Trader’s Narrative

Ticker Sense mentioned that according to the Merril Lynch’s monthly survey, investors’ optimistic sentiment is now down to six month lows. As well, 70% of those polled said that they expect inflation to rise this year. “This is the highest level since March 2005 which coincided with another short-term spike in interest rates.”

I’m not surprised at all to hear that since I mentioned previously that according to the COT and other techincals, the yield of the 30 year Treasury bond is headed for a tumble.

The sentiment on inflation also dovetails nicely with something else which has already started to play out: the weakness in gold stocks. According to the k-ratio, gold stocks were rather stretched and were headed for a tumble. Since I wrote about it, the Amex Gold Bugs Index has fallen from 387 to less than 340.

As you have probably surmised, these two seemingly separate markets are actually very much related because they both key off inflation.

In fact, if we compare the the Amex Gold Bugs Index and the 30 year Treasury bond yield, we see that around March 2005 (when inflation fears were as prevalent as now) they both made an intermediate top.

For many, this intermarket relationship is a fact and therefore assumed to be a give. Yet, for me it is fascinating that different technical tools can, in the end, guide us to the same conclusion and in essence, reiterate the relationship.

The 30-year Treasury bond has been on a very steep downtrend for most of this year. Now, sentiment is getting so negative that I think we are close to an inflection point. Note that the chart below is the yield (not the price) of the 30 year Treasury bond:

Now, take a look at the recent commitments of traders:

As you can see things are getting very lopsided. The (smart money) commercials have taken a huge long position and have been adding to that bias for about 3 months. And the (dumb money) small speculators have been taking the other side with a large short position. The tell that an inflection point is coming soon is that the open position has ballooned to 851,211 contracts.

Sooner or later, the score will have to be settled and the winnings divied up. I think it will be sooner rather than later and the winner will be the commercials.