Markets I Trade: January 8, 2019

In my non-registered investment account I am developing my trend following strategy continuously. I don't pretend to have all the answers; I am always exploring and learning and I am sharing that journey with you on this blog.

All I know for sure is that I want every trade to end in three ways: a small loss, a small gain, or a large gain. I predetermine my risk on each trade and aim to make sure that risk is never exceeded.

A big focus of my trading is to expand my access to a broad range of markets while using my investment capital very efficiently. Instead of holding standard positions in ETFs or stocks, I am using LEAPS options and futures contracts.

Options and futures contracts allow me to bet on the upside or on the downside of trends with minimal penalties. They also require a small capital allocation to control a large position. Unlike with common stock or ETFs, options and futures do not require borrowing costs to short an asset.

I try to limit my investing process to liquid markets that have the highest potential for bigger price movements. This generally means using LEAPS options on the largest ETFs and using futures contracts for commodities and currencies.

Thanks to the wide range of choices in the ETF markets and the massive breadth of the futures markets, I can theoretically get easy exposure to hundreds of different assets across the planet.

To monitor each instrument I trade, I look at moving averages and volatility measurements. Although there is no holy grail indicator, looking at these tools can help paint a pretty solid picture of where the markets are going. This can improve the odds of success in trading.

Moving averages help identify the direction of trends and can help show turning points in direction. Using volatility measures makes it easy to size each position based on pre-determined exit points. High volatility markets translate to smaller positions while low volatility markets allow for larger positions.

I also look at breakouts, although I am not using them to enter or exit positions. Breakouts can be very helpful in confirming trends and seeing points of previous resistance.

Silver (SI=F)

In today's post I will share my analysis on my latest large trade in silver. I used futures contracts in this trade as the LEAPS options market on the silver ETF (SLV) is pretty thin. A single futures contract for silver gives exposure to 5,000 ounces for delivery at a future date. Most contracts are settled financially rather than being physically delivered.

I have been watching precious metals quite closely for the past year looking for an entry point. In the late summer, gold prices seem to have made a bottom which later set up my entry for the options trade on GLD.

Gold and silver often trade in tandem, but throughout the late summer and fall, silver prices kept falling while gold prices inched upwards. In late November, it required more than 86 ounces of silver to buy a single ounce of gold. That's one of the highest ratios in several decades.

Silver appears to have made an interim bottom in November and has shown strong upside movement since then. Since my entry point, my silver trade has done very well. It has jumped about $0.85 per ounce from my purchase price and I am holding exposure to 10,000 ounces.

Silver (Weekly Bar)

Source: StockCharts.com

In the beginning of September 2018, silver was oversold on a technical indicator and had a bounce up from that low point around $14.00 per ounce to about $14.90 per ounce.

Prices quickly turned down and dropped below $14.00 per ounce in early November 2018—once again touching an oversold metric. This time, selling volumes were high but buying volumes were lower on the upside than the previous move in September-October 2018.

Silver has shot up from my entry point a bit over $14.80 per ounce and volume is still pretty subdued.

Upside Optimism

  • An interim higher high was made when silver jumped over $14.90 price level in September-October.
  • Silver moved from a technical oversold period which can indicate a longer term bottom due to seller exhaustion.
  • The price moved strongly above the 10-week SMA.
  • At the end of December, the price soared up and closed above the 40-week SMA for the first time since early 2018.

Upside Caution

  • The 40-week SMA is still declining at the moment, indicating a long-term downtrend.
  • Betting on a pivot point (change in direction against the long-term trend) always has more risk than buying into a confirmed uptrend.
  • If the price continues to expand aggressively, silver could quickly become technically overbought and that would signal a good probability of a price pullback.
  • The range from $16 to $18 per ounce could see a lot of selling pressure.

Although I don't trade based on stories, silver prices have been depressed for nearly seven years. It costs more than $15 per ounce for major miners to produce silver. I don't believe prices could fall much lower than they are.

SI=F (Daily Bar)

Source: StockCharts.com

This chart shows my entry point (blue) and my current stop level (red). The price has pulled away strongly from my stop, so I will carefully monitor my risk on this trade to prevent over-exposure.

I entered this trade using silver futures contracts on the COMEX exchange for March 2019 delivery. The margin (or deposit) per contract is just US$3,600 plus any applicable paper losses.

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A Current Look at Relative Momentum Across Equities

Coming to the close of 2018, we're seeing an incredibly divergent year in equities markets across the world.

This stands out when we think back to just a year ago where every market across the world seemed to be going straight up. Beyond broad equities and the scope of this post, we had crypto going nuts, pot stocks exploding higher, tech companies across the world soaring, and private equity was simply insane.

Just eleven months later, hardly anything is left standing. Equity markets, the highly liquid indicators of investor optimism on the economy, have shrunk quite shockingly across the globe. Only the U.S. market is hobbling along, but it's also looking shakier by the day.

I'm not ready to declare we're officially in a global bear market yet but, given that the MSCI ACWI Index (in USD) has declined more than 15 percent from the peak, we're sure getting close.

US Stocks vs. European Stocks

Source: TheRichMoose.com, MSCI Inc.

If we look at the above chart, we can see the very clear divergence of these markets which started in May 2018.

While both the U.S. and Europe had a sharp pullback in late January and February, the U.S. recovered into September while Europe kept on sinking.

At this point, when priced in U.S. dollars, European stocks are down nearly 15 percent for the year and nearly 20 percent from the January peak.

U.S. Stocks vs. Japanese Stocks

Source: TheRichMoose.com, MSCI Inc.

Japanese equities were outperforming U.S. stocks in the beginning of this year. In fact, Japan had a great year in 2017.

But, like the other major developing markets, Japan couldn't work past the January 2018 high point despite being positive for much of the year.

Finally, in May, Japanese stocks diverged and are now down more than 5 percent on the year. They are also down over 15 percent from the peak in January.

U.S. Stocks vs. China

Source: TheRichMoose.com, MSCI Inc.

We see a similar pattern in Chinese stocks. Again, the year-to-date chart shows a big divergence beginning in May 2018.

The Chinese market was actually booming earlier this year and showed strong relative momentum compared to U.S. stocks.

Like European stocks, Chinese stocks never recovered after the January peak. They are down over 20 percent this year and have a peak decline in excess of 35 percent within 2018 alone!

Market Cycle Performance

If you look across this entire market cycle, it is clear: U.S. stocks, particularly technology stocks and small cap stocks, have been the major winners.

Investors in foreign markets have gone almost nowhere since the beginning of 2008.

Source: TheRichMoose.com, MSCI Inc.

While it is looking like the global equity bull market is ending for the 2009 to 2018 up-cycle, most investors haven't been richly rewarded. Especially if they bought heavily near the end of the previous up-cycle cycle in 2007-2008.

Nearly every major equity market has experience a ten year gross cumulative return of less than 20 percent! Japan looks comparatively good at around 30 percent.

During this same time frame though, an investor in the U.S. equity market would have more than doubled their money.

This level of global divergence is incredible. We have yet to see how the down-cycle ends up, but given the strong declines across many foreign markets, we could have some great entry points in the future.

The last time we saw a level of divergence even close to this in a equity market up-cycle was in the 1990s. We know the next up-cycle starting in the early 2000s proved to be fantastic for the investors who chose the markets that were under-performers in the 1990s.

I think it would be very smart for investors to look for good entry points in many commodity producing markets, several of the more depressed European markets, and in China and India.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.