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Bullish Signs for Stocks, Silver

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There are a number of signs that suggest shorting stocks and silver is risky right now.

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Since late April, stocks and silver have experienced significant declines. Stocks briefly flirted with bear market territory for a few hours. Silver has already experienced a 47% decline from its April high. However there are a number of signs that suggest shorting stocks and silver is risky right now.

Stocks
The recently completed third quarter was the ninth-worst third quarter in U.S. stock market history going back to 1800. Here is what happened next with the top eight:

1801: Stocks went down 22% over the next eight months. However, stocks went up 73.5% over the next five years and two months from September 30, 1801, despite the inauspicious beginning. This equates to an 11.24% annualized return.

1807: Stocks declined by 20% over the next four months. But from September 30, 1807 to January 31, 1810, stocks were up 53% despite the initial drawdown. This equates to a 26.55% annualized return.

1837: Up 23% in October, then new lows.

1946: October 9 was a low, then a 14.7% bear market rally over four months.

1974: October 4 was the low, then a start of six-year bull market which took the S&P up 125%.

1990: October 11 was the low of a 19% correction and the bull continued for another 9.3 years.

2001: September 21 was the date of a tradable bottom (October 1 was the low in the fourth quarter). The market managed to go up another 13% over the next 3.2 months before the bear resumed.

2002: October 10 was the low and the start of five-year bull market which went up 101%.

So over the last 200 years, when the stock market has had a particularly nasty third quarter, there seems to be a sweet spot for buying stocks the first 11 days in October. Note the current low was on October 4. While this indicator does not tell you when to sell, it suggests that you should cover your shorts, go long stocks and worry about selling later.

Another problem for the bears is the put/call ratio has hit high levels day after day for over two months now. Past history suggests it is going to be difficult for the market to have a sustained downward move with the put/call ratios this high. While the put/call ratio was also high in October 2008, the market traded in a range until the put/call ratio was alleviated to a certain degree. Then the market had another leg down. While the market did manage to hit new lows in October 2011, it only spent about 24 hours below the August 9th bottom.

Finally, stocks have put it new lows as predicted by my August 9 (the exact day of the previous low) column Low RSI of Wilshire 5000 Says It's Time to Buy, Then Sell. The pattern since the August 8 signal (which is ranked #5 since 1980) is identical to the #1, #3, #4 and #6 readings of the indicator mentioned in the article. The market rallied significantly after the second low. The second highest reading (post 9/11) saw an initial multi-month rally of 23% which did not test the lows until many months later.

Silver
Going back to January 1986 (when the data starts), the small speculators in the Commitment of Traders Report are the 11th most bearish on silver in this weekly survey's history. This is the 99.2% percentile. The top 10 readings were all in 2001 and 2008.

Note all previous 10 readings were in the middle of stock bear markets. What is also interesting is that some of these readings were near starts of bear market rallies. For example:

  • March 27, 2001: 21% bear market rally from March 22-May 22, 2001
  • September 18 and 25, 2001: 24% bear market rally from September 21, 2001-January 7, 2002
  • November 18, 2008: 27% bear market rally from November 21, 2008 to January 6, 2003

The maximum silver drawdown in 2001 when the small specs were this bearish was 11.2%. The maximum drawdown in 2008 was 15.6%. The upside was big. Interestingly enough, if silver had a 15.6% drawdown from the date of the bearish small specs COT report, it would equate to $26.31 which was close to the $26.04 intraday low on September 26. So while a retest remains a possibility, this indicator in isolation would suggest it would hold for now. Silver has already had an 8% drawdown from the signal so perhaps it is already bottomed.

Another interesting indicator for silver is the Rate of Change. The 21 day ROC for silver on September 30 was -30.81%. This was the 99.89% percentile. This is not useful for telling whether or not silver will bounce now as sometimes it continued to collapse like it did in 1980 and mid August 2008. However, in both scenarios silver came back to the levels of which it was when the ROC was at -30.81%. In other words, silver could either rally here or crash. But if it crashes, it should bounce right back up to the low $30s on the ensuing rally.

On one hand, the small specs suggest limited downside for silver. On the other hand silver is still extremely overvalued by a number of metrics discussed at great lengths in earlier columns. One solution is to cover shorts in silver and stocks and invest the profits in stocks which are due for a rally. While silver may have an oversold bounce as well, stocks have an earnings yield of over 7%. This offers a margin of safety which silver just doesn't have.

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No positions in stocks mentioned.
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