COMMODITY FUTURES FORECAST WEEKLY REPORT
The Dow Has Biggest Day
Philip Gotthelf
(January 13, 2005) The headlines claim yesterday's 61.56 point gain in the DOW was the year's biggest. Of course, the year is only two weeks old. But, a headline is a headline. The question as we head towards January 31 is whether the Dow will exceed its ending point on December 31 and signal a positive "January Effect."
For those unfamiliar with the January Effect, it postulates that January's performance reflects annual performance. Thus, if the Dow is up in January, it will close higher by year end. The degree of accuracy is questionable and the deficiency is that we cannot predict the size of the year-over-year gain. Thus, this theory/superstition should not carry any significant weight. Yet, January's performance continues carrying significant weight when traders and analysts move forward for the remaining eleven months of every year. A correction in mid summer is attributed to "a lower January." Or a year-end rally is given the same causal correlation.
For the moment, the Dow's January performance does not bode well for the year. Having begun the year above 10750, the current 10600 area is shy of the necessary advance. Further, the formation suggests a test as low as 10450 or a trading range between 10450 and 10600.
However, the overall technical complexion reflected in the daily chart implies a definitive reversal from the volatile downward channel constructed through November. When considering a 61.56 daily advance on modest news, it is not difficult to achieve a new monthly high within the next two weeks.
Fundamentally, cash is building on the sidelines. This means that funds will be forced into the market on the slightest inkling of good news. Perhaps encouraging earnings reports this week like the welcomed Apple surge will provide the catalyst for a rally. Whatever the case, the mood seems better on Wall Street.
In contrast, the broader S&P 500 seems closer to its consolidation support and may be showing a reversal flag, i.e., a bullish signal. The prior downward channel was less defined compared with the Dow and we see a fulcrum bottom or "inverted W" formation that projects to approximately 122500. The bears point out that 122500 was essentially achieved at the end of December. But the bulls report that the 122500 level is a first objective measured from the fulcrum bottom to the November breakout...about 85 points. With a retracement from 121700 to 117500, the market covered 50% and is easily ripe for a new high that would be an encouraging 129700.
The weekly picture provides a different perspective that demonstrates a breakout above a slow consolidation channel drift. We are in prime resistance territory drawn back to last quarter 2001- first quarter 2002. In fact, we have a breakout above 118000 that many believe will carry to a new interim high.
There is a consensus that July '02 through May '03 represented the consolidation bottom. With the economy improving and the Fed consistent with "measured" short-term rate increases, a betting man has odds in favor of a continuing rally. Still, volatility remains a problem, as I have been experiencing.
A pressing issue is whether President Bush's Social Security initiative will gain any traction after his inauguration. Bush says it's broken. His opponents say "It's not our problem." According to various estimates, the system, as is, does not fail until 2040/2050. By that time, most politicians will be dead or close to it. Thus, it's not their problem.
Bush isn't looking at Social Security's ultimate failure. The Bush initiative is designed to boost the stock market and create wealth for the current retiring generation...Baby Boomers. The structure of private savings has completely changed since personal pensions were put into place. The explosion in managed money and associated mutual funds evidences the shift away from government funded retirement towards private resources.
In truth, Social Security was designed upon totally shortsighted assumptions that population growth would be reliable. The dip in Generation X coupled with living expense miscalculations proves that the ultimate Ponzi scheme of taking from current workers and giving to former workers will not prevail over the long haul.
Politicians who fear the confusion over Social Security reform scream, "Who cares?" Let the next generation of politicians wrestle with the headache. Fiscal conservatives retort that young people need to privatize now...before a disaster. More importantly, the surge in cash entering stocks and bonds from the Bush plan will re-inflate pensions decimated by the recession from 2000 forward. So, the real incentive is to bring pension values back to where they were in 1999.
Will Social Security be part of Bush's inaugural speech? If it looks like there will be a turn-around in Congress in favor of Bush, I believe the bull market stage will be set. Behind closed doors, Congressmen will hear the one-two pitch for boosting stocks going into future elections. Who wants to be on the other side of a bull market program? It's like voting for higher taxes!
Strategically, March ratio spreads offer a long 1140 put at 9.70 and short two 1125 at 15.00 on the quote machine. Give or take, it's about 4.00/50 net. For calls, long March 1225 7.50 and short two 1235 at 12.50 for net 5.0 give or take. Assume 7.00 or better for the entire transaction. Much depends upon tomorrow's action. This leaves us safe on the calls up to 1252 and on the puts down to 1103. According to SPAN, the margin is about $12,500. It is not a small commitment, but if everything expires, you earn $1,700 or better which is 14% on margin up to the March expiration.
That's if nothing happens of consequence. If either call or put ratio goes into the range, there is more profit potential. The question is whether we will see increasing volatility coming into the second quarter. Much depends upon unknowns like the Iraqi elections and earnings, but I sense a cautious attitude among institutional investors for the moment. This means we can see time value erode...at least through part of February.
All That Glitters Is Gold?
After selling the April gold 450 call/put straddle with the 475 call and 425 put wings, there were sighs as prices broke below 425 to offset our $18 net premium. Gold busted the upward channel to prove it was a continuation pattern for a downside test of about 41750. Now, we see some upticks.
Measuring from the top, we have an approximate $20 decline to the consolidation and another $23 to the last support around 41750. This means that a 50% retracement brings the price to approximately 432.50. That's not good enough to give us a comfortable profit.
Ideally, we want a rally to 45000. April is even weaker, despite the assume increase in carrying costs associated with higher interest rates. If the stock market rallies, do investors really want to be in gold? If oil prices decline, is gold worth the bet? If the dollar gains strength, isn't gold going to adjust downward?
Fundamental arguments seem to favor a continuing bear trend. However, as Iraq's election draw near, momentary uncertainty can drive gold back to an assumed midpoint between $400 and $500. At least that is what we hope for.
Our silver position is more comfortable because we were able to take advantage of that momentary bullish pop that yielded excellent premiums on 900 and 925 calls. We have considerably more room to work with and less time.
Overall, silver is likely to remain range bound and not likely to break out above 72500 or crash below 62500 between now and the March expiration. Even if it did, can we see more than 92500 by then? I don't see it in the chart or fundamentals.
Is The Greenback Flat-Backed?
Just as we sold into the dollar's rally with a short March Swiss Franc, the greenback decided to roll over and retrace. What looked like a strategic entry is now a loss. The inverted "W" pattern with a bust below the 8600 test pointed to a continuing slide. I was seeking 8400 support, but prices rallied above the channel at 8550...even after penetrating the same channel on the downside. Today's bust is encouraging because it places prices back into the consolidation and provides hope that the pattern is, indeed, a continuation with 8400 support as a first objective.
Last week's revelation that Euro economies are weakening was supposed to get the greenback off its back. A consensus for lower European rates and rising U.S. rates was supposed to take the dollar higher and it did. Now, a rise in jobless claims and steady retail sales rallied 10-year notes. In turn, U.S. rates are not rising to encourage the greenback. Still, the Swiss Franc came off from its rally.
When the dollar turns with such strength and consistency, a break in the trend is usually a stall. It does not mean the trend is over. Recall my comment that when Warren Buffett goes public with his dislike for the dollar, it usually means he is buying in his short dollar position...unless his age is getting the better of him.
As we see, 10-year notes are in a lengthy and wide trading range that is forming a wedge. This has allowed us to enjoy the short option strategy. Today's rally is not likely to penetrate the consolidation range. However, there is a potential for a bust below 111'00 support as the wedge comes in.
While the 10-year rate remains static, the U.S. Dollar waits. After all, it already accomplished an impressive gain against the Euro. If this is similar to the last turn-around, we can expect a longer-term shift with the dollar making parity by the summer.
Everyone has claimed the U.S. deficits are a sure-fire indication of the greenback's decline. Until the dollar is taken out as the world's reserve currency, I do not see the potential for continuing deterioration. We'll see.
January 14, 2005
Philip Gotthelf
Commodity Futures Forecast
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