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posted on 19 December 2017

Two Opportunities For Early 2018

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Macro Tides Technical Review 18 December 2017

Last December I thought the two best ideas going into 2017 were Emerging Markets and Gold stocks.


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Emerging Markets had a great year and the Emerging Market ETF EEM exceeded my price target of $44.00, after I recommended EEM on January 9 when it was trading below $35.00. Gold Stocks as measured by the Gold stock ETF GDX started the year strongly by rallying from under $20.00 to $25.71 on February 8. I recommended selling GDX in early February when it was trading above $25.00. Since then GDX declined to $21.00 in March, May, and July which were followed by rallies and a secondary high in September when the GDX reached $25.58.

Since the high in February I have been waiting for Gold and the Gold stocks to indicate that a solid intermediate low was forming. As noted last week the positioning in the futures market showed a marked improvement in the week ending December 4. The data released by the CFTC on Friday indicated even more improvement, so the odds of a solid intermediate low forming have risen significantly. Let’s review the Big Picture which will illustrate why this low could be important.

From its September 2011 high Gold declined from $1920 to $1046 in November 2015, a drop of $874 (A). A 50% retracement of this decline would target a rise to $1483 (1920 - 1046 = 874/2 = 437 + 1046 = 1483). From its low of $1046 in November 2015, Gold rallied $329 to a high of $1375 in July 2016 (wave A). At the high in July 2016 sentiment toward Gold had become extremely optimistic with more than 90% of traders bullish about its prospects. This suggested that Gold was likely to enter an extended period of congestion / pullback to wear off the excessive level of optimism. By early December 2016, Gold had corrected to $1123 which may be the low for wave B. An equal rally of $329 from this low would target a move up to $1452 which is not far from the 50% retracement target of $1483.

However, it is also possible that the rally from the July low at $1123 to the September 2017 high at $1357 was the first part of wave (B). If this is correct, Gold would have the potential to rally $234 ($1357-$1123 = $234) from last week’s low of $1236 to a high of $1470. Gold has the potential to rally smartly in 2018 but we’ll take one step at a time.

Click on any chart below for large image.

Positioning in the futures market is probably the best measure of sentiment since it shows how money is positioned. When positioning becomes extreme, with Large Speculators holding a large long or short position the odds are high that the trend is about to change. Large Speculators are trend followers so by definition as a group they hold their largest long position as an uptrend is nearing a high and the largest short position after a large decline that is close to a bottom. The unwinding of large long positions held by Large Speculators contributes to a decline as they sell, and pushes prices higher as they buy to cover a large short position.

The middle panel (green line) illustrates the positioning of Large Speculators. As Gold was posting its major low in November 2015, Large Speculators were not long at all. But as it rallied, they increased their long position significantly, and by July 2016 Large Speculators held their largest long position in years. As Gold fell between July 2016 and December 2016, Large Speculators sold which contributed to the decline in the price of Gold. The small long position held by Large Speculators in December 2016 was one of the reasons I expected Gold and the Gold stocks to rally in early 2017.

When Gold broke out above $1300 in late August, Large Speculators jumped onboard aggressively which was why I thought the breakout would not last as I noted in the September 11, 2017 WTR:

“The rally in Gold last week above $1350 resulted in large Speculators holding their largest long position in gold futures since the high last July 2016. This suggests that chasing Gold is not a good idea. A close below $1306, the breakout level, would negate the breakout and suggest Gold was vulnerable to a further decline."

By September 18 Gold had fallen below $1300.

Since November 27, Large Speculators have reduced their long position from 224,417 contracts to 107,068 as of December 11 after Gold fell below $1260. Their selling is what drove Gold below $1260 as I expected it would. Their current long position is the smallest since July 17 when they held only 60, 138 contracts long. If Gold does manage to decline below $1240 in coming weeks, Large Speculators will likely have lowered their exposure down to where it was in July and possible near the level they held in December 2016.

Commercials (red line middle panel) typically take the opposite side of the trade that the Large Speculators hold. When Large Specs hold a large long position, the Commercials hold a large short position. As just described, Large Speculators are often wrong at intermediate turning points, which is why the Commercials are considered the ‘smart money’. As the Large Specs were selling in recent weeks, the Commercials were buying and lowering their short position. Since November 27 the Commercials have reduced their short position from -246,541 contracts to -119,463 contracts. This suggests that if Gold does fall below $1240, the Commercials would likely be buying as the Large Specs were selling.

My conclusion is that any additional weakness in Gold and Gold stocks should be bought. The positioning in the futures suggests Gold is likely rally to at least $1305 and could make a run at the September high of $1357 in the first quarter of 2018.

These were my recommendations last week:

“A 25% position is recommended if Gold drops below $1230 and GLD trades under $117.00, which should be increased to 50% if Gold falls below $1215 and GLD trades under $115.00. A 25% position is recommended if GDX trades under $21.30 which can be increased to 50% if GDX trades under $21.00."

The low last week in the Gold ETF GLD was $117.40 and the low in Gold was $1236.50 so neither of these recommendations was executed. If Gold does rally to $1350, GLD has the potential to rally to $128 or more than 6% from under $120. I would recommend establishing 25% of a normal allocation immediately, and increase it to 50% if GLD trades under $117.40.

The low on Tuesday December 12 in GDX was $21.27 and a 25% position in GDX was established at $21.28 on a limit order. Based on the improved positioning in the futures market, I increased this position to 50% today at $22.17. I would increase this position to 100% if GDX fell below $21.80. If Gold does rally to $1350, GDX has the potential to rally back to its February and September highs near $25.50.

I also established at 25% position in the Junior Gold stock ETF GDXJ at $32.035. I would increase this position to 50% if GDXJ fell below $31.02. If Gold does rally to $1350, GDXJ may run back up to its highs above $37.00. GDXJ is extremely volatile and is not for the faint of heart.

If Gold exceeds its high at $1350, the next stop would be the July 2016 high near $1375. A close above $1375 would then open the door for Gold to run up to the 50% retracement targets between $1452 and $1483. If Gold reaches $1375 GDX may challenge its 2016 high of $31.79 and GDXJ may test $52.00.

A note about positioning: Many advisors allocate 5% or so to Gold and maintain that allocation through thick and thin as a form of ‘insurance’. This makes little sense to me. Given the volatility in Gold and Gold stocks, there are times to have less than a normal allocation and times to hold a larger than normal allocation.

As discussed, the upside potential for Gold and the Gold stocks may be significant which argues for holding a larger than normal allocation. If Gold does rally to $1350 and GDX pushes up to $25.50, the above average portion of the allocation can be pared to the normal allocation.

Approaching Gold and Gold stocks in this manner allows Gold and Gold stocks to be accretive to portfolio performance rather than a mindless allocation that helps sometimes and is a drag at other times.

Treasury Bonds

As discussed at length in the monthly Macro Tides and these Weekly Reviews, I think Treasury yields are likely to rise in 2018 and potentially more than most investors expect. Additional support for this view was found in the current positioning in the 30-year Treasury bond futures. As of December 11, Large Speculators (green line middle panel) held their largest long position since the 30-year Treasury bond yield bottomed in July 2016 at 2.10%. Conversely, Commercials now hold their largest short position also since July 2016. If inflation picks up modestly in the first quarter as I expect, the bond market will be forced to price in more rate hikes by the Fed than expected. A whiff of inflation might even provide a tailwind for Gold as well.

A move up to 3.17% to 3.20% on the 30-year Treasury bond, the highs last December and in March is likely in the first half of 2018. It took nine months for the yield to rise from 2.20% to 3.20%. An equal move in yield and time suggests the yield on the 30-year Treasury could approach 3.75% by June of next year. Since making a short high on October 2, the 30-year T-bond yield has fallen from 2.98% to a low of 2.687% and has formed a declining wedge in the process. A close above the down trend line and above 2.81% may lead to a quick move up to 3.0%.

The 10-year Treasury bond yield sports a slightly different pattern but the conclusion is the same. From a low of 2.034% on September 7, the yield rose to 2.475% on October 25. The 10-year has been consolidating that increase since October 25 and formed a triangle in the process. A close above 2.43% would represent a break out above the top trend line and suggest a quick move to 2.62% was likely to follow. In the first of 2018 the 10-year may rise to near 3.0%.

A partial position to short long term Treasury bonds was established on December 7 when the 30-year Treasury bond was yielding 2.71%. This was accomplished by buying the short Treasury bond ETF (TBF) at $21.73. This ETF is NOT leveraged and moves inversely with 30-year Treasury yields. If the yield on the 30-year T-bond climbs to 3.0%, TBF could trade up to $22.70 and above $24.00 if the yield on the 30- year T-bond climbs to highs of December 2016 and last March near 3.2%. I plan to add to this position. A close below $21.50 would call for a reassessment.


Unless the Dollar rises above the neckline of the inverse head and shoulders at 94.25, the downtrend is intact. The high last week was 94.22 before the Dollar reversed lower after the FOMC meeting. There is a good chance the Dollar will test the September low of 91.01 in the first quarter before a potentially major rally commences. There remains a very large short position in the Dollar and a multi-year high long position in the Euro. If the Dollar is able to close above 94.25, a bout of short covering is likely to push the Dollar higher as short positions are covered.


As long as the Euro holds above the neckline of its head and shoulders pattern near 1.1675, the trend is up and a rally to 1.2200 seems likely. If the Euro does rally to 1.220 it would likely offer an opportunity to go short the Euro, and long the Dollar, especially if the Dollar trades below 91.30.

When the Euro bottomed near 1.05 in March 2015, Large Specs were short more than -220,000 contracts while the Commercials were long 274,300 contracts. Now the positioning is reversed with Large Specs long 113,889 contracts while the Commercials are short -135,530 contracts. These are the most extreme positions in at least 6 years. This suggests the Euro is likely to establish an important top in the first half of 2018.

Institutional Mindset

As discussed last week, money managers, mutual funds, and hedge funds will want to show their clients they are close to being 100% invested on December 31. What most institutional investors will not be doing is increasing their allocation to cash before the end of the year. The complete lack of selling pressure, allure of tax reform, and benign Fed statement despite the increase in the federal funds rate has kept the bull market running as I expected based on the favorable seasonal pattern.

My guess is that a modest pullback is likely in the first half of January as the market absorbs some selling on the news and investors book some profits. A more meaningful correction is not likely until interest rates begin to rise and the bond and stock market are forced to consider whether the Fed will raise rates 1, 2, 3, or 4 times in 2018. My guess that crossroad may wait until March or April.

In the meantime I think it is of value to monitor how the broad market is performing as well as the relative performance of Growth versus Value stocks. The Equal Weighted S&P 500 is continuing to lag behind the S&P 500 which is weighted based on capitalization. Although the underperformance is beginning to narrow, it is still holding below the blue down trend line. The bias toward big cap stocks has certainly benefited the DJIA which has outperformed the S&P 500 by almost 7% since August.

The Value stocks continue to lag behind the Growth stocks as I thought likely, especially going into year end. As long as the relative strength line is below the red down trend line and the blue 134 day average, value stocks will not signal a reversal. My guess is that Value stocks will strengthen in January if profit taking curbs the current enthusiasm for Growth stocks at any price.

Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator (MTI). As long as the MTI indicates a bull market is in force, the Tactical Sector Rotation program is 100% invested, with 25% in the top four sectors. When a bear market signal is generated, the Tactical Sector Rotation program is either 100% in cash or 100% short the S&P 500.

The MTI crossed above its moving average on February 25, 2016 generating a bear market rally buy signal. The MTI confirmed a new bull market on March 30, 2016. The MTI continues to indicate that a bull market is in force.

Although the Major Trend Indicator is positive, the MTI has been posting lower highs since peaking in early March. Since late July, the odds of the S&P continuing the streak of no corrections of either 3% or 5% seemed quite low based on historical patterns and signals from a number of reliable technical indicators. The Tactical U.S. Sector Rotation Model Portfolio has been 100% in cash since July 24 based on the probability of a 5% correction. In my judgment (so far incorrect), upside potential has been limited relative to the level of risk.

Although the Major Trend Indicator is below its peak registered in early March, the MTI continues to hold above the green horizontal line which is another sign that the market is not yet vulnerable to a decline greater than 10% or a major trend change.

Since mid August I have tried to identify special situations that were uncorrelated to the stock market and oversold. On August 24 I purchased the Powershares DB Agriculture fund (DBA) at $18.66 and sold it on November 15 at $19.02. On August 29, I purchased the Dollar ETF (UUP) at $23.83, since I thought the Dollar was poised for a rally. This position was sold on November 14 at $24.43.

On October 27, I purchased the VanEck Oil Services ETF at $23.67. This position was reduced by 40% on November 8 at an average price of $25.79. The balance was sold on December 4 at $25.42.

A partial position to short long term Treasury bonds was established on December 7 when the 30-year Treasury bond was yielding 2.71%. This was accomplished by buying the short Treasury bond ETF (TBF) at $21.73. This ETF is NOT leveraged and moves inversely with 30-year Treasury yields. If long term yields rise in the first half of 2018 as expected, TBF will rise in value. A 25% position in the Gold stock ETF GDX was established on December 12 at $21.28 and increased to 50% on December 18 with an additional purchase at $22.17.


The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.

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