Giving the bulls the benefit of the doubt

OK, I was partially right. On Monday, I wrote that commodities were setting up for a rebound (see Commodities poised to rally?):

All of these conditions are lining up to suggest that commodities are poised to rebound. The euro, commodity sensitive currencies and gold are all at key technical support levels. As I write these words, precious metal prices are substantially in the red. Watch for signs of stabilization, or better yet, reversal on the day. If that were to happen, expect that the rotation back into cyclical sectors will continue and stock prices to continue to grind higher.

I was partly right. Gold appears to be turning around here, though it is more correlated with the safety trade than the risk trade. The chart of GLD below shows a constructive bottoming process, with overhead resistance at about the 150 level.

On the other hand, the rotation into deep cyclicals hasn't fully developed yet. Consider copper as an example. The red metal has rallied through a downtrend and seems to be consolidating sideways.

Other industrial metals remain in a downtrend, though.

And oil prices, as measured by Brent global oil price benchmark, are still in a downtrend and has not participated yet in a commodity upswing.

Though natural gas seems to march to beat of its own drummer as it staged an upside breakout, driven by positive fundamentals.

I remain constructive on the rotation into the deep cyclicals. Despite the market's freakout over Bernanke's off the cuff remarks* about the possibility that the pace of QE might be tapered, followed by a poor HSBC manufacturing PMI out of China and Japanese stocks cratering by 7% (though they are recovering as I write these words), the technicals for the cyclical trade looks intact.   Consider this relative performance chart of the Morgan Stanley Cyclical Index (CYC) against the market. These stocks held up well in light of the mini-panic over the last couple of days.

Joe Fahny wrote that he is seeing very jittery traders and signs of panic, which suggests to me that any pullback is likely to be short-lived:

Today is May 22, 2013. The general market declined by less than 1% (0.82% to be exact) and my phone has been blowing up with panic by people who are IN the market!!! My trading friends are either calling or texting me with serious worry, and even a few stories of mini “blow-ups” today. I’ve never seen anything like this in my 17 year career! God help these people when (not if) we get a serious correction.

As well, Barry Ritholz pointed out this piece of analysis from Jeff deGraaf [emphasis added]:

Jeff deGraaf, technician extraordinaire (formerly of Lehman now at Renaissance Macro Research) makes an interesting observation about the heavily overbought markets.

Last week, the S&P500 had ~93% of all stocks trading over their 200 day moving average. Normally, this degree of overbought should lead to a correction. As you can see in the inset box, it sometimes does.

However, if you are looking out a year, we see that over the past 3 instances, markets have been higher.

Is the market overbought? Yes. But these conditions constitute what my former Merrill Lynch colleague Walter Murphy termed a "good overbought" condition.

I am inclined to give the bull case the benefit of the doubt for now, though I am maintaining a risk control discipline of tight and trailing stops.



* Paul Volcker once remarked that as Fed Chairman, he was so guarded about his public remarks that if he went to a restaurant, he would say, "I'll have the steak, but that doesn't mean that I don't like the chicken or the lobster."

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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