Deep thoughts

There's a lot on my mind so buckle up...this is going to be a long post. Readers of this blog know my LT bullish stance on the market and by LT I'm talking about the up cycle that began in March 2009 which I believe has yet to run it's course. Coming into the year I said to expect to see a consolidation phase and so far this is what looks to be playing out here. The US markets are pretty much flat for the year while the TSX is actually down 4%. But could this be more than a consolidation? Now, let me call a spade a spade. There's clearly a change in character in the market. The downside we've been seeing since the market peaked in May feels a lot different than the dips before that. It's been gradual, yet relentless. Anytime the market hits ST overbought readings it handles them poorly by falling apart quickly. This is not like the action we saw from September to May whereby any downside was sharp but rather quickly recovered and ST overbought readings were often handled well by the market by going sideways for a few days as opposed to falling apart like it has been doing lately. So, what does this mean? It means that the market is either in full blown correction mode or bear mode. Last summer we saw similar action. Even as a bull you must respect this change in character. It means that you have to be on the defensive now and only cherry pick the best of any long opportunity that you see out there while keeping a heft cash reserve until you see the "whites of their eyes" type of despair and a fully sold out market that would mark a bottom. We are seeing lots of doom and gloom out there no doubt, but we haven't seen panic and I think that's what's missing here. Just look at the VIX....it's still too low to indicate we've seen some sort of crescendo in fear.

I said it before, I think the market is going to break well known support levels and moving averages, in particular, the 200 DMA to flush out the last remaining weak holders and truly convince a lot of people the LT trend has changed to bull to bear. Remember, most people out there are traders now....they no longer believe in buy and hold (which ironically has been the best strategy to go by) so therefore, in order to make fools out of as many men as possible, Mr. Market is probably going to target the traders and their indicators. He's been doing it all throughout this bull run so far.

Now on to crude. I've been thinking a lot about it lately. The IEA's release of oil into the market is a drop in the bucket but the fact that it caused such a large drop in crude could mean 1 of 2 things. Either it's just a knee jerk reaction or there is large underlying weakness in the oil price i.e. it was heading down anyway and so any kind of bearish news like this simply accelerated the inevitable downside. It could be a bit of both but I think the latter has more to do with it. There was a ton of hot money in the form of long futures positions that chased oil earlier this year when it broke above $90. This net long position in crude is unwinding putting pressure on the price and it's still quite large. With the IT trend now decisively down for oil coupled with soft economic data we've been seeing, these liquidations are likely to continue. It's seems quite unlikely to me that this downdraft in crude will end for good until this large net long position substantially shrinks. You argue peak oil all you want...the motto of this blog takes precedent every time in my book.

There's been rumblings out there for Washington to restrict speculation in key commodities like oil for quite some time but the rumblings seem to be getting louder after oil spiked to over $100. Now that the economy is in need of further stimulus and there seems to be no other options left, what better way to do so than to try to bring down the price of oil by chasing out the speculators which would drive down the price.... and dong so wouldn't cost the government anything. Now, some people might be thinking "great, more government intervention" but to this I would say who's really intervening here? Do you think that crude oil futures speculators are adding value to the economy? Some of them are indeed needed to take the other side of the trade from hedgers such as oil producers, but thanks to the proliferation of CTA pools and hedge funds there's a lot of money flowing into commodities speculation..oh sorry I guess the proper term is "investment demand. These hot money flows are probably distorting what the price would be under more "normal" circumstances. I say probably because I know there's arguments for and against this distortion in commodities actually being true. Well, it just seems logical to me that if you have a billions of dollars worth of net long positions in any asset class, the price has to be higher then what it would be if that money wasn't there. Anyhow, the bottom line is that if the government would enact higher margin requirements for oil or some other method to choke off speculators, the price would likely drop sharply. When we see the hot money get chased out of the oil (through government action or just on it's own) the price of oil will drop further and we will see what the "real" price is. I think this would be a benefit to all. Oil producers know that too high a price is not in their best interest LT because it could harm the economy leading to a price bust (I'm not so sure though what would be the "economy choking price" of oil). Most would be happy to see oil in between $75-$90. I'm sure because that's the price where it would be not too hot and not too cold.

For me personally, I would be in favor of the government stepping into raise margin requirements for crude or somehow limit the hot money flows into them...not because I hate capitalism and I'm rooting for the government to keep up it's stimulus measures but because I believe there should be limitations in the speculation of commodities that are essential for everyone. Actually, I'm in favor for government restrictions to all forms of speculation....and I said restrictions, not elimination. Excessive speculation in any part of the financial market creates consequences for everyone either directly (like with oil which everyone uses) or indirectly (like the tech bubble bursting...not everyone bought tech stocks but the tech fallout tanked the economy which did effect everyone).

The bottom line as far as crude oil prices go is that they are vulnerable here for both financial and potential regulatory reasons. A further fall in the oil price would take away the drag of high energy price in the economy. More importantly, it creates falling inflation which would then result is China ending their tightening campaign. When the market starts to sniff out that China is just about done, it could be the eventual catalyst that powers the market to new highs. We'll just have to see what happens now won't we? For me personally, since I'm bearish on oil in the IT, I have been further reducing my energy services position and look to lighten up further on strength.

I realize that my words and actions have been quite an "about face" from what I was saying and doing before. Well, that's the way I roll. When I sense change in the market or no longer have confidence in my thesis, I will act swiftly and take swift action. I have no ego to protect nor do I have any loyalty to any of my positions or any particular side of the market. I have no problems going from super bull to a super bear or vice versa because if that's what the market suggests I do, then I should do it. Right now I feel the same way I did last year at this time which was LT bullish but IT term cautious/neutral. Although I'm bullish LT, I have a "show me" attitude towards it because the burden of proof is now on the bulls. This correction will likely be just that...a correction but I don't want be left holding the bag with a high exposure to equities (especially the way I was with energy services) if it turns out to be more than just a correction. My strategy is to wait until mostly in cash until I see either a truly sold out market with an extreme in bearish sentiment across the board or the market acting like a bull market again.