I’ve lost the illusion of sensing I can see good opportunities on the grain markets.  And, the softs seem a wee bit off kilter for my tastes.  So, I’m pairing my focus at the start of this week to metals, currencies, and indices.

Options traders remember we have expiration coming on Friday!  The next expiration will be December expiration at which point the smarter trading community will already be taking position for the new year’s trend.  It’s not too early to start thinking about 2010.  This markets may be able to run higher, but, not forever.

While I’m on the subject of options, keep in mind what sort of traders will be rewarded this expiration.  Let’s just assume our more sophisticated traders are using rather dumb market neutral strategies.  Let’s assume the more naive players have a directional bias.  So, roughly speaking the majority of “smart” trades would have gone on around October 16th.  Let’s assume sometime around 10-15 days into the trades, IF AND ONLY IF, they were profitable, they would have taken them off.  Otherwise, smart money would be looking for those markets to be within a similar price range as we close out those contracts which will expire this week.  At which point those markets will be free to explore new ranges in ways they haven’t previously been able too.  One market near and dear to my heart is the metals market.  If this logic pans out, I could see perhaps one more sucker’s rally before a decent breather.  Time will tell.

General outlook:

As always, this is purely an empirical and a theoretical exercise.  Trading is extremely risky.  If you were to trade, you should only ever do so with money you can afford to lose.  Be well, be safe, and be warm.

It’s Sunday evening and the futures markets are testing Friday’s highs.  I love it.  That’s encouraging for the bears in the neighborhood.  I’d be looking at an opportunity to catch a short on the equities Monday through Wednesday of this week.  Of course, a big part of this observation has to do with the risk/reward.  Although new highs in equities is somewhat hard to imagine, new lows in the Dollar isn’t.  So, as always I’m quite likely wrong.  So, if you find yourself short the market and hitting new highs, get out.  Big picture: this looks like as good a risk reward as you could look for on a trade and the markets are heading towards halfway home… perhaps it’s time for a break.

Last week should not be taken lightly.  A 5% sell off on US equities is not a trivial affair.  If we can take off up to another 10% in the next two weeks, I will be relieved and strangely bullish.  On the other hand, if we take out the highs, I will very quickly be on guard for significant crash symptoms ahead.

What do I expect this week ahead?  I expect over the course of this week and possibly part of next week to put in some short term bottoms on equities and a number of other commodities.  But, more important than expectations are what you are prepared to handle.

Keep in mind 2 of the 4 indications of a very large market top being put in have occurred.  The first being we have extreme correlation.  Not only do we have more markets intensely correlated than is systemically healthy; but, many of them are starting to get to extreme levels.  It’s pretty much the world against the dollar and bonds.  If the dollar and bonds go down, stocks, grains, oil, metals, other currencies, other commodities, go up and vice versa.  The second key ingredient to a major market top is extreme volatility.  We are seeing VIX over 30, 5% weeks, breaking of major support and resistance in a wide range of markets.  You should be on alert!

If you followed my commentary last week, I wrote:

Favorite set-ups on the horizon: Very interested in an opportunity to short metals on the immediate horizon.

Silver opened the week at 1771 and closed down at 1630, falling 8% for the week.  So, if you didn’t catch my post on Wednesday before the GDP announcement to take profit, you got another break on Friday.  Of course, if you have more contracts out there, leave some for the longer run.  I read about Joe Ross calling Gold at 400.  Why not leave a little on for the bigger play.

Meanwhile what other opportunities lie ahead for this week?

I’m starting my week looking at possible short in Cotton, Oil, and Sugar below current prices.  Only below current prices.  I’d love to be long bonds.  But, I just don’t have the appetite for that much exposure at the start of the week.  So, as much as I may believe in the trade, I’ll hold off on that one.

General outlook:

We are officially on red alert.  Be prepared to sustain this pace right up until Thanksgiving and beyond.  It is very unclear as to exactly how the story will unfold in the immediate future.  But, this is a great time to pay attention.  With both Fed announcement and Jobs reports, this is likely to be a high impact week.  Be safe.  Be conservative.  And above and beyond all, be prepared.

With the markets generally accepted as being overvalued and the economy widely accepted as being in the toilet, it’s hard to feel too bullish about price action going into the last week of the month.

What topics and themes are likely to emerge?  Let’s work backwards from next week.  Next week will end with the G20 meetings kicking off, unemployment rate / non-farm payroll, AND and FOMC statement…. not to mention some manufacturing numbers and some pending home sale data.  So, next week is a rocking news week in the financial markets.  We are about to commence “the week before next week.”  This week includes:

• Tuesday’s Consumer Confidence report
• Wednesday’s New Home Sales and Durable Goods Orders
• Also noteworthy on Wednesday is New Zealand’s rate statement

In term’s of the general market outlooks… my bias’ going into the start of the week are:

Favorite set-ups on the horizon:

• Very interested in an opportunity to short metals on the immediate horizon
• Possibility of a short Aussie near-term
• longer term horizon looking at a possibility to short some sugar next month
• An opportunity to buy some indices next month

General observation about markets, cycles, and timing:

As bleak as the current state of the economy and globe may be: as bad as housing may be, as bad as emerging markets may be, as bad as finance industry may be, and as bad as things may be for the US consumer, I would not be shocked if price bubbles continue to melt up significantly before they prices are annihilated again.  It’s well past time many traders expected prices to be heading south.  But, as markets tend to humble their participants, it would not surprise me if they have a few more surprises in store.  I’m just not seeing the technical signs in the market that things are too overdone.  But, the very first technical sign of systemic imbalance is in place: grossly correlated overvaluation across a broad set of asset classes.  But, that’s about it… some meltdown’s come unannounced, but, most don’t.  So, as always, precede with extreme caution.  Keep your powder dry.  Only fire when you must.  And, all the traders I have the pleasure of knowing good trading this week.

Here is the forecast:

The forecast suggests we should be on the look out for:

• a major top around January 24th
• a major bottom around March 26th
• a major top around  May 7th

The next chart is what actually happened this year:

The actual chart shows:

• a high the week of January 30th (in-line with forecast)
• a low on week of March 13th (a week earlier than forecast)
• a high on May 15th (a week later than forecast)

So, the forecast proofs relatively interesting.  The biggest discrepancy comes after the May 15th high.  The forecast indicates the market generally drifting lower.  Yet, prices have been generally drifting higher.  What gives?

First off, it’s just a forecast.  By no means is there any guarantee of accuracy.  But, if there is any faith in the model, what might explain the difference?  Said differently, why might the forecast be “broken”?

Possibly the US Dollar has something to do with it.  As the dollar falls, other assets priced in dollars are rising: equities, energies, metals, and commodities.  Cotton falls into the last category.  Let’s take a look at what was expected of the dollar this year and what actually happened.

The following chart is a simple forecast of the USD for 2009:

Some highlights from the forecast include:

• starts on an uptrend until a major top on February 23rd
• a major high on March 23rd
• a major low on July 25th
• up from their… before rolling a bit later

The next chart is the actual performance of the US Dollar:

The actual performance of the US Dollar shows:

• an uptrend until week of January 23rd (about a month before the forecast)
• a major top on week of March 6th (a couple weeks before the forecast)
• a major bottom on June 6th (a bit more than a month prior to the forecast)
• then the actual price just starts rolling over to new lows…

Perhaps this dollar sinking beyond expectation has something to do with why cotton has been pushed to higher forecasts and the forecast itself is broken?  It’s all conjecture.  But, with the dollar testing lows, and extremely oversold, it’s not a bad time to start thinking long dollar.  Albeit, it may be a bit early for such a trade.  Perhaps in November we will see more convincing follow through in the dollar.  Regardless, if the dollar will rise that will put downward pressure on cotton, which will only reinforce the short position.  Hence, some of my curiosity regarding a the value of a short position in the cotton market.

As always, there is no trading advice offered here.

At the top of my list…

• consider being short JY
• GC rolling over…
• long DX…
• KC and CT are getting up there…
• EU may be ready to roll
• what’s up with NG… sure would be nice to be in that long

NOTE: Questions on gold… who is in this?  Records show it’s all the small players.  So, does that mean it’s time to get out?  Very curious isn’t it.

There is significant evidence that at this point in time the equities markets are overvalued. Now I’m saying this on very little authority and a lot of opinion. Perhaps someone more gifted at traditional valuation can shed some light on the topic? But, with my focus on market psychology, market timing, market cycles, quantitative characteristics of markets, trader sentiment, and market history, I’d say this goose is cooked.

I don’t believe there has been much improvement in the system. I do believe things were oversold. But, they have over-recovered.