Monday, September 24, 2007

U.S. Dollar Feels Pain as Loonie Flies High

Gold soars as investors shift bets

Monday, September 24, 2007
The Montreal Gazette

All eyes were on the loonie last week as it reached parity with the U.S. dollar for the first time since 1976.

The leaping loonie has provoked squeals of pain from Canadian manufacturers and exporters, who have beseeched the Bank of Canada to lower interest rates in an attempt to slow the dollar’s ascent.

Less noticed amid the hoopla are the travails of the U.S. buck. The housing meltdown and credit crisis south of the border have sent the U.S. dollar crashing like a stone, not just against the loonie, but also other major currencies like the euro, which broke to record highs in mid-September.

Even the sickly Japanese yen has ended an 18-month downtrend against the U.S. dollar, shooting up seven percent since June.

In fact, in early September, the benchmark U.S. dollar index—a closely watched average of the U.S. currency’s value against that of six major trading partners, including Canada—closed below 80 for the first time since 1992.

Last week, the dollar index hovered a hair above its 1992 intraday low of 78.43 for much of the week, then briefly pierced that low late in the week.

The 78-to-80 zone has been a highly watched psychological level of support for the U.S. dollar for years.

Until this month, it’s acted as a kind of trampoline for the index five times since 1991. Each time this floor was touched, the dollar ended up bouncing smartly back up.

But as the U.S. Federal Reserve Board sought to resuscitate the financial system by lowering interest rates last Tuesday, that put still more downward pressure on the dollar.

One reason: lower interest rates make U.S. government bonds less attractive to foreigners. That’s a problem for the dollar because about half of the $4.4-trillion U.S. federal debt is held by non-Americans, up from a third in 2001.

Why does any of this matter, especially to Canadians?

Some analysts have argued for years that the world’s chief reserve currency is headed for a collapse as the U.S. economy suffocates under mounting housing debt.

A dollar panic could force the Fed to reverse course on interest rates and hike them back up to stem any sudden capital flight from the United States.

That, of course, could kneecap the global economy as it struggles to emerge from a liquidity crisis that has rapidly spread beyond U.S. borders to Canada and other countries.

Underlining the U.S. vulnerability, Chinese government officials last week said Beijing would sell off its $900 billion in U.S. bond holdings if Washington imposes sanctions over Chinese trade practices.

Another blow to the dollar was struck last Thursday when Saudi Arabia refused to cut its interest rates in lockstep with the U.S. for the first time, saying it didn’t want to ignite domestic inflation.

The move ignited speculation that the Gulf kingdom would break its currency’s peg to the dollar, which some analysts said could provoke a stampede out of the American buck.

The dollar’s troubles were further underscored last week by the soaring price of safe-haven gold, which hit a 28-year high above $735 U.S. an ounce.

The developments had one analyst predicting a gold mania unseen since the attempted French invasion of Britain in 1797, which sent bullion prices into orbit.

In a Times of London story last week, analyst Christopher Wood, of Hong Kong brokerage firm CLSA, said gold would quadruple to above $3,400 within three years, spurred by a U.S. dollar collapse.

But some currency and gold analysts said the apocalyptic scenarios are overblown.

“Unless we see a vicious economic contraction in the U.S., the doomsday scenario of dollar weakness is not inevitable,” said Boris Schlossberg, chief currency strategist at, a foreign exchange news website and brokerage.

U.S. Fed doctrine is to let the greenback slide when faced with economic turbulence, even if it means higher inflation, Schlossberg said from his New York office.

“That’s the bet the Fed has made for the last 25 years. The key thing central bankers have learned is if they can monetize these crashes, that’s better than deflation like we saw in the 1930s,” he said.

“People would rather see high prices than high unemployment.”

But Schlossberg said the U.S. isn’t the only country facing economic weakness, and when other countries start lowering interest rates, that will buoy the U.S. dollar. “The economic fundamentals in the Euro zone are not as sound as everyone believes,” he said.

“It’s quite likely the Euro is peaking here.”

As for the Canadian dollar, Schlossberg said it “has become the darling of the currency market. The market is telegraphing that the Canadian economy has decoupled from the U.S. economy because it’s the only safe liberal democracy that contains a huge amount of resources.”

However, Schlossberg also cautioned that the Canadian dollar has shot up too far too fast, and a decline in oil prices or further bad U.S. economic news could send it into a tailspin.

“The Canadian dollar tends to have very sharp reactions,” he said. “It is obviously, clearly, grossly overbought.”

Gold analyst Jon Nadler also doesn’t expect the doomsday scenario to unfold any time soon.

“The call for the death of the dollar is mostly premature,” sad Nadler, who works for Montreal-based bullion dealer Kitco.

“People wishing for four-digit gold (prices) should examine the reasons for their wish. (Such a scenario) means everything else we own has gone sour,” he said.

Nadler expects the greenback may fall a little further to 78.50, fueling a possible rise in gold to $775. But he cautioned anyone investing in gold to be ready for a vicious pullback. The historic post-war equilibrium price of gold is $400, he said, which means ample room to the downside.

“These markets move very fast,” he said. “The volatility can be expected to excite and disillusion.”

[AR: The published version of this story included charts of the U.S. dollar index, Canadian dollar, crude oil and gold since 1990.]

Wednesday, September 5, 2007

Is the Market Shakeup Over Yet?

After major tremors shook stock markets around the world this month, many shell-shocked participants have wondered whether the bloodied bulls will regain the upper hand and continue to take stocks higher

Montreal Gazette
Monday, August 27, 2007

Is it over? That’s the question shell-shocked investors are asking themselves after stock markets keeled over into a month-long tailspin in July and August.

The debacle slapped Toronto’s S&P/TSX composite index down 11 per cent, before it rebounded somewhat last week. Overseas markets got wounded even more, with London’s market whacked 13 per cent and Japan’s hobbled 16 per cent.

Some analysts are invoking fears of the 1987 and 1998 stock smash-ups. “From fear we’re morphing into panic,” said venerable analyst Harry Schultz, author of one of the top-rated U.S. market newsletters.

“The ‘other shoe’ will be falling for a long time, so investors should stop waiting for the markets to ‘calm down,’” he wrote in a column at

His advice: park your investments in safe havens like gold and the Swiss franc.

“Quite frankly, it looked like the markets were going to crash on Thursday (Aug. 16), led down by the absolute disaster in financial stocks,” wrote Mark Arbeter, chief technical strategist with Standard & Poor’s Equity Research.

The freaked-out talk was flamed by word of blow-ups at several large U.S. hedge funds that made risky gambles in highly leveraged computer-led trading. The funds started to bleed money when liquidity vanished in the wake of the subprime real-estate crash.

But other analysts say the fears have gotten excessive. They say while there’s a decent chance the selling is still not over, a look at the charts shows the turbulence so far is just an ordinary correction within the broad five-year uptrend that has lifted markets since 2002.

“The major trendlines are still intact, so I’m still overall bullish,” said Matt Caruso, a Montreal-based independent trader who heads the local chapter of the Canadian Society of Technical Analysts. (Technical analysis is the study of market charts to spot price trends.)

Caruso isn’t diving back into the market blindly just yet. He expects more volatility in coming weeks that could send markets spiraling back down to test the mid-August lows, and perhaps even a little lower.

But he believes those levels will likely hold up, providing an opportunity to put some money to work in the markets. “I already have a list of names (of stocks) to buy. Every pullback is another opportunity to buy,” he said.

“It’s normal to have 10-per cent corrections in the markets. There was no major technical damage to the indexes. I see higher prices to come.”

Robert Drach, a Tallahassee, Fla.-based author of a long-lived investment newsletter acclaimed for its accurate market calls, is also a bull.

His reason: corporate insiders and stock exchange members are buying stocks. That’s made Drach so bullish he said he threw all his cash into the markets and got leveraged by an additional 50 per cent on Aug. 10, at the height of the market slide.

Drach cautioned he still expects a “very choppy” market until traders calm down. “The market’s not going to move up and be wonderful,” he said.

Some analysts, however, are more uneasy. Tom Bulkowski, a Keller, Tex.-based technical analyst and author of the Encyclopedia of Chart Patterns, is in cash waiting for surer signs of a bottom.

“I tend to think we will pull back from here,” he said. “It’s just a gut feeling.”

Bulkowski’s nervousness actually flies in the face of his own chart-reading and number-crunching.

He agrees the selloff hasn’t violated any important uptrend lines.

The markets also appear to have already finished correcting based on similar drawdowns in the past he has studied.

The Dow Jones industrial average, for one, has completed a textbook example of what Bulkowski calls a pullback out of an “ascending, right-angled, broadening formation.”

Past such patterns led him to forecast the Dow would bottom at around 12,497.

In fact, it touched bottom not far away—12,456—on Aug. 16, then rebounded smartly back above 13,000 last week. That should mean the correction is over, he said.

Yet, Bulkowski isn’t breathing easier. “I’m just kind of nervous right now. I guess we’ll know in a month or so. If the (Federal Reserve) decides not to cut interest rates (at its next meeting on Sept. 18), then the markets could resume the downtrend,” he said.

Another dean of technical analysis, John Murphy, is also unnerved. Even though he feels the “worst may be over for now,” he added a note of worry in a recent market brief.

“The market will have to do a lot to repair that damage,” he said. “I suspect the recent lows will be retested at some point over the next couple of months. It’s extremely important that they hold.”

One of the concerns of some analysts is the seasonal period of weakness that often trips up markets in the fall.

“We are at a critical juncture at the very beginning of the historically weakest time of the year,” wrote Jeffrey Hirsch in the latest issue of the Stock Trader’s Almanac newsletter.

“(September) is the worst month of the year by nearly all accounts,” he said, as it is the only month with a negative average performance historically.

Hirsch also noted years ending in “7” have historically been trouble for markets, with crashes in 1907, 1937 and 1987 and nasty selloffs in 1917, 1947, 1957 and 1977.

Hirsch isn’t completely pessimistic, saying the damage so far “has not been that bad,” but he warned that a deeper credit crunch “could cause a pullback of historic proportions… So much for the summer doldrums.”

[The published version of this story was accompanied by charts of the S&P 500, TSX composite index and Nikkei average showing their uptrend lines since 2003. The caption was titled “Keeping the uptrend intact” and read: “The bull market’s five-year ride had a wild turn in recent weeks. But despite the turbulence and panicked talk, major global stock indexes all survived the correction with their uptrends intact. Analysts advise watching those uptrend lines carefully in the often-volatile autumn months to see if they hold up.”]

Things Will Get Better, Not Worse—Probably

Analysts optimistic despite dire warnings

Monday, August 13, 2007
The Montreal Gazette

Markets around the world are getting their heads caved in, and investors and analysts are in a flutter about how much worse the damage could get.

The bloodbath, stoked by the U.S. housing debacle, lopped eight per cent off the value of the Standard & Poor’s 500 index and S&P/Toronto Stock Exchange composite index in just three weeks.

Some sectors like energy stocks fared worse, with leading U.S. energy-stock indexes down 15 per cent off their late July top before rebounding a little last week.

Losses from the market rout totaled an estimated $2 trillion in the United States alone, according to data compiled by Bloomberg.

The carnage has some analysts predicting an outright stock collapse, just weeks after the major stock indexes were powering to lofty new highs.

Forbes magazine last week published an article titled The Crash of 2007, which advised readers to sell most of their investments and go sailing.

“There is a really high probability that we are in the midst of a stock market crash, the first since 2002,” the writer said.

Not so fast, says Mark Arbeter, chief market technician at S&P Equity Research in New York. It’s probably too early to tell if the correction has more to run, he said, but the worst is probably over. At least for now.

“There are times when you say, ‘I don’t know and have to wait,’” he said. “(But) I think there’s a better than 50-50 chance that we have seen the worst of this.”

Matthew Pugsley, chief U.S. equity strategist at BCA Research in Montreal, agreed. “Probably most of the damage is done,” he said. “I’m not expecting a bear market right now.”

Both analysts are cautiously optimistic for differing reasons. Arbeter studies price charts and investor sentiment to arrive at his conclusions. His read is that sentiment has gotten so bearish so quickly, it’s actually a positive sign.

This is based on the contrarian notion that the crowd is usually wrong at critical market junctures.

“I think it’s constructive that investors threw everything out at the same time,” he said. “There’s been a selling capitulation. The internals got completely annihilated. There are so many people who got negative in such a hurry here. It’s like the world was coming to an end in two weeks.”

Analyst Mark Hulbert had a similar take in a column in Barron’s last Wednesday. Hulbert tracks a long list of investment newsletters to see how negative or positive they are on the markets. His finding: the newsletters were so bearish as of last Monday, they recommended only 5.4-per-cent exposure to stocks and nearly 95 per cent of portfolios to cash.

That’s a sharp contrast to what happened after the March 2000 top of the dot-com bubble, Hulbert wrote. In the weeks that followed, newsletter editors become even more steadfastly bullish in the face of the worst market crash in decades.

“That is classic market-top behavior,” Hulbert said. “Today, in contrast, we’re not seeing anything like the stubborn bullishness that was prevalent then.”

What it means, he said, is we’re not yet at the end to the five-year bull market.

Pugsley’s optimism, in contrast, is driven by market fundamentals. He believes the economy remains solid despite the woes that hit housing. He is bullish on a longer-term basis, saying he believes stock prices will be higher in 12 months than today.

“We expected a correction,” he said. “Now that we’re in one, I don’t want to get more negative. In fact, it makes me more positive because (asset) values improve.”

However, Pugsley says the coming weeks will see continued ups and downs as investors shift their anxiety from the sub-prime mess in real estate to underachieving third-quarter corporate earnings.

“The market will shift its concern from the credit market to the economy,” he said.

Pugsley predicted equities will bounce upward a little but fail to follow through and then drop to retest their early August low, possibly even breaking to a somewhat lower point.

“But I wouldn’t expect we will have sustainable new lows, barring some exogenous shock,” he said.

Wild cards that could upset this rosy scenario, he said, include a sharp spike in crude oil prices or an inflationary shock that ratchets up interest rates.

Like Pugsley, Arbeter predicts equities indexes will waft upward, fail to gain wind and then swoon to retest their early August low.

“The retest usually scares people—including myself—to death, usually on bad news,” he said. “If the market does hold at that level, that would be bullish.”

In fact, Arbeter said sentiment has gotten so dismal, an eventual recovery could catch downbeat investors by surprise—a scenario that could see them scrambling to get back into the markets and send prices to new highs in November or December.

“Conditions exist for some kind of potential upside explosion,” he said. “(But) expect a lot of volatility near-term.”

The analysts’ overall bullishness is reinforced by data from the U.S. Commodity Futures Trading Commission, which reports on futures and options holdings of investment firms, hedge funds and commodity producers.

In June, commercial hedging firms—often known as the “smart money” because of their accuracy in calling market turns—accumulated one of their highest relative net long positions in Dow Jones industrial average futures and options since the data started in 1995.

Meanwhile, large speculators—known as the “dumb money” because they are usually positioned the wrong way in the markets—built their largest net short position in NASDAQ 100 index futures and options in two years.

However, a warning sign comes from the data for the S&P 500, where small traders (who also tend to be wrong in the markets) started to place gigantic bullish bets in mid-June. In the past, that’s usually meant the S&P 500 would fall, as it did shortly after.

[Accompanying charts for this story showed the uptrends since mid-2006 of the S&P 500, FTSE, S&P/TSX composite index and Oil Services Holders, and how they've being tested or violated during the recent correction.]

At the Mercy of the Bond Market

As the yield on the 10-year U.S. Treasury note shot up by 28 basis points in the past two weeks, its effects immediately spilled across the border by bumping up interest rates in Canada

Monday, May 28, 2007
The Montreal Gazette

Start talking about bonds with most people, and they’ll probably want a siesta.

Not Mark McClellan. He’s a bond expert at Montreal-based BCA Research, and what he sees in the bond market has him wide awake.

Bond action tends to herald what’s in store for other markets—everything from home sales to gas prices, the stock market and the Canadian dollar.

So when the yield on the trend-setting 10-year U.S. Treasury note broke out of a narrow trading range and shot up 28 basis points in the last two weeks, McClellan and lots of folks on Wall and Bay Sts. paid close attention. (A basis point is one-hundredth of a percentage point.)

“There was quite a capitulation,” McClellan said. “Technically, it was pretty impressive.”

The yield rose to just under 4.9 per cent last week, up from 4.4 per cent in December.

Lenders in the U.S. and Canada closely follow the 10-year Treasury note as they set interest rates.

The U.S. bond action immediately spilled across the border, bumping Canadian consumer interest rates higher and bond prices down. (When rates go up, bond prices fall.)

In mid-May, a key Canadian bond fund, the iUnits Canadian Bond Broad Market Index Fund, suffered a serious blow when it broke below a key psychological level of support that had buoyed its price since last October.

The question now is whether the sharp and sudden spike in interest rates is just a blip or something more worrisome.

McClellan said he’s not worried—at least, not just yet. “The market has revised up growth expectations,” he said.

Strong growth and low inflation are a positive environment for the equity market. But if people start worrying about inflation, that would change.”

In fact, far from knee-capping equities, the Treasury’s move may just mean money is pouring out of safe-haven bonds into the roaring stock market, said Mark Arbeter, chief market technician at Standard & Poor’s Equity Research in New York.

“Probably what’s happening is that money is going from bonds to stocks because of the recent advances,” said Arbeter.

“Probably it means stocks are going higher, as perverse as it sounds.”

The problem will come, he said, if interest rates keep going up.

“That would hurt equities,” said Arbeter.

He and McClellan agreed a key test will come at 4.9 per cent, the Treasury note’s previous high of last January.

The yield made a run at 4.9 per cent last week, and if it blows past that number, both analysts warned of further interest-rate rises and storm clouds for other markets.

“If it gets above 4.9 per cent, it would be a bad sign for equities,” McClellan said, saying that would suggest growing fears about inflation.

“Keep an eye on inflation expectations if it gets above 4.9,” he said.

Arbeter thinks that’s just what will happen and predicts the 10-year yield will shoot up to 5.5 per cent. He pointed to action in the futures and options markets as a sign the recent bond move may have legs.

Large commercial firms that hedge in bond derivatives turned highly bearish on the 10-year Treasury note in March. These traders, whom Arbeter calls the “smart money,” tend to time the markets with uncanny accuracy.
When they sour on a market, watch out.

Arbeter said the commercial traders’ bond holdings suggest lots of institutional money is behind the Treasury move.

The rate jump may already be translating into weakness in commodities. The price of gold, which tends to lead other commodities, suffered a breakdown in May, ending a seven-month uptrend that had shot it from $563 U.S. last October to $698 in April.

At bullion dealer Kitco, analyst Jon Nadler said sentiment is gloomy.

“The mood is bearish (for gold),” he said. “Bond yields breaking out could add to the current woes. (Gold) now looks to correct.”

Arbeter agreed that higher bond yields could inflict pain on commodities while helping revive the sickly U.S. dollar, which has nose-dived vs. the loonie since March.

“It could lead to a breakout (in the greenback) or at least to stopping the bleeding,” he said.

Alex Roslin’s market blog is at

[Accompanying charts for this story showed the breakouts in the 10-year and 30-year Treasury yields, the breakdown in the iUnits Canadian bond ETF (symbol XBB) and the recent breakdown in the gold price.]

Timing the Markets With COTs

Who says you can’t time trades using the Commitments of Traders Reports? This COTs-based mechanical system beat the NASDAQ by 728 percentage points—with only one trade needed per year.

By Alex Roslin
Technical Analysis of STOCKS & COMMODITIES
May 2007

Ever wonder what the smart money is doing in the markets? How do the folks with the best information and deepest pockets invest their wealth? A small handful of analysts and traders has found an interesting way to tell. It’s called the Commitments of Traders Report, and its devoted fans say the report is the closest thing in the public domain to a holy grail of market forecasting they’ve found.

The COTs, as they’re known in the business, don’t make headlines like those celebrities of the world of economic indicators, the Consumer Price Index (CPI) or the unemployment numbers. But a growing legion of “commitments analysts” is glued to computers each Friday at 3:30 p.m. (Eastern time) when the Commodity Futures Trading Commission releases the latest weekly COTs numbers.

The data, which used to be available only to paying subscribers but is now free, shows how many of the world’s largest commodity-producing firms, index funds, and hedge funds are positioning trillions of dollars of futures and options bets in more than 90 markets—everything from frozen pork bellies to the Standard & Poor’s 500, orange juice, the Canadian dollar, and unleaded gas.

But this treasure trove of insider information is hard to interpret and not obviously usable in its raw form. The data doesn’t appear to correlate neatly with subsequent prices in the cash markets. What’s more, analysts don’t agree on how to act on the data.

Should traders position themselves in the same direction as the commercial hedgers? Commitments analysts often call these commercial traders the “smart money” because they are presumed to have the best market information. Or should we fade the noncommercial traders—usually known as the “large speculators” or simply the “dumb money”—who are often said to be positioned the wrong way at major market turns?

Some analysts suggest the commercials and large specs are most useful to watch when they take extreme net long or short positions, which often suggests a market turn is imminent. But when is an extreme really an extreme? Varying systems of measuring the extremes produce widely varying buy and sell signals, many of which fail to make any money at all.

One popular approach is to trade with the commercials in the physical commodities like gold and crude oil while fading the large specs in the financial markets like S&P futures and Treasuries. But it’s not clear what data this approach is based on. Analysts who have devised systems to analyze the COTs won’t reveal their methodologies publicly because they are proprietary.

And even these analysts generally say their systems don’t give trading signals per se. Instead, they suggest the COTs are best used merely as an early-warning system, which must be coupled with technical analysis to time trades.

But a closer look at the data shows a trading system can indeed be devised for the COTs. The results also suggest that following the smart money isn’t always the smartest approach. We actually need to know what the dumb money is doing—the really dumb money.

Follow the Dumb Money

One group of traders often gets overlooked in discussions on the COTs—the small traders. These guys are the hedgers and speculators whose positions are too small to be included with the commercials or large specs. They are listed under the “nonreportable” category in the COTs reports.

The small traders are the truly dumb money no one seems to care much about. But they may just be too dumb to ignore. Fading the small traders when they take extreme futures and options positions appears to be the best strategy for trading the S&P 500.

A switching strategy of fading the small traders when their net percentage-of-open-interest position was two standard deviations or more from its 22-week moving average would have resulted in a 316% profit since 1995. (This is the year the CFTC first released combined futures and options data in electronic form for free.)

That result was over two times the S&P 500’s gain of 139% in the same period. In addition, fading the small traders would have required only a dozen trades—six long and six short—or about one per year, leaving lots of time to spend your profits!

The system was based on trading on the next weekly open after the signal was given. The maximum drawdown for this system was 16%. (The figures are valid as of the week of December 4, 2006, and don’t include slippage, dividends, or commissions.)

Meanwhile, fading the large speculators would have also beat the market, but not by nearly as much. The best combination appears to have been using a 208-week (four-year) moving average and fading the large specs when their net percentage position was 1.5 standard deviations or more away. That would have led to a 59% profit since June 1999, compared to an 8% gain in the S&P. (The best result came with delaying the trade until the weekly open two weeks after the signal was given.)

The large specs were clearly dumb enough to fade, but nowhere near as dumb as the small traders!

The commercial hedgers did better. They made a 230% profit since April 1998, compared to 24% for the S&P. That amounted to a 0.5% profit per week in the market—less than the 0.54% profit of the small traders. The best result for this group came from trading with the commercials when their net percentage position is one or more standard deviations from its 156-week moving average. It was most profitable to delay the trade until the weekly open three weeks after the signal was given.

NASDAQ Timing System

On the NASDAQ, the small traders didn’t do as well. Here, the large specs truly were the dumbest money around. The best result from fading them yielded a 725% profit since May 1999. During the same period, the NASDAQ lost 4%.
The large-spec gain worked out to 1.83% per week in the market, while requiring only eight trades (seven of them profitable), or slightly less than one per year. The maximum drawdown for this trade was 9%.

This trade was taken whenever the large spec net percentage position was one standard deviation or more from its 156-week moving average. The best result came from delaying the trade until the weekly open one week after a signal was given.

The next best result for the NASDAQ was a tossup between the small specs and commercials. The best return for the small specs was a 592% return since Jan. 1997 (or 1.15% per week), compared to 79% for the NASDAQ. This result came from fading the small traders when their net percentage position was 1.5 standard deviations or more from its 20-week moving average. The trade was made on the next open after a signal was given.

As for the commercials, their best result was 469% since May 1999 (or 1.18% per week), compared to a 5% NASDAQ loss. This was from trading with the commercials when their net percentage position was one or more standard deviations from its 156-week moving average and buying at the next open after a signal was given.

Conundrum Solved

The results shed fresh light on the COTs data. Clearly, each commodity has its own personality and requires a specially tailored system of optimized trading signals. Unfortunately, analysts often cite the ups and downs of the data without a good understanding of what it means.

For example, in late 2006, the COTs data for the S&P 500 was a mess of contradictory signals. Here was an important market juncture during which many analysts fretted about a possible correction to coincide with the often-turbulent fall season of the midterm year of the U.S. presidency. What was the COTs data saying at the time?

In August, the large specs seemed to be giving a colossal sell signal on the S&P 500 as they built a record net long futures and options position. The dumb money got more and more net long through the fall of 2006. But fading the large specs would have been disastrous as the S&P rallied to multi-year highs.
In fact, the most profitable large spec timing system for the S&P 500 has been on a sell signal ever since January 2005.

As for the commercial traders, the most profitable system on the S&P 500 has been on a sell since January 2006.

What to do? The answer lies with the small traders. The really dumb money gave a timely buy signal last August when it swung to a huge net short position. (As of early March, the small traders were still on a buy.)

The data has been clearer of late for the NASDAQ composite index. In late November 2006, the large specs gave a sell signal. The small traders followed suit with a sell in December, followed by a sell from the commercials in January (after the data in the accompanying chart was compiled).

But fading the large specs has given such clearly superior returns on the NASDAQ that they’re the only traders we need to follow for this index. Case closed!

Alex Roslin is an investigative journalist and active trader in Montreal. He can be reached at Watch for his COTs analysis at Thanks to Mike Gordon for his invaluable advice on Excel.

How to Build Your Own COTs Database

Want to crunch your own COTs data? It’s simple—and free. The hardest part is learning a bit about Microsoft Excel.

The COTs data can be imported into Microsoft Excel from the website of the Commodity Futures Trading Commission and easily updated each week. (The site has easy-to-use downloading instructions.)

Break out all the historical data for each commodity into separate worksheets. You can calculate the net position of a group of traders by subtracting its short position from its long position.

I found the highest returns consistently come from using the net percentage-of-open-interest position for each group of traders, rather than the absolute number of contracts. The percentage positions are found in columns AW through BE.

Calculate the moving average and standard deviation by using Excel’s AVERAGE and STDEV functions. In my systems, a buy or sell is signaled when the net position equals or exceeds the moving average plus or minus the standard deviation.

One time-saving trick for extending a calculation in one cell to an entire column: Click the first cell and, while holding down shift, click the last cell in your column, then press control-D.

To turn your data into a chart, click “Insert” in the upper toolbar and go to “Charts.”

Save the COT!

The Commitments of Traders reports are safe. Thanks to an overwhelming public outburst of support, the Commodity Futures Trading Commission says the 44-year-old reports won’t be discontinued. The commission announced in December 2006 it would keep publishing the data unchanged and start a new weekly report for some agricultural commodities to reflect the rise of index trading.

“The reports will continue,” says John Fenton, the commission’s director of market surveillance.

The commission sparked an outcry last June when it issued a call for comments on the reports, suggesting the data may be skewed by changing patterns in trading activity in some commodities. The notice asked for public comment on whether the reports provide a “public benefit” and should be discontinued. It said it was under no legal or regulatory obligation to keep publishing the data.

An unprecedented 4,659 responses came from 23 countries—by far the largest number the commission has received in response to such a notice in its 31-year history. (The previous record was 1,062 comments.)

The response was unanimous. Not one respondent said the reports should go. “Please, please do not discontinue this very valuable report,” one said. “Don’t you dare,” said another. “Leave it alone you knuckleheads,” the CFTC was advised. “Save the COT.”

Instead of dropping the reports, the commission decided to break out a new “index trader” category for 12 commodities, drawn from the current commercial and noncommercial groups. The new report will be tried as a pilot project for two years. The CFTC will then decide whether to expand it to other physical commodities.

Fenton acknowledges the wording of the call for comments created an unintentional controversy and promises that the COTs are here to stay.

“I would say it’s a permanent decision—as permanent as things are,” he says. “We didn’t mean to imply that we were really planning that. We didn’t consider discontinuing the reports was likely. We were trying to consider all options.”

Best Combos

The most profitable systems I found for trading the COTs on the S&P 500 and NASDAQ are listed in sidebar Figures 1 and 2 for each category of traders—commercials, large specs and small traders.

The three variables for each system are: (1) the number of weeks used to calculate the moving average and standard deviation; (2) the number of standard deviations that the net percentage-of-open-interest position must equal or exceed above or below the moving average in order to get a buy or sell signal; and (3) the timing of the trade following a signal (whether on the first open the week after the release of the COTs report, or up to three Mondays later).

We trade on the same side as the commercials and fade the small traders and large specs.

I calculate the size of my position based on the maximum drawdown for the trade and my risk threshold of 2% of total assets.

The data in sidebar Figures 1 and 2 is accurate as of early December 2006. And it’s important to remember that past results are no guarantee of future earnings.

[Accompanying this story were two tables showing the results for the best setups for the S&P 500 and NASDAQ for each of the three groups of traders.]

(c) Copyright Technical Analysis of Stocks & Commodities

POST-SCRIPT TO THIS STORY: Since this story was published, I've made some major refinements that you'll see on my blog: (Click the "Latest Signals & Results" link in the navigation bar for specifics on my new S&P 500 and NASDAQ signals.)

There’s a Bear Lurking Out There Somewhere

The bull market is almost 5 years old, and many analysts are wondering just how much longer it can continue without a major correction

The Montreal Gazette
Monday, May 14, 2007

The major stock indexes have shrugged off their winter blahs and zoomed off into the cosmos. The S&P 500 is testing its 2000 dot-com highs. The S&P/TSX composite index has been shooting to new record highs since last fall, closing at yet another high of 14,003.8 on Friday.

Last Monday, the Dow Jones industrial average recorded its longest winning streak in 80 years, matching its 1927 record of 24 up days in 27 sessions.

The gains have surprised much of Wall St., where gloomy sentiment has been all the rage since last summer’s nasty correction. Analysts are wringing their hands about just how far the nearly 5-year-old bull market can creep without a major correction.

Ominous comparisons are being made with the bubbles of the late 1920s, late 1980s and late 1990s, which led to the spectacular crashes of 1929, 1987 and 2000.

“(The 1987) time period, as well as the chart pattern from back then, matches up pretty good with today’s action,” said Marc Arbeter, chief technical strategist for Standard & Poor’s Equity Research, in a Business Week magazine story in late April.

“We stand in awe of the sheer majesty of this rise,” said analyst Dennis Gartman in his influential Gartman Letter in early May.

Gartman compared the current bull to the four-fold rise of Japan’s Nikkei index from 1984 to 1989, which led to an 80-percent correction that took 14 years to finally end.

“It will stop suddenly,” he wrote. “It will end in tears, but it can and likely shall continue to move higher nonetheless.”

Some analysts say the very fact that Wall St. is so fretful is actually a plus for equities. The explanation for this contrarian thinking comes from a couple of old trader’s dictums: Markets like to climb a wall of worry. And the crowd is usually wrong at market tops and bottoms.

When everyone gets highly optimistic, it’s often a sign that a speculative bubble is about to burst and a good time to sell. On the other hand, when everyone is super-negative, it often means there’s been excessive market panic—a good time to buy.

The current nervousness suggests the top isn’t in yet because investors have yet to become excessively speculative, said Philip Roth, chief market technician at institutional securities firm Miller Tabak in New York.

Today’s bullishness is nowhere near the levels seen in episodes like 1987, said Roth, who addressed a meeting of technical analysts in Montreal last week. (Technical analysis is the study of market chart patterns.)

“There has been much more bearishness of analysts during this whole bull market. That’s because they were hit on the head after the last bull market,” he said in an interview.

“It’s something like 1987, but there are differences. I think we are vulnerable to a very extensive correction, but I just don’t think we are vulnerable to that kind of plunge.”

Ron Meisels, a Montreal-based technical analyst, also thinks the bull may have further to run.

“This is a remarkable performance for an aging bull market,” he wrote in his newsletter last week.

Meisels noted that the bull, which started in 2002, is in its fifth year and getting old in the tooth.

“If this truly is a five-year market cycle, then the second half of 2007 is shaping up as a very ominous period for the bulls. The ‘light at the end of the tunnel’ will likely be the oncoming train marked BEAR,” he said.

What has many analysts scratching their heads is the fact that the market has gone a year without a serious tumble.

Much of Wall St. expected a major correction would start last fall. The autumn is typically the weakest period for the markets, and last fall was expected to be especially harsh because it was also the mid-term year of the U.S. president’s four-year term in office.

The Stock Trader’s Almanac has found that markets tend to bottom every four years or so, most often during the mid-term year of the presidential term.

Concerns about a crash last year were so prevalent that small traders stood at record levels of bearishness through most of last summer and fall, as measured by their positioning in S&P 500 futures and options as reported to the U.S. Commodity Futures Trading Commission.

Meanwhile, the markets kept climbing with no significant selloff, except for a small hiccup in February and March that stocks quickly shrugged off.

And yet, while the markets rallied, small traders in April again had historically extreme levels of bearish positioning in S&P 500 futures and options.

The same thing was happening in the tech-heavy NASDAQ composite index. In March and April, large investment firms and hedge funds stood at historic extremes of bearishness in NASDAQ futures and options.

When the investment funds and small traders get super-bearish, it has historically meant the markets are likely to go up.

That’s because the big investment funds and small traders tend to be positioned the wrong way at key market turns.

Meisels sees the possibility of some “minor selling” this spring, followed by a summer rally, then a “blowoff” probably in September or October, leading to a 15-percent correction.

Roth agreed. He said the lack of a selloff last fall means the expected plunge may just have been postponed to this spring or fall.

When it comes, he predicts an “average” correction—six to nine months in length, with a downside of 20 to 25 percent—“not a killer bear.”

[Accompanying charts published with this story showed the NASDAQ's 28-percent climb since last summer, the NASDAQ's languishing compared to the Dow Jones industrial average, the recent breakdown in crude oil's uptrend and the VIX Volatility Index, which shows market complacency hasn't declined to the lows of last winter.]