Trader’s Narrative

Earlier in the week we looked at the situation the gold market finds itself in with the precious metal sitting at the important $1000 level. I offered various takes on the technical position as well as the sentiment for gold. Here I want to delve in a bit deeper into the sentiment to see if we can glean whether there is any excess optimism which would flag a contrarian sell signal.

Here is the Google Trends chart for the keywords “buy gold”:

Not surprisingly, the peak occurred in the week of October 5th 2008 (3.66). The keywords: “how to buy gold” also reached a peak a bit earlier on Sept 21st, 2008 (not shown in graph). That’s still around the same time. This was, of course, right around the time that the equity market was getting a shellacking.

The term “stock market crash” reached a peak in Google searches at the same time (October 5th 2008). But right now, while slightly elevated, this makeshift indicator isn’t really signaling an excessively speculative sentiment towards gold. Of course, this is noteworthy because gold is trading about 20% higher than it was in October 2008.

In my earlier analysis of the gold market, we looked at the Commitment of Traders report, MarketVane’s as well as the Hulbert Gold Newsletter sentiment indexes. Let’s take a quick look at several other measures of sentiment for gold:

Rydex Traders
Guy over at the Technical Take mentions the asset levels in the Rydex gold fund. While the Rydex investor is the trigger happy type to jump on a trend, either long or short, there is no evidence that they have piled on gold at this time. There is only about $200 million in the Rydex Precious Metals Fund. I agree with Guy, there is a distinctive lack of froth.

Put Call Ratio
The put/call ratio for gold is also in neutral territory. This is the options data on the futures contracts which is about as speculative as you can get considering the built in leverage. There was a slight uptick in call buying as gold made its latest move towards $1000 but even as that level has been pierced, the put/call ratio has backed off (traders are less optimistic).

Conclusion
The consensus from several different measures of gold sentiment is that there is mostly a shrug of the shoulders from traders and investors in reaction to the latest rally in gold. The only conflicting data point is the CoT report which shows small speculators in the futures market heavily long gold contracts.

Here’s an interesting way to measure the general mood of the public towards the stock market: look at the frequency and trend of searching for related keywords. For example, “bull market” or “bear market”. Although not everyone knows that nomenclature. How about “stock market crash”? Everyone knows what that means.

Thanks to a new service from Google (GOOG) called Google Trends we can look at the popularity of various searches over time and even across different geographic areas. Persevering readers might remember that we first looked at this new measure of sentiment back in January 2008: Hunting For Sentiment Data.

Since then we’ve continued to collect data for this so here’s an updated chart comparing that Google Trend to the S&P 500 Index (SPX):

There was a massive spike which corresponds to October 5th 2008 as the stock market was barreling down head first. There was a smaller spike which corresponds to the March 2009 low.

Other than that I can’t see a clear relationship between the two. Perhaps we need more data or perhaps the keyword isn’t the right one. I’m sure one of you out there who is more statistically inclined can take the data and hash something out. If you’re interested, drop me a note and I’ll forward you the spreadsheet.

In any case, looking at the most recent data not very many people are concerned about a stock market crash. The recent numbers shows the kind of apathy last seen August 17th, 2008 and December 23rd, 2007.

It is official. And about a year too late. But the economists at the National Bureau of Economic Research (NBER) have spoken:

The committee determined that a peak in economic activity occurred in the U.S. economy in December 2007.
Business Cycle Dating Committee

Way back in September 2007 I started wondering, “Are we in a recession already?” - then at the start of January 2008, officially called it: we are in a recession.

In that post I showed a chart of the Google trends for “recession”. By the end of January 2008, the Google trend for “recession” was off the charts.

Then most recently, I mentioned that according to Dr.Copper we are in a recession. If you look closely at that chart, the annual rate of change did go negative in early 2007 (just barely). But enough to warrant a signal, just as previous ones.

Even LOLcats got in on the act and signaled a recession before the NBER economists.

Economics must be the only profession where you can make a living driving by looking at the rear view mirror. Too bad traders can’t make buy and sell decisions once the charts have been printed.

Apologies for the delay, I’ve been trying to keep up with this fakakta market. Here is this past week’s sentiment overview:

Sentiment Surveys
The AAII survey for this week showed only 33.33% being optimistic (bulls), and again, a whopping 55% thinking that the market is going to continue to go down. If you recall, historically, anything above 50% bearish sentiment is very significant. However, sentiment in a bear market is different than that in a bull market. So adjust your lenses accordingly.

The sentiment survey of Investor’s Intelligence by ChartCraft showed only 33.7% bulls and 47.2% bears (with the rest sitting on the fence).

Before we leave surveyland, it is important to note that something has truly scared the average American investor because not only are they very pessimistic as described above, they are now positioning their portfolios so defensively, it has only happened a few rare times. They are holding a +35% in cash, only 51% equities and the rest in bonds. The last time we saw a lower equity allocation for these guys was way back in the throes of the last bear market (late 2002) where it reached into the 40’s.

Options Continue to Confuse
On Friday, as the market continued to bleed, the ISEE sentiment ratio came in at 119, meaning that retail option traders were comfortably buying more calls to open positions than puts!

And the CBOE put call ratio (equity only) came in at an anemic 0.79!

So the options markets continue to confuse the heck out of everyone. I’ve read as much as I could find about it but either people are scrambling valiantly to explain it with outlandish theories or they are outright ignoring it.

The best alternative theory I’ve heard put forward is from Barron’s:

I mentioned sentiment being fearful earlier and certainly the Chicago Board Options Exchange volatility index, aka the VIX, registered some extremely high readings this week. Dubbed the “fear index,” when the VIX reaches extreme highs it often marks a bottom of some kind.
Finally, something for the bull column.
But can we truly believe the VIX, which is based on options premiums? After all, investors are no longer allowed to sell more than 1000 stocks short thanks to a temporary ban. One of the few places to hedge a portfolio is in the options market, and that may be changing the VIX in ways we just cannot know at this point.
Anecdotally, I don’t see the “get me out at any price” fear in the mainstream and financial media. Investors are fearful, but I don’t think they are truly as panicked as we might believe.
So, the scales seem to be tipped for the bears, keeping capital preservation tops on my list of investment activities. The final word from Washington could change things in a hurry, but from the technical evidence we have, this bear market is not over.

The What Spread?
This is truly scary. The TED spread continues to go up. The what spread? Yeah, that’s what a lot of people are wondering too. Take a look at the chart showing the trend of this search query in google’s search engine (worldwide). At the beginning of September, things go bonkers:

The reason I say scary is that it is creeping higher rather than spiking higher. That makes it difficult to know whether the trend has exhausted itself.

Magazine Covers
A qualitative contrarian sentiment guide is the magazine cover. Ideally, it will be tremendously pessimistic and have wide, general public circulation. This week, the only one fits the bill is the Time magazine cover of the 1929 soup line with the title: “The New Hard Times”.

The Economist and Forbes are arguably specialty magazines but their most recent editions’ covers are pessimistic as well. Although, the Forbes one does show the chart going up towards the end. And the article that corresponds with the cover, also hits some optimistic notes, mentioning the large amount of cash on the sidelines (more details on the cash cushion here). So, as pessimistic covers go, it doesn’t really qualify fully.

Here is the second installment of the conditions that precede new bull markets, as put forward by Jim Stack of InvesTech:

“Formal” Recession - confirmed (not just feared) by media headlines. Once again, this reveals the importance of being a contrarian investor… buying when no one else wants to. Historically when you see “RECESSION!” in the media headlines, it has often been the time to back up the truck to start loading up on stocks.

According to the data from Google Trends, there was a peak of “recession” headlines or mentions towards the end of January 2008:

I thought there was an increase towards the end of the year in 2007 but that was before the rate again doubled within the first month of the new year. You can see the same chart for mentions of “recession” before the spike in January.

But whether we are or were in a recession depends on who you ask. The most accepted answer comes from the National Bureau of Economic Research (NBER) and they have yet to confirm anything. But they always do so after the fact, which isn’t all that helpful anyways.

According to the Conference Board, the “data certainly reflects a weak economy, but not one in recession”.

The Recession Buy Indicator
The Recession Buy Indicator is an intriguing indicator used the veteran stock market newsletter writer, Norman Fosback. It is made up of four indicators which are “coincident” - that is, neither leading or lagging but a measure that moves at the same time as the economy.

These four are: manufacturing and trade sales, personal income, non-farm payrolls and industrial production. These are the same measures used by the NEBR to pinpoint recessions.

According to Fosback, there is a buy signal when each of the components is below its rolling 6 month high. That is the case right now since the coincident index has not gone up since October 2007.

Coincidentally I wondered out loud back in mid September 2007: Are we in a recession already? That may turn out to be accurate.

This Recession Buy Indicator gives infrequent but very good buy signals. There have only been only 4 in the past 30 years but they provided 30%+ annual returns on average. The validity of this indicator comes from the historic pattern of the stock market hitting a major bottom approximately six months after the economy enters into recession.

Like all historical patterns though, we don’t have a guarantee but a picture from the past that this is what has happened on average. The exceptions are important. For example, this indicator gave a buy signal in February 2001, which if followed, produced a tremendous amount of loss and pain. The stock market bottomed almost two years later in early 2003.

Conclusion
It’s difficult to tick this condition off as being met since the NEBR has not officially labeled a recession. It may or it may not. But going by everything else, it would seem to have been met.