Monday, December 6, 2010

It's Beginning To Look A Lot Like Christmas

After a chaotic trade last week, today's price action was more in line with the kind of market environment I'd expected to see this December.  After opening on a rather soft note this morning, the equity market quietly drifted higher through the session and finished essentially where it started the day.  Volume was seasonably light with about 2.9 billion shares traded on the S&P 500 as the approach of the holidays continues to draw participants from the marketplace.  Outside of the equity sphere, commodities captured the bulk of the day's volatility as crude oil, silver, and gold all traded to new intraday highs.  Much of this strength was likely due to short term momentum traders taking advantage of relatively thinly traded markets, though concerns over global currency values no doubt added to the bullish bias on the day.  Despite these concerns, Treasury bonds saw a fair bit of buying, perhaps as a hedge against equity market weakness.  To be sure, though, this was anything but a resounding shift in sentiment towards Treasuries over the intermediate term.

Of all the things that stood out to me today, the new highs in silver and gold prices were without compare.  While silver has greatly outperformed gold over the past few months, today's price action in both markets reaffirmed the speculative frenzy that has been engulfing them for some time now.  Currency devaluation concerns are certainly a contributing factor to this madness, but the scale of recent gains simply can't be fully explained by central bank policies; especially when inflation remains subdued almost everywhere.  And in those countries like China who are experiencing a pick up in inflation, the majority of this spike is food based and unlikely to remain in place for an extended period of time.  As such, the metal space now appears to be composed of a pair of quintessential momentum markets.  Markets who see moves extended simply because investors are more fearful of missing the next leg higher than they are of losing money.  Sound familiar?  It should.  This is the sort of mentality that characterized both the tech stock and housing booms and we know how those stories ended.  I fear that it may be happening once again.

But as is so often the case with bubble-like markets, it's nearly impossible to predict when the momentum will lose traction and send market prices tumbling lower.  As frequent readers know all too well, I called for short positions on the gold market to be placed back when bullion prices sat around the $1,360 level.  And while this call appeared prescient at the time as the yellow metal backed up a few percentage points, this decline has proved more shallow and less prolonged than I originally expected.  And while I'm not quite out of the trade as yet, I may very well be shaken from my position tomorrow if/when prices pop above $1,430.  This is not to say that I believe that the decline in gold prices I've been anticipating is no longer in the offing.  Rather, this will constitute an attainment of my risk tolerance limits.  This is part of the reason why I will not be flipping over to the bullish side of the coin if this occurs; there simply hasn't been a meaningful change in the near term fundamental and technical outlooks for gold (and silver). The risk of a sharp decline is growing by the day.  When that day will rear its head is the only question that remains in my mind.  But such is the dilemma when markets feed on themselves.

Looking to tomorrow, I would expect a similar trade as today's with very little economic data due out.  Consumer credit levels is the only data point of consequence and even that will likely prove a non-starter for most market participants.  As has been the case for nearly two years now, traders are expecting another reduction in credit levels ($2.5 billion decline) as U.S. consumers continue to delever their balance sheets amidst a challenging employment environment.  Other than that, we're likely to be at the mercy of the program traders for the majority of tomorrow's session, so I wouldn't be surprised to see a fair bit of intraday volatility that ultimately pushes the major equity indexes now where.  Nothing exciting, to be sure, but last week's rip higher certainly laid the foundation for a week of consolidation.

Until tomorrow.....

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