Wednesday 5/26/10 Commodity Ideas

Opening Note:
Yesterday morning the Equity markets opened near their lows for the day on a test of the February and yearly lows. While the middle portion of the day saw the stock market crawl slightly higher it was a late day rally and continuation overnight that sealed a strong rejection of these February lows. The rest of the macro market had a strong reversal led by the Equities as many markets are now displaying two days in the last week with spiky lows that could be forming reversal patterns as shorts cover temporarily and dip buyers enter the market on the pullback. This rejection was not based on a specific news item, so I believe that it is just the market showing that it is currently oversold.

I have had a cautious approach at different times over the last week, but have been proven wrong as the rallies have remained minimal and the moves lower in conjunction with the direction that I would like to be positioned. However, this rejection yesterday and into this morning is different than the other ones throughout May. The strong technical and psychological level associated with the February lows looks like it will be able to hold the market flood lower for the time being as two strong rejections are now associated with the level. I do remain bearish the overall market for the next 4 - 5 months as the weekly charts for Equities have now reversed to a bear trend, but I recommend lightening short positions for the rest of the week if you are not a long term trader. Some markets like the Australian Dollar and Nasdaq do have nice bullish double bottom and cup and handle patterns that could be taken advantage of with a little more rally, but I will only attempt a minimal long position on the strongest patterns if they come into play. I am still focused on selling rallies in supportive Commodities as I believe that this will be a short term consolidation rally prior to a lower continuation as the global debt story unravels.

Buys to Watch:

Sells to Watch:

Put on the Radar: *This is a long explanation, but I will refer to this passage going forward for reference with comments on the trade's dynamics only in the future.

Sell Copper with a Long Gold Hedge- I mentioned this idea briefly yesterday, but the trade revolves around the weekly chart for Copper. The Copper market outperformed nearly every market on the recovery since March of '09, including Equities, and this was done on a historically large amount of open interest entering the market. About a month and a half ago when I warned of weakness in the Copper and Crude Oil markets that was based on this large amount of open interest that had entered late and was holding large losing positions and in some cases adding to them despite price drops. While the Copper market has basically cleaned all of these "bad buying" longs on the short term (Crude has not finished yet) I believe that if the weekly chart caves in that there could be a much larger liquidation of the all time highs in long positions. I believe that this wipe out on the weekly Copper chart is likely dependent on Equities falling below their February lows as well, so the trade should stay on the radar for the time being until better entry is available.

The Copper market has recently acted as a strength among the overall market in relation to other Commodities. This is a strong signal if the entire macro picture was strong as well. However, I believe that Copper is incorrectly being grouped with the precious metals of Gold and Silver as a long term store of value. I have commented in the past on why Silver is different than Gold because you have to carry 63 times as much for equal value, but with Gold at $1200/oz and Copper at $3.10/lb you need roughly 6,200 times the amount of Copper to equal Gold. Copper is a resource that has an industrial value, but it is not a strongly correlated market to the precious metals as it tends to fall much harder on larger macro breaks.

Because of this relationship I believe that you can use Gold as a hedge at least on an initial short in the Copper market to have an opportunity at a large long liquidation. To get a better view of what you are looking at use Gold/Copper on a weekly chart. If you notice in late '08 and early '09 a large spike formed in the ratio between the Commodities on the larger macro break as Gold held it's value much better than Copper. As I look around at the Currencies and other "run to safety" relationships and markets like Fixed Income I notice that some of these markets are projecting moves towards similar spikes in the market while this ratio is just beginning to breakout. I believe that there is a lag in this relationship right now with a great buying opportunity on a longer term trade.

For entry on the trade I am recommend using either a 1:1 or 3:2 Gold to Copper execution ratio to equal out the contract size and recent volatility in the market. The 1:1 will provide better opportunity on a large Copper break, but will not provide as much protection. Using the daily chart for Gold/Copper I believe that an initial small position can be entered on a pullback to the 3750 level, which is above all of the trade in the ratio since last July and the long consolidation range. I recommend this as an initial position only though and not as execution for the whole trade. I will be watching the outright Copper market for the next entry level in a spot that is a preferable short in the market. Because the magnitude of this trade is dependent on a larger macro break and a longer term position please take this into consideration when executing and establishing size.

Notes:

Australian Dollar- Yesterday I provided two aggressive short entry levels for the Australian Dollar market. Both low volume entry levels worked temporarily as they stalled the market and reversed prices lower, but the uptrend for the last 24 hours was strong and continued higher through both levels. Now the Aussie has a spiky bullish reversal pattern similar to a double bottom. The breakout for the pattern is .8345 and has a projection range from .8625 to .8641. This is in contradiction to the large weekly bearish cup and handle pattern that I have the market in right now that had a projection at .8547 and a projection to .7784. While I still believe that the Aussie is going lower over the next few months I do not want to fight a strong short term bullish pattern and believe that you may actually be able to make some quick money if some short covering momentum emerges. Note: There is a low volume zone from .8342 to .8380 with larger volume resistance at .8404 that could stall a rally and possibly create a new bearish reversal in the market. I recommend waiting until after this .8404 level if you are looking to join the bullish crowd.

Bonds- Late in the day the Bonds dipped into my low volume zone from 124.29 to 125.00 with larger volume resistance to 124.19. This level held well and actually worked a bit into the early morning, but with the reversal higher in the macro market continuing into the late morning the Bonds broke below this support. Two days ago I gave a large low volume zone for the bonds between 123.01 to 123.31 that should provide some support and possibly a bullish price reversal for the market. I still have the Bonds in a weekly bullish cup and handle pattern with the breakout at 123.25 and a projection range from 133 - 134. This recent reversal has been strong though and I recommend laying off buying for the time being unless the market enters this low volume zone and you have a strong opinion.

Nasdaq Bullish Reversal, but Caution- The Nasdaq has been the strongest Index on both rallies and breaks at times in the market lately, meaning a lot of two sided volatility. However, the bullish reversal pattern is strongest in this Index right now and should have the best rally potential. The breakout level for the pattern is 1840 with a projection range from 1914.5 to 1925. Use caution on execution if you decide to play the bullish side though. The Nasdaq has a low volume area from 1845.5 to 1857.5 that could stall or reject prices. The S&P 500 also has a low volume zone from 1097 to 1105 that could stall overall market prices as well. I believe that Equities will continue lower below the February 5th lows in the coming weeks and recommend only using a minimal position if you are looking to jump on the short covering rally.