The Season for Rotation

When winter morphs into spring, the risk-on/risk-off trade seems to flip-flop. In late winter 2006-07, a strong rally gave way to a short but sharp 6% decline in the S&P 500. But in the 2007-08 and 2008-09 periods, it was the opposite. Heavy selling gave way in mid-March to rip-roaring rallies of +15%.

Over the past few years, while the U.S. equity markets have in typical cyclical bull market mode, buying once again has given way to selling. In 2009-10, the January selloff shaved nearly 9% off the S&P 500 in a few weeks, and in 2010-11, a February selloff of 7% set up the mid-March lows.

All students of statistical analysis understand that five-for-five means very little from a purely inferential viewpoint, notwithstanding what trading-desk sales traders and sell-side analysts claim. However, when this track record is combined with underlying deteriorating technicals and important divergences, it can mean a whole lot more. The contributors here at Real Money Pro have done a fine job of pointing out the many non-confirmations and divergences that have been generated over the past several days, especially in the equity markets.

We are now seeing many of these divergences pop up in the other risk-on markets, such as currencies and metals. In recent days, silver and copper have confirmed upside exhaustion DeMark signals, along with "price-flips," which are simply additional signals that confirm the potential change in trend. Below is a DeMark silver study.

TD Silver Daily

Bloomberg

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Last week, silver experienced another massive outside down day, much like the one in August of last year.

Silver ETF Daily

Bloomberg

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Over in the gold market, hedge-hoggers' incessant chatter of getting long in recent weeks is being borne out in futures positioning reports provided by the Commodities Futures Trading Commission. Speculative longs are now back to levels that prevailed back in the summer of 2011. When the hoggers start trumpeting their best ideas, all I can advise is caveat emptor.

CFTC Gold

Bloomberg

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Speaking of precious metals, copper has certainly acted like one over the past several years. The speculative shorts have now been run out of this market as well, as positioning is neutral. In fact, speculators now hold more longs than the average of the past 52 weeks.

Finally, over in the euro currency pits, the commercial traders have finally begun to distribute their massive long position to the disgruntled bears who are running for cover. The euro rallied more than eight handles from its recent low over the past few months, and apparently the last few percent have finally inflicted enough pain on the specs to cause the first serious bout of covering. The euro will now likely trade in a narrow range between 1.300 and 1.3500 until another upside attempt commences.

CFTC Euro

Bloomberg

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While speculators have rotated away from several risk-on trades, they have entered into fresh bets on others. Longs had already built positions to record levels in the unleaded gasoline market, but in recent weeks we have now seen a surge into the West Texas Intermediate oil futures as well. Speculative long positions have increased by 33% in just the past few weeks, and are approaching the record highs of one year ago. Prices were able to grind higher for another month in 2011, reaching a peak of $115 in April. Is this another case of déjà vu? I believe so, as another $0.10 to $0.15 added to the current pump price of gas will cause consumer spending to stall into the summer, especially given the extremely warm winter here in the Northeast.

CFTC Oil

Bloomberg

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Global stock markets are throwing off many warning signs of an imminent trading top, one that could morph into something more significant, as in 2010 and 2011. Other risk-on markets are coming off the boil in ways eerily reminiscent of the past few years, while crude is running up in yet another speculative run. The evidence is sufficient for me to become extra cautious (I know -- hard to believe!) and turn my sights to the short side of the market. As usual, the equity indices will make life difficult for both bulls and bears, with greater opportunity found among the individual issues rather than the broad market.

At the time of publication, Casa was long SPY puts.