The week just over brought a heavy decline on rising volume in stocks – is this the dreaded sizable correction start, or the general February weakness I warned about a week ago? I‘m still calling for the S&P 500 to be in a bullish uptrend this quarter and next, though I‘m not looking for as spectacular gains as in the 2020 rebound.

Many are calling for a start of a deeper than a handful of percent correction, and it‘s not difficult to come across charts with rising wedges or trendlines. These inevitably get sooner or later broken through pure inertia, because every market needs to take a rest sometimes. Refusal to keep rising without a pause shouldn‘t be confused with readiness to take a plunge though.

Look instead at what has changed and what has not. The Fed is still activist, and not really willing to discuss tapering – not that it would be on the table anyway, but even to talk its contours. The current balance sheet expansion commitment is sizable enough to keep short squeezes in GameStop GME, silver, and elsewhere in check, as this might be part of the explanation for the broad-based selling in many stocks.

Leading economic indicators are crucially still pointing in the direction of economic expansion, and red-hot copper and other base metals, are merely pausing in a sideways trading pattern. The same for oil, which I called back in October as likely to surprise on the upside (XLE ETF, specifically). The economy keeps rebounding, yet stocks would lag behind commodities, is my call.

Gold remains in a wait and see mode, and in the latter half of today‘s analysis, I‘ll dig deep into its near-term prospects, which are mixed, unlike the bullish medium-term outlook that I have covered a week ago.

I don‘t see gold plunging to any dramatic number such as $1,700 but given that the dollar looks to have stabilized for now, and may even attempt a modest and brief rally from here, gold may get again under corresponding (and weak) pressure again – should the silver squeeze be defeated. Would a stock market correction get gold under pressure just on its own? If you look at the below chart, your answer is probably also going to be no, as the two assets haven‘t really displayed any kind of stable correlation one way or the other (charts courtesy of www.stockcharts.com).

Bottom line is that it‘s the stock market that is the one more vulnerable here, not gold.

S&P 500 Outlook

Friday‘s trading brought stocks under pressure, and Wednesday‘s lows didn‘t hold. The result is the month of January finishing in the red. Will the S&P 500 turn down from here much deeper, as the weekly indicators are enticing the bears to sell?

The daily candle isn‘t marked by higher volume than on Wednesday‘s selloff. Lower knot, intraday rebound attempts, and still respectable volume – that‘s part of the search for local bottom in a whiff of risk-off environment to me.

Before diving into its anatomy, let‘s quote how I described it in the second intraday follow-up analysis (Friday mid-session):

(…) The bullish reaction in the opening hour gave way to selling, which continues unabated in stocks. Riskier corporate bonds have been holding up better before reversing to the downside, yet they are trading well above their Wednesday’s lows currently – unlike the S&P 500. This makes me think of yet another hasty move, facilitated by options expiry, that is overdone unless other markets join in the melee. Gold is not plunging, crude oil little changed, dollar marginally higher while Treasuries are down. Technology is acting weak while semiconductors are above their Wednesday’s lows, and healthcare together with biotech is trading right at these levels.

Crucially, the Force index (for SPY ETF, which is a proxy for S&P 500) is not making a new low, and new highs new lows are rising today. This is why I view the current move as likely to run out of steam. Remember, it’s the last trading day of the whole month on top. The fright from the Fed even thinking about tapering, is gripping the markets still, despite having been made clear that the monetary accommodation is here to stay as the coronavirus scars run deep, and the economy needs support. Similarly, a deal on the $1.9T stimulus would be reached.

Remember, the big picture is still about the supportive Fed that wasn‘t all too willing to entertain tapering questions, pointing out the protracted nature of the longer than earlier anticipated recovery instead.

Credit Markets

High yield corporate bonds (HYG ETF) closed the day on a weak note, yet remain still well within their sideways consolidation of recent weeks. I don‘t see a trend reversal as likely, meaning that stocks have ample time to get their act together.

Both leading credit market ratios – high yield corporate bonds to short-term Treasuries (HYG:SHY) and investment-grade corporate bonds to longer-dated Treasuries (LQD:IEI) – are trading at their local lows, not breaking below, not leading the market down, but paring the prior bullish bets.

High yield corporate bonds to short-term Treasuries (HYG:SHY) with overlaid S&P 500 (black line) gives perspective to the outsized move in stocks. Please note how deep has the ratio‘s Stochastics declined, and how shallow a decline have the bears to show. That‘s a hallmark of a strong bullish trend to me.

The 3-month Treasury yield continues to plunge, as the sell first, ask questions later sentiment was ruling the markets on Friday. That‘s the explanation of parking funds in short-term Treasuries.

Put/Call Ratio and Smallcaps

The put/call ratio has moved up, reflecting rising fear in the markets, but its generally declining tendency (both moving averages are falling) coupled with Friday‘s value being both below the pre-elections and early September peaks, make me point out we have not seen a change in sentiment, and have actually progressed quite deep in the current correction already.

The Russell 2000 has not crashed from its spectacular post-election rise and is doing relatively better than the 500-strong index. This is expected as the stock bull market matures. When I made the stock bull market call in spring 2020, it‘s perfectly normal to see smallcaps underperform in its early stages. Now that the bull run is more mature, the Russell 2000 isn‘t lagging far behind, and the fact we‘re not seeing it lead to the downside, is encouraging for the bulls – in line with the rotation theme covered in Tuesday‘s article, it‘s the big (tech) names who are the underperforming ones.

Gold and the Miners

Another day, another upswing attempt. Again rebuffed. Gold is holding up, and not reacting to the weakness in stocks as I made clear in today‘s very first chart. Still, I‘m not viewing the gold consolidation as over, and see more patience as necessary before we get the spring upside breakout from this large basing pattern.

Gold miners aren‘t really on a tear as the HUI:GOLD ratio shows. In the latter stages of a trend (the 5-month long consolidation has been pointing down), it‘s not unusual to see a false break (in the miners to the downside) being invalidated, and that is what I view as likely to become apparent when we revisit this chart in say 3 months.

Gold, Ratios and the Dollar

Rising yields decrease the appeal of gold, as the yellow metal pays no interest. Since the July-August one-way ride, gold had trouble sustaining its steep gains and entered correction whose path I predicted early in August. Yields are now bobbing around their lows, yet gold isn‘t declining. A nascent sign of most of the downside being already in? I strongly think so.

Comparing gold to commodities brings up a different reality – one described by a rebounding economy, and commodity price inflation that goes beyond copper, oil, or agriculture. It‘s broad-based, and gold has quite some catching up ahead.

Gold and the dollar, that‘s always an insightful examination. Trading with the usual strongly negative correlation, gold has seen little price change since mid-January, while the dollar hasn‘t progressed much either. Let‘s check the fiat currency for more clues.

Bouncing marginally higher in 2021, the greenback can (and likely will attempt to) stage a rebound attempt, yet I do call for it to fizzle out, and for much of 2021, the world reserve currency will remain on the defensive, which means rolling over well below the opening 2021 lows. It‘s the curse of both fiscal and trade deficits which work to bring it down, and all we‘re seeing now is a temporary technical stabilization.

From the Readers‘ Mailbag

Q: What to make out of the apparent silver squeeze and lots of long going into silver? How and how aggressively to play it? Via what instruments? Physical? SLV & Co. Futures? Miners?

How do hedge against “unknown unknowns”? Back in 1980 when silver had hit USD 50, decided to change rules in the middle of the game and bankrupted the Hunt brothers…..the silver price collapsed and the insiders had saved their skins. This time it is JPM is the insider that apparently has the biggest short position and obviously as friends in all market and governmental oversight bodies..…

A: The silver squeeze is as undeniable as the „social finance“ uprising that has enough firepower to take down / stick it to hedge funds. First time ever. Before, it was up to the hedge funds to mess up all by themselves (think LTCM) – and they can do that still today too. The success of the squeeze though depends on participants‘ ability to communicate and coordinate. And on their trading platforms not pulling the plug, as the only recourse, the little guy then has, is to leave a one-star rating on Google Apps to those who decided to democratize the world of finance. You get the point – that‘s what changing the rules throughout the game looks like – and we‘ve all personally met that in many walks of life.

I like your question as to the degree of aggresiveness. This is volatile – just like Swiss franc dropping the peg to euro, or the 2016 Brexit result and Trump win. It‘s also happening on double the regular silver volume. I would personally scale down paper market position sizing, or if my investment horizon were really longer-term, went with physical silver – but expect their premiums to drop significantly once this squeeze is over. Now, you‘re paying for the bars and coins through the nose. Therefore, I would play this move with perhaps 5 or 7 times wider stop-loss (and proportionately smaller position) if I really wanted badly to take part in this bet on the popular revolt success.

These moments really increase the tail risk (systemic risk, black swan), making it nigh to impossible to correctly price it into the markets. Remember the 1987 crash that was exacerbated by modern portfolio theory – everyone using this gold standard was on the same side of the boat, and it capsized naturally (these days, algos just withdraw their bids). The question then is contagion – where and to what degree will the damage spill over? Probably it forms part of the answer to the chart disbalances that I laid out after Wednesday‘s plunge, and that I am laying out also today.

My point is that this environment is prone to sharp and violent moves (also in stocks, not just in precious metals) going both ways.

Summary

The stock market broke below Wednesday‘s lows, yet again was performing worse than bonds. Sure, it‘s concerning when the S&P 500 ignores quite solid tech earnings and sends the sector down, but small caps are powered to go higher, much higher still – and so will the 500-strong index, albeit at a slower pace. While the jury is out, there are indications that this 4% correction has already made quite a run, and the relative resiliency in credit markets is a good sign for the bulls.