Investor appetite for risk is what drives markets higher as that appetite increases and lower as that appetite decreases.  One of the best measures of investor appetite for risk is the performance of high yield bonds in relation to U.S. Treasuries.  This spread shows a very close correlation to the performance of the S&P 500 and its behavior over the short term can actually help determine if a pullback is merely corrective or if it signifies something deeper.   

The chart below shows a spread between the iShares High Yield Bond ETF (HYG) and the Lehman 7-10 Year Treasury Bond ETF (IEF).  When the black line is rising, that means that high yield bonds are seeing more inflows than treasuries (bullish).  When the black line is falling, that means that treasuries are seeing more inflows than high yield bonds (bearish).  The S&P 500 index is also plotted (the red line).

Notice the high correlation between the spread and the S&P 500 over the last three years as the spread and the S&P 500 tend to peak and trough at roughly the same time.  There were instances, however, where the spread diverged from the S&P 500, and was in fact a leading indicator.  Notice in the chart below how the HYG:IEF spread bottomed in December 2009, a full three months before equities, showing that investors were beginning to move back into riskier assets.  Now take a look at late April 2010 toward the right side of the chart.  The spread made a double top formation as the S&P 500 pushed out to its late April high.  That was a negative divergence that showed risk flows were not supportive of the final push to the April high. 



Now let's take a closeup look at the current time frame and see what the relationship is telling us. 

First notice in the chart below how the spread began to break down in January 2010, before the S&P 500 began its sharp decline.  Now take a look at the May bottom.  The spread actually bottomed in mid May while equities continued to sell off.  That showed solid inflows into high yield bonds vs. treasuries which meant that investors were willing to take on higher amounts of risk - a good sign for equities.  A sharp rally followed.  Finally, take a look at the right side of the chart below.  Notice how the spread has broken out to a new high, showing that risk flows are still favorable in the market.  That bodes well for continued strength in equities over the near term. 



I am anything but a perma-bull on this market, but when the markets speak, we need to listen.

        

Gold mining stocks have been mired in an ugly slide, losing over 12% from their June 18 closing high.  The unwinding of risk averse trades is being credited with the decline in gold and the gold miners.  Much of that thought is predicated on the sanguine view over European debt and the 'stress tests' recently completed on the European banks.  Anyone with half a brain knows that those stress tests were nothing more than cheap propaganda pieces meant to deceive investors into believing that the worst has indeed passed.  If things are all of a sudden so rosy, why are Euribor rates continuing to tighten?  Something is up here and I think we are a long way from the end of risk aversion, in fact, we are still in the early stages.  Risk aversion may return to this market much sooner than many polly-annas want to think, and the gold miners look ready for some fresh inflows.

First let's take a look at the GDX, pr Market Vectors Gold Miners Index.  In my work, I try to analyze markets in much different ways than simply throwing a basic momentum indicator and/or volume on a chart and making a call.  In the chart below, I have two plots below price that I am sure many of you are not used to seeing.  First, we will take a long term look at GDX with these indicators to give you a better idea of how they function. 

In the middle pane, I have plotted what is best described as an On Balance Volume type of indicator that is computed using the top ten weighted stocks in GDX.  Each day the closing price of each of the ten stocks is analyzed.  If the stock closed higher on the day, that stock's volume is added to the positive volume column.  If the stock closed lower on the day, that stock's volume is added to the negative column.  A percentage of positive volume to total volume for the day is then computed.  Since the resulting data stream can be rather choppy and unusable in its raw form from day to day, I smoothed the data stream with a ten day moving average. The indicator is simple to interpret since the calculation provides a normalized scale of 0 - 100.  Typically when this indicator reaches 70 and above, positive volume has reached a short term peak and a price pullback is due.  Typically when it dips down to 30 or below, positive volume is ready to flow back into the market, providing at least a short term bounce. 

In the bottom pane I have plotted a 'z-score' of the price of GDX relative to its 40 day moving average.  That is, how many standard deviations did the price close above or below GDX's 40 day moving average?  The standard deviation is computed over the last forty days as well, so it sees slight changes daily along with the moving average.  When using standard deviation, 70% of the price action should be within the range of 1 to -1 standard deviations, while 95% or price values should fall within a range of 2 to -2 standard deviations.  We are looking to exploit those rare situations where price moves outside the range of 2 to -2 standard deviations.  This provides trading opportunities as price reverts back to its statistical mean.   

When looking at the chart, you will notice three things.    First, when the Positive Volume Indicator peaks over 70, that usually coincides with short term peaks in price (dashed lines).  Second, when the Positive Volume Indicator falls below 30, a bounce follows (circled).  Third, when the Standard Deviation Indicator falls below -2 a short term bounce follows (circled).  



Now we will zoom in and look at the current situation of GDX in relation to these indicators.  

Notice in the chart of GDX below how the Positive Volume Indicator is showing positive volume flows into the top GDX weighted stocks even as the price of GDX itself continued to fall.  This creates a bullish divergence between the indicator and the price of GDX.  Next, notice how the Standard Deviation Indicator closed at -2.04 on July 27 before bouncing higher on Wednesday, July 28.  Both of these indicators are saying that a bounce is due in GDX. 




Will this be enough to get the uptrend moving again?  The conviction of new buyers needs to be measured with volume totals.  If volume increases on an upward push, it is a pretty safe bet that GDX will move sharply higher from here.  For those of you who are looking for higher prices based on some form of fundamental analysis, this statistical evidence backs up your claim.  If the bloom really begins to fade from the European rose and the euro begins to crack again, this could simply be the beginning of a very large move. 

        

With all of the hoopla surrounding the recent rally in crude oil prices, such as the excitement and bullish implications of spot crude hitting its highest price in three weeks it is time for a bit of a reality check.  With the U.S. economy in continuing decline as evidenced by moribund housing and employment numbers, there is little reason to be a perma bull based on U.S. Demand.  Those that insist on taking the bullish slant look to China as the godfather of consumption, but cracks are beginning to show  in China's economic situation.  Besides - does the Shanghai Composite (down 22% for the year) have the look of a world economic leader?   Weakness in the Shanghai Composite has been evident since its August 2009 top:



Next let's have a look at one of my favorite charts that shows the performance of XLE vs. the S&P 500.  Many equity traders use energy stocks as proxies for the crude oil market.  If the price of crude is expected to rise, traders buy the stocks of companies who would benefit most from the rise (energy companies).  The same is true of gold and gold stocks. 

When the black line is rising, energy stocks are outperforming the S&P 500.  When the black line is falling, energy stocks are underperforming the S&P 500.  The red dashed line plotted on the chart is the price of West Texas Intermediate Crude Oil.  Notice the very strong correlation between the two lines from 2005 to the 2008 top.  During the 2008 meltdown there was an obvious disconnect as all financial markets were rattled to the core.   The correlation reasserted itself in the spring of 2009, but so far in 2010 there has been a troubling divergence as the XLE;SPY spread has headed south while crude oil prices continue to levitate. If a rally in crude oil were brewing, there would not be net outflows in energy stocks vs. the broader equity market. 



Next let's have a technical look at crude oil prices along with volume.  I find it amazing that so many pundits make predictions in the crude oil market or any other market for that matter with incomplete information.  Volume is the piece of the analysis puzzle that shows the amount of conviction behind rallies or selloffs.  Price advances on declining volume (low conviction) usually turn out to be corrective bounces and nothing more.  Notice the bearish volume pattern in the daily chart of the continuous crude oil futures contract below. 



Notice also how the common Fibonacci 61.8% retracement level is providing resistance as crude has stalled at that point following the low volume rally off of the May low.

Finally, let's have a look at the weekly chart which further confirms the bearish volume and also gives us a much clearer look at price action which allows for a simple A-B-C pattern price projection.  The principle of market symmetry governs the use of A-B-C projections in that the length of the A and C legs will be very similar.  The distance of the A leg is subtracted from the top of the B leg to give the ultimate C leg target.  In this example, the length of the A leg is subtracted from the top of the B leg to give the C leg target (see chart for calculation).   Also notice on the weekly chart how volume has declined during the push off of the May low.  This again shows a lack of conviction among participants.



I have tremendous respect for the pit traders that do this for a living.  If there is no conviction among those that know this market best, why should we view it any differently?

        

The European Union is in a world of hurt right now dealing with the excesses of their member countries.  The situation in Greece has been all over the headlines during the last couple of months.  While the media has tried to stir up fear over the Greek situation, the fact of the matter is that the market has already priced in a Greek bailout.  Letting Greece go under is unthinkable at this point as the IMF and the EU are lining up with their wallets open.  Now, however,  it seems that we have a new contestant in the game of 'bailout roulette'. 

From Forbes.com - Portugal has to refinance euro5.6 billion of bonds by May 20, a day after euro8 billion ($10.8 billion) in Greek bonds matures. Some euro20 billion ($27 billion) of Portuguese debt comes due this year, most of it Treasury bills. The debt agency intends to issue debt worth up to euro10 billion ($13.4 billion) in the second quarter.

Two of the PIIGS (Greece and Portugal) have been exposed, which leaves three to go.  With Spain, Italy, and Ireland lined up next, prospects look bleak indeed for the Euro over the intermediate term.  The EU will have to keep the printing presses rolling 24/7 just to keep multiple governments solvent. 

The chart of the Euro/FX Composite below shows just how weak the Euro is.  Notice first how price has declined sharply from its November 2009 high as sovereign debt issues have emerged.  The 14 period Relative Strength Index (a momentum indicator - in the middle pane) showed a positive divergence from February into March.  While price made a lower low, the RSI did not.  That usually forecasts a spirited bounce which clears out the weak shorts.  The Euro couldn't even muster that, which is a testament to its weakness.  

Next notice the broad consolidation pattern that has been in place since February.  The best that the Euro could do was chop sideways following the steep two moth decline.  The volume MACD (a representation of volume momentum - in the bottom pane) has been heading south which means that this consolidation pattern is close to resolving itself - but which way?  For a hint as to which way it will go, take a look at the price pattern which is shown by the two red lines on the price plot.  These lines show a support area in the 1.32 - 1.33 area along with a pattern of two descending tops.  This is known as a descending triangle which is a pattern that is common before down side breakouts.  As price has tried to rally each time off of the support area, upside momentum is weak and volume is declining, not good signs for the bulls.

   
Next let's have a look at a monthly chart of the Euro to see where support may be found should a downside break occur.  In the chart below, notice that the Euro has been in an up trend since 2001.  By connecting the bottoms along the way, an up trend line can be constructed which has acted as support in the past.  A break below this long term line is confirmation that sentiment toward the Euro has changed.  Right now that line is at the 1.30 level.  Should that line break, next support can be found in the 1.17 - 1.23 area as demonstrated by the congestion area shaded in yellow on the chart.  This is a zone where buyers and sellers have wrestled for control twice in the past and each time the bulls have won.   If that level gives way, there is very little standing between the price of the Euro and par with the U.S. Dollar. 



For those of you who have never taken the time to learn or appreciate the discipline of technical analysis - this presentation is not suggesting to short the Euro here.  The table is set for a decline, but any new Euro shorts should not be considered unless 1.32 gives way on accelerating volume.  This would show that sellers are in control and want to drive the Euro lower. 

        

With all of the attention given to gold and crude oil recently, it is now time to take a look at the gold miners.  There seems to be a lot of bullish sentiment toward the miners simply because they have exhibited slight outperformance over gold since January and also because a majority of their stocks are in uptrends along with the rest of the market.   Let's take a closer look at GDX and see what the charts say. 

The first chart of GDX below shows a number of factors that support the case that a short term top is in.  Every market or security normally has ebbs and flows between buyers and sellers.  This rhythm allows an analyst to project time frames in which a reversal is likely to occur.  When multiple time projections cluster together, that produces a high probability date for a turn.  Notice at the top of the chart how three different time projections point to April 12 as a possible turning point, which so far is right on the money.  These time projections were created measuring the duration of prior swings in the price action of GDX.  Anyone who would like a deeper explanation can send me an e-mail and I will be happy to explain it further.

Next in the same chart, notice how multiple resistance levels are coming into play in the 48.66 - 49.59 area.  This is an area where selling has picked up, turning the price lower.  The most important level in that group is 49.32 which is a 61.8% retracement of the December - February decline.  Finally, notice how choppy the 'rally' has been off of the February low.  Price has labored to move higher as the five waves (A-B-C-D-E) overlap each other.  This type of chop and churn is common during corrective phases. 

Next, let's take a look at GDX from another price pattern perspective.  You will notice in the chart of GDX below that I have plotted a momentum indicator (MACD) as an overlay on top of  volume.  This gives a very clear picture of the volume momentum or buying/selling power exerted by market participants.  The 'normal' volume bars are also plotted in the same window in light gray. 

One thing that has not been widely acknowledged by the gold share bulls is the obvious head and shoulders chart pattern that formed from September 2009 to January 2010, which is a very reliable reversal pattern.  Please bear with me as I explain the pattern for those who are interested.  It starts when price makes a new high for the move  - this formed the 'left shoulder' in October 2009.  Following that high, price corrected down to its late October 2009 low with a solid jump in volume momentum (the volume MACD).  This showed that profit takers were beginning to head for the exits in increasing numbers.  Selling pressure then eased, allowing price to push out to a new high - the 'head' - which was formed in December 2009.  Notice how on the push to the new high, volume momentum only reached the same level as the October 2009 correction.  This signaled that sellers were becoming a viable force in the battle for the direction of GDX.    Following the formation of the December high, another correction developed which pushed price down to its mid December low.  The October 2009 low and the December 2009 low can be connected which forms the 'neckline' of the pattern.  That is the line that, when crossed, gives a signal that the up move is essentially over.  Price then rallied one last time, falling short of the December 2009 high as buyers exhausted themselves, which formed the 'right shoulder'.  Notice how volume momentum (the MACD) was very weak on the push higher to form the right shoulder. 

The head and shoulders pattern uses price projections to compute downside targets.  In this case, measuring from the top of the head (55.40) to the neckline (43.25) gives a value of 12.15.  Now project 12.15 down from the 'break' of the neckline (46.85).  That gives a target price of 34.70. 

FInally, take a look at the developing volume pattern which is not good news for the bulls.  Notice how strong volume momentum (the MACD) was on the selloff into the February 5 low, and how anemic it was on the corrective push higher off of the February low as price chopped higher.  This is an indication that sellers are taking control of the action.

Beware of those that are saying now is the time to buy mining stocks.  As I outlined in earlier articles, gold and crude oil are ready for nice declines over the near term which will allow for better price entry when their up trends resume.  Gold miners are in that group as well. 

        

There is much excitement in the perma bull camp for gold these days as gold has rallied 7% over the last couple of weeks.  A closer examination, however, shows that the rally is nothing to get too excited about.  In the chart of GLD below, there are two series plotted under price.  The first is 21 day intra day intensity which is a price/volume based momentum oscillator.  Readings above zero are positive (generally bullish) for GLD and readings below zero are negative (generally bearish).  Notice how the 21 day intra day intensity dipped well below the zero line in late March and has just now crossed above zero while the price of GLD is attacking its January 11 high.  In fact, Intraday Intensity is still in a downtrend that was started at the December high in GLD.   This shows a lack of conviction on the part of buyers in GLD.  Under Intraday Intensity is a plot of normalized volume.  In this case, volume is normalized over a 50 day period which means that each day's volume is divided by its 50 day moving average.  That puts the daily volume on a scale where 100 equals 100% of the 50 day moving average of volume.  This means that readings over 100 are above average and readings below 100 are below average which makes volume readings easier to interpret.  Notice how volume has  been unimpressive during this two week rally phase.  In fact, as price reached the January 11 high, volume came in around average.  Not the type of conviction one would like to see in a market that is trying to break through resistance. 



To gain a deeper perspective, let's take a look at GLD in relation to the two major world currencies.  The chart below contains a price plot of GLD (the red line) along with a GLD US Dollar spread (the black line) and a GLD:Euro spread (the blue line).  Notice how GLD has pushed up to its January 11 high, it has broken out to new highs against the Euro (the blue line).  Also notice how GLD is lagging vs. the dollar (the black line).  This says that investors have been dumping the Euro to hold gold since the Greek debt crisis deepened in early February.  Notice how the price of gold is stable in dollar terms, remaining rangebound since January of 2010.  As the EU and IMF fire up the printing press to bail out Greece's incompetent leadership, fears will ease further and the markets will await the next sovereign debt crisis, which will cause a flow away from the safe haven of gold - for now.   



In the future, gold will rocket out to new highs as multiple sovereign debt crises challenge the very fiat currency system on which the world economy is based.  It is just not time yet.  There is still farther to go in the equity rally as the printing presses continue to run 24/7 around the globe and free capital is pumped into the markets.  It is just a matter of time, however, before the greed and incompetence of global leadership will bring gold to the forefront as the tangible investment of choice. 

        

On March 31, I posted a story about how the Nasdaq Advance/Decline Oscillator was predicting weakness.  The reason for using this oscillator is because it uses advance/decline data one step removed from price and volume action itself.  It allows an objective look at broad market data in relation to the price of the index.  As has been the case all too often during this liquidity driven up trend, buyers have swooped in at the first sign of weakness to push the indices higher, however there still has been no discernable improvement in the Nasdaq Advance/Decline Oscillator as price has appreciated.   Notice how the Nasdaq oscillator has made a lower high over the last few days and looks ready to turn lower here. 



Now let's take a look at the S&P 500 along with the broadly used NYSE Advance/Decline line.  In the chart below, the price of the S&P is plotted in the top pane while the NYSE Advance/Decline line is plotted in the bottom pane along with its 30 day moving average ( the red line).  Notice how as price moves higher, the advance/decline line moves higher along with it.   In effect, the A/D line is confirming the market trend.

 

Now if we take a look at the A/D line in a slightly different light, it is predicting that a pullback is ready to unfold.  The chart of the S&P 500 below has the same plots of price and the A/D line, but now I have added a momentum plot of the A/D line in the middle window.  The histogram plot is simply the difference between the A/D line and its 30 day moving average.  This, in effect, normalizes the A/D line over a 30 trading day period, which gives us a deeper look into the momentum of the A/D line.  Notice in the past how the histogram did not make higher highs along with price.  This was an indication that market internals were losing upside momentum.  This meant that there was less support for an up move in prices as reflected by market internals.  Now notice how the A/D histogram  has recently made a much lower high while price has pushed out to new highs.   



Now - for you Jim Cramer following perma-bulls out there, I am not calling for a major top here - not yet.  I am merely calling for a correction.  Could a major top develop here?  Absolutely, but one step at a time.  Even the most important tops start with simple corrections.  Once the correction develops, let's see how the selling progresses.  Patience is warranted as this rally grinds on.  It is time to lighten up on longs, but it is not yet time to short.   

 

        

Yes, crude oil hit its highest price level since October 2008 on Thursday, but it is still rangebound.  How can this be?  The chart below shows that crude oil is now merely back to the top end of its six month old range.  Yes the range bound pattern has the definition of an uptrend with higher highs and higher lows posted along the way, but this is about as benign as an uptrend can be and still be labeled as such .  All of those out there celebrating Friday's jobs report as further evidence of 'economic expansion' could be in for a major surprise if crude oil does what it has done the last two times it has traded at this level.  Notice in the chart below how the price of crude has been in a gently up sloping range since last October, hardly the look of a market ready to explode to $100 as many have predicted.  Also take a look at the ten period stochastic in the bottom pane.  That shows once again that momentum has been flagging on this last push to the upper end of the range. 



Not only is crude oil at the top of its range on suspect momentum, but the commitment of traders data shows large speculators near the same level that prompted selling in October 2009 and January 2010.  When speculative levels get this high, it means that most of the buying for the move has already occurred, leaving the door open for a move to the bottom of the range.



Also - let's consider the price of crude oil in dollar terms, which is fair since the West Texas Intermediate futures contract is priced in dollars.  Recent dollar strength has eroded the value of crude oil.  Even though it moved out to a 17 month high in pure price terms, it has not even broken out to a new 2010 high in dollar pricing terms.  Below is a spread chart of crude oil and the dollar.  When the black line is rising, crude oil is rising in price relative to the dollar.  When it is falling, crude oil is less valuable in relation to the dollar.  Notice how crude oil has made lower highs since October 2009.  



Finally, let's take a look at a chart I have presented more than once of late.  It contains a spread between U.S. energy stocks (XLE) and the S&P 500 (this is the black line).  The price of crude oil is also plotted (the red line).  When energy stocks are leading the broader market (a rising black line), that is good for the price of crude oil since energy stocks are, in effect, leveraged bets on the direction of crude oil, which means that market participants are expecting higher crude oil prices.  When the black line is falling, that means that energy stocks are underperforming the broader market, which usually coincides with a weaker crude oil market.  Notice lately how the divergence between the price of crude oil and the XLE/SPYspread has not narrowed.  Even the dead cat bounce of the energy stocks last week is not enough to fool savvy investors into biting on this 'rally'.




So while many out there are calling for an upside explosion that seems inevitable, once again I am urging crude oil bulls to keep their powder dry for now.  For this to be such a slam dunk trade, there are many issues underneath the market that warrant closer attention.






 

        

To show just how disjointed the signals given by the market have been, today's entry is almost contradictory to yesterday's piece regarding copper confirming the high in equities.  For months, this rally has shown weakness in two key technical areas, volume and momentum.  Volume is normally necessary to push price higher as buyers come in and create an imbalance in the market, pushing the bid prices higher.  I say 'normally' because healthy volume patterns have not been necessary in this rally with the continued grind higher.  Good momentum shows that price is moving with strength relative to where it has been in the past. 

Today's chart of the Nasdaq Composite shows the index plotted with the Nasdaq Advance/Decline Oscillator.  It is a good oscillator to use because it is not based on Nasdaq price momentum, but on Nasdaq advance/decline data.  This is an oscillator that I have shown in the past, and now it is flashing a very troublesome signal.  In the chart below, I have marked peaks in the oscillator with a vertical dashed line.  Peaks in the oscillator show that market internals are not supporting further upside movement until a correction of some sort unfolds.  That correction could be either a selloff or a simple chop sideways.    

The oscillator peaked on march 10 and is now heading south while the price of the Nasdaq levitates near its high.  This type of action is bearish as price seems to have nothing but air underneath it.  Think of the coyote in the old road runner cartoons taking that one last step off of the edge of the cliff.  He is suspended in mid air for a moment as he realizes his mistake but by then it is too late.  Could the market be setting up for a 'coyote ugly' moment?  Watch this week's jobs report.  The equity market is closed on Friday, so Monday could be a very interesting day indeed. 

        

One of the best confirmatory indicators in equities over the years has been the price of copper.  Both equities and copper need the prospect of good economic health to move higher.  Equities need the prospect of growing earnings due to economic expansion, and copper needs the prospect of solid demand for electronics and home construction to increase the bid for its price. 

Notice the high correlation between copper (the black line) and the S&P 500 (red line).  Copper actually rallied into the summer of 2008, but once copper broke down in the fall, equities crumbled also.  Also notice how copper bottomed in December 2008 and made a higher low in March 2009 - a divergence that forecast higher equity prices.  Now that copper has confirmed the latest high in the S&P 500, higher prices can be expected which puts the S&P on target for its 1240 target which was projected by last years inverse head & shoulders pattern. 




There has been much debate over the source and sustainability of this economic recovery, and as most of my readers already know, I have been skeptical of this whole scenario while participating in this rally as equities continue to grind higher.  For now, however, the markets are saying that there is more upside to come.  As the Fed keeps the printing press humming and foreign governments continue to also have an accommodative stance on money supply, the riskier asset classes should benefit as the surplus capital looks for a home.  Equities are more appealing than government paper due to low yields which is a by product of easy money. 

Watch interest rates here.  If the ten year note yield reaches 4%, that could provide competition for funds flowing into equities.  Thirty year bond rates are breaking up through resistance at 4.75%, and now have an upside target of 5.25%.  The Fed has been doing its best to hold rates low with their open market purchases of U.S. debt, yet there has been upward pressure on rates since last fall.  If the ascent can not be contained, the investing landscape could change in a hurry.  There is enough momentum in this market to get the Dow to at least 11,000 and the S&P to at least 1200, but after that, we need to watch interest rates very closely.  
   


The bottom line here is that the trend in equities is up.  Fighting the Fed and the printing press is a fool's game, but if the mighty Fed can not contain interest rates, what then?  What is the tipping point with regard to equities and interest rates?  Only the market knows for sure.