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   -- Weekly Market Update for the Week Commencing 31st March 2003

Forecast Summary

The Latest Forecast Summary (no change from previous update)

Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

Bond yields (long-term interest rates) will move below their 2002 lows during the first half of 2003.

The US stock market will move well below the October-2002 low during 2003, but a major bottom won't occur until 2004.

The Dollar commenced a bear market in July 2001 and will continue its decline during 2003 and 2004.

A bull market in gold stocks commenced in November 2000 and will continue during 2003 and 2004.

Commodity prices, as represented by the CRB Index, will rally during 2003 and 2004 with most of the upside occurring in 2004.

The message from the COT Report

In the 24th March Weekly Update we discussed some of the potentially important changes in the positions of the commercial traders (the 'smart money') and the small traders (the 'dumb money') that had recently occurred. In particular, we noted that the 18th March Commitments of Traders (COT) Report (the latest available report at that time) had revealed substantial reductions in the commercial net-short positions in gold futures, Swiss Franc futures and (strangely enough) S&P500 futures. The commitments were hence well on their way to becoming bullish for gold and the US stock market and bearish for the US$ (relative to the SF).

There were further substantial and, we think, important, changes revealed in the latest COT Report. From our perspective, the most interesting of these were:

a) Between the 18th March and 25th March (the dates of the two latest COT Reports), the gold price dropped by around $9/ounce, but there was no significant change in the commercial net-short position. There was, however, a substantial decline in the net-long position of the small traders. In fact, the net-long position of the small traders in COMEX gold futures has fallen to its lowest level since March of 2002 (see chart below). In other words, the dumb money is now less bullish on gold than it has been at any time since March of last year (when, by the way, the gold price was around $290). 

The drop in the net-long position of small traders was offset by a corresponding rise in the net-long position of the large speculators. We categorise both the commercials and the large speculators as 'smart money', so the smart money has bought gold's drop to major support while the hapless small traders appear to have once again exited at exactly the wrong time.

b) After being net-short the Swiss Franc to the tune of 37,000 contracts just 2 weeks ago and net-short by 11,000 contracts 1 week ago, the commercials are now (according to the 25th March COT Report) slightly net-long the Swiss Franc. This confirms what we said in last week's Update, that is, that the best part of the Dollar's rebound is most likely behind us.

c) The pattern of 'smart money' buying and 'dumb money' selling of S&P500 futures continued over the latest week. In last week's Update we pointed out that there had been substantial reductions in the net-short position of the commercial traders and the net-long position of small traders during the week ended 18th March. This was an unusual development because the commercials rarely buy and the small traders rarely sell when the market is rising, yet the S&P500 gained 65 points during the week in question. During the 5 trading days covered by the latest COT Report the S&P500 made only a marginal gain, but the commercials continued to buy while the small traders continued to sell. The upshot is that the commercials now have a net-long position in S&P500 futures for the first time since May of 2000 and the small traders are less bullish than they have been at any time since May of 2000 (see chart below).

The overall message from the COT Report is rather confusing from an inter-market perspective in that it is bullish for the stock market yet bearish for the US$ relative to safe-haven currencies such as the SF and gold. The COT Report is, however, just one piece of the puzzle and must be considered in conjunction with other sentiment indicators, price action and fundamentals.

The Money Supply

The US financial establishment has managed to do what its Japanese counterpart couldn't do - during the 3 years following the bursting of the US stock market bubble the US financial establishment has managed to keep the US money supply growing at a rapid rate. Another way of saying this is that the stock market bubble might have burst, but the underlying credit bubble has been kept alive. Some ramifications of this are that a) the US real estate market has remained strong throughout the trials and tribulations of the past 3 years, b) the US stock market has avoided the type of massive selling climax that would otherwise have occurred by now, c) the US current account deficit has continued to expand, d) the US$ has been weakening relative to commodities and the less-inflated fiat currencies, and e) the US economy has not experienced a severe recession.

The on-going expansion of the US money supply hasn't solved any problems, it has just ensured that even bigger problems will be faced at some future date. A few months ago it appeared as though that "future date" would almost certainly occur this year. However, the below chart reveals a recent up-tick in the CPI-adjusted money supply (M2) growth rate, so perhaps it is still too early to start writing the credit bubble's obituary.

The US Stock Market

A picture of frustration

Over the past 8 months the US stock market has been frustrating for both bulls and bears because there has been no follow-through in either direction. As the below chart shows, the S&P500 Index entered a trading range last July and since then it has simply moved back and forth within this range. Our expectation is that the top of the 8-month trading range will be tested over the coming month or so before the start of a major decline that takes the S&P500 well below the bottom of the range.

The below chart of the OEX Volatility Index (VIX) also illustrates the indecisive nature of the recent market environment. As the market has traded sideways, the implied volatility of the market as measured by the VIX has moved within a contracting range. We don't think it is appropriate to analyse the chart of a sentiment indicator such as the VIX in the same way that a stock-price chart would be analysed, but the below chart does make the point that there hasn't been a major peak or a major trough in volatility over the past several months. This, in turn, suggests that neither bulls nor bears have been able to sustain an advantage.

Current Market Situation

Below are two charts of the NASDAQ Composite Index. The first chart highlights the downward-sloping channel that has been in force over the past 2 years while the second chart zooms in on the past 6 months. 

During the week before last the NASDAQ broke upwards out of a short-term downtrend, projecting a move up to around 1550 over the coming 1-2 months. Last week it pulled back in what currently looks like a normal test of the breakout. 

If the NASDAQ can continue to hold above its former short-term downtrend during the additional consolidation that is likely to occur over the next week or two, then a subsequent move up to the 1550-1600 range will become a high probability. Note that the top of the longer-term channel shown on the first of the above charts will be at around the 1600 level at the end of April. Given the market's lousy fundamentals, the current low equity-fund cash levels and the strong likelihood that a rise of this magnitude would create almost universal belief that the bear market had ended, the probability of the NASDAQ moving beyond the top of the longer-term channel over the next few months is extremely low. A far more likely outcome is that a move to the channel top will be followed by a drop to the channel bottom. This means that if a rally to the 1550-1600 range does occur as currently expected it will likely present us with a wonderful short-selling opportunity.

Considering the news backdrop (the prospect of a drawn-out war in Iraq, the severe form of pneumonia that has broken out in some parts of the world, falling consumer confidence and the generally uninspiring economic data) it is almost inconceivable that the market will rally at all over the next few weeks. However, the news tends to follow the market, not the other way around.

At the current time the best approach for investors is to remain out of the market altogether. And, until the focus starts to shift away from Iraq and back towards the problems that caused the bear market in the first place, the best approach for most traders will also be to stay on the sidelines. We are, however, going to suggest one potential long-side speculation with a reasonable risk/reward ratio (see "Update on Stock Selections" for details).

This week's important economic/market events
 

Date Description
Monday March 31 No significant events
Tuesday April 01 ISM Index
Construction Spending
Wednesday April 02 No significant events
Thursday April 03 ISM Non-Manufacturing Index
Friday April 04 Employment Report
ECRI Future Inflation Gauge

Click here to read the rest of today's commentary

 
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