We are seeing some amazing imbalances in the markets. I don't remember so many different asset classes being this heavily shorted or hedged by large commercials, all at the same time. Don't get me wrong, to rise and fall together is fairly normal now. It is the extremes we are reaching that is amazing. The red line on the charts show commercial long positions minus short positions in the various futures instruments. The more net short they get, the lower the red line goes. Notice how the price (which is the blue line), usually turns down when the red line gets too far down. The bottom right chart is of the US dollar which is moving counter to everything else. These are not the only heavily shorted commodities. These charts have 5 years of data.
These big traders are registered as commercials by the Commodity Futures Trading Commission because they are in the business, either as growers or users of the underlying commodity. Normally they have a very accurate track record when it comes to forecasting prices.
They seem to be selling to lock in these high prices.
Click image to enlarge
We are seeing warning flags, that seem to be saying that Bernanke's inflation gambit is a bluff. Are they sending us useful signals? Does what the position in corn or beans mean anything to the price of equities? Do the cycles offer any clues of what to expect? Lets see.
The last time I looked at the stock market I warned that a sizable short squeeze should occur. Please see "Are the stock bears doomed". The subsequent ramp up has done a serious injustice to the bears.
What are the cycles saying now
In the chart below you see a chart of the SPY (S&P 500 exchange traded fund). On it I have marked the 4 month cycle that typically dominates the smaller cycles. As you see we are due for a low within the nextfew weeks. You will also notice that unless there is crash, it will be higher than the last 4 month low we made in July. Notice too that we have gone up for 3 and 1/2 months. If you look back on the chart you will see this is typical of bull markets. It is called late translation and it signals that the larger trends or cycles, the ones bigger than the 4 month trading cycle, are going up as well. The result is represented by the orange envelope.
Also notice that the low we made in July was lower than the two previous 4 month trading cycle lows. That is indicative of a larger cycle influencing the4 monthtrading cycle. I am making the assumption that it was the 1 year cycle low, which normally bottoms in the fall. It has not been as predictable as the 4 month cyclebut several other markets such as the metals bottomed at the same time, so I am attaching some importance to it.
Click image to enlarge
The things we can take from looking at the price motion is:
1) We have gone late translation in this rally and are due for a 4 month trading cycle low soon.
2) Where and when the next 4 month low is made will tell us a lot about the bigger trends (orange channel). A higher low should give the same subsequent bullish resultsthat were seen in mid to late 2009.
3) If I am right about July being a low of longer duration (1 year), then wehave seenlate translation in that cycle as well. It topped in April and only fell for 2 months. The July low has also come in much higher than the crash low of 2008, that means the sum of all trends longer than 1 year are going up as well. Although I didn't draw it in, you can visualize a larger envelope connecting the lows of 2008 and July 2010 and it is going up as well.
There are conflicting signals
Just about every asset is stretched to the upside and the large commercial users of those products are making bets that there will be lower prices ahead.
At the same time, the late translation we see in both the 4 month and the 1 year trading cycles of the stock market hints at a strong underlying current, which should provide lift into the new year.
The 4 month low is not in yet and we can still break hard to the downside in the next 2 weeks. Also there is always the chance that we go from late translation in this 4 month cycle, to early translation in the next. Although it is rare, it is not impossible and I will be watching for it.
The imbalance we are seeing in all assets except real estate are waving a yellow flag, so we need to stay vigilant.
Bottom line
Is a stock market crash imminent? The next couple of weeks leading up to the Fed meeting and the election will be very telling.
If we get past the coming 4 month trading cycle low without a large dislocation to the downside, then as it currently presents itself, the cyclical model says the stock market looks like it will continue to be strong into next year.
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