moderna's
competing product was introduced at the start of this week.
The
Pfizer vaccine has the disadvantage of having to be stored/transported at
minus 70 deg C, whereas the Moderna vaccine can be kept in a normal
fridge. On the other hand, the Moderna vaccine requires a much larger
dosage to be effective, which could make it riskier.
The optimism
also is linked to the tidal wave of US government spending that
potentially will be set in motion within the next few months and the high
probability that central banks will do their utmost to maintain ultra-easy
monetary conditions for the foreseeable future.
It can be argued
that the optimism is way overdone, given current extremely-high valuations
and the potential for things to go wrong. The other side of the coin is
that the more dire the economic situation becomes in the short-term, the
more aggressive will be the monetary and fiscal responses during the first
half of 2021.
Our view continues to be that the stage is being set
for major rallies in some cyclical stock-market sectors during the first
half of next year, with the stocks of oil, natural gas, industrial-metal
and fertiliser producers being among the biggest beneficiaries. However,
for the senior US stock indices we think that risk outweighs reward over
every timeframe from two months to two years.
For the cyclical
stocks mentioned above, the main risk is short-term and is associated with
the potential for a US$ rebound. This risk will persist until the Dollar
Index breaks to a new 52-week low.
Gold and the Dollar
Gold
Regarding the US$ gold price, here's what we wrote in the latest Weekly
Update:
"Minor corrective moves within multi-week trends often
last 4-8 trading days. Therefore, the bounce from support over
Tuesday-Friday of last week could be a minor corrective move within the
context of a new multi-week decline. If so, a drop to $1800 or lower
(potentially to as low as support at $1690-$1700) could occur within the
next few weeks.
The alternative is that last Monday's plunge
completed a 3-month correction from the early-August high by establishing
a double bottom.
Given the shift in the fundamental backdrop, we
think that the former possibility is the more likely."
We then
pointed out that while gold had held support in US$ terms, it had broken
out to the downside in terms of some other major currencies.
Over
the first three days of this week the US$ gold price stayed above support
at $1850 and below its 20-day MA, which implies that nothing has changed.
A drop to $1800 or lower (potentially to as low as support at $1690-$1700)
is still the most likely short-term outcome.
It's possible that our Gold True Fundamentals Model (GTFM), which
turned bearish last week after having been non-stop bullish for about 11
months, will chop around between bearish and bullish over the next several
weeks, but based on what we think will happen economically and monetarily
it probably will be bearish during the bulk of next year's first half. A
bearish GTFM combined with a weakening US$ would be very bullish for
industrial commodities.
In any case, we'll take the evidence as it
comes and hopefully respond appropriately.
Gold Stocks
We now can be certain that the gold mining correction didn't end in
October, because on Wednesday 18th November both the HUI and the HUI/gold
ratio made new 4-month lows. The relevant daily charts are displayed
below. Notice that the HUI is now only 4% from intermediate-term support
defined by the 2016 high and the 200-day MA.
Throughout the past four months the HUI's 200-day MA was considered to
be the most likely place for a correction low and October-November was
considered to be the most likely time for a correction low, so a
multi-month bottom could be close in terms of both price and time.
However, with the fundamental backdrop now slightly bearish for gold, the
gold mining indices/ETFs currently not 'oversold' on a short-term basis,
the HUI/gold ratio having broken well below its 150-day MA (the green line
on the above chart) and no evidence of a price reversal, the short-term
risk is too high to justify buying for a trade.
Note that a bounce
within the context of a continuing short-term downward trend could last up
to eight trading days and boost the HUI to as high as the 330s, but in the
absence of a significant fundamental change we would be sceptical about
the sustainability of any bounce that began from near the current level.
Also note that it could make sense to add some exposure to the gold
mining sector if a) the HUI spikes down to the mid-280s within the next
few days, b) you currently don't have much exposure to the gold sector and
c) you are prepared to hold for at least 6 months. However, a point we've
been emphasising is that within the commodity realm, gold is not the best
place to be at the moment and probably won't be the best place to be
during the first half of 2021. In particular, the industrial metals have
been outperforming gold since April and probably will continue to do so,
with multi-week corrections along the way, for at least another six
months.
The Currency Market
Via a sequence
of small daily declines, the Dollar Index (DX) has moved back down to near
its lows of the past few months. As previously mentioned, the potential
for a rebound to the 96-98 range will remain until/unless the DX ends a
week below 91.75.
Updates on Stock Selections
Notes: To review the complete list of current TSI stock selections, logon at
http://www.speculative-investor.com/new/market_logon.asp
and then click on "Stock Selections" in the menu. When at the Stock
Selections page, click on a stock's symbol to bring-up an archive of
our comments on the stock in question.
Chart Sources
Charts appearing in today's commentary
are courtesy of:
https://stockcharts.com/
http://www.goldchartsrus.com/
