The Bears are Back, and more ferocious

(Please consider this more as a preliminary post and the usual research notes with stats, references and charts will be posted over the weekend).

The events surrounding Dubai have led to a renewed round of panic in the markets. It has brought back fears of the financial crisis. The crisis owes its origin to those who are in a perpetual state of intellectual deficiency and were convinced that building those castles in the sand and the sea were good business propositions (and all those morons who actually bought them). The Dubai problem is not per se very large - "only" about 60 billion dollars. But that has upset the "sentiment" which could be rebuilt only after all the government's pumped in about US$12.9 trillion over the past year. This default( though not yet in a technical sense) is likely to lead to exactly all those changes that took place after Lehman, only a more grand scale with all emerging markets likely to be hit by risk aversion, which will lead to a shooting up of the cost of debt and increase their spreads. Imagine this is the position of a government that has liquid assets in the form of oil, which is anyway rising because of speculators. What will it be like if others are hit?

The best case scenario is this: Fed and all the other governments' step in and go back to pumping in another 2 or 5 trillion dollars. That will lead to exactly the type of situation that we saw since march. I think we are likely to have that. Then after the fall, we will have commodities shoot up. It is likely that we will have a dip in the markets and a rise after that (a false dawn) which should probably be used to get out of the markets. The commodity market is likely to witness a 20 percent correction (in the worst case another 35% correction). If you have the stomach for it, short oil below 74. In the intraday hourly chart, it looks like it is likely to break the 75.35 level, which is the head and shoulder break. That should be stop loss. It is getting short-term support at 74.50 level. if that holds then good or else the next major support is 74. If there is a rise in the market over the next week (major trading will take place in the US only on Monday) then use the rally to take up short positions - if one is an aggressive trader. For the next one week there are only two good places, USD and US Treasury bonds. (i know both are bad

In the worst case: Dow will go back to 5000. I think that sums up the worst case in a sentence.

There is one very interesting development that we have been talking about: bond funds drawing a lot of funds over the past two months. Looks like the bond market has got the whole thing right, as usual Equity market it turns out is the dumb money. Currency guys are the thundering hordes who are jumping all over the place, and well commodity markets are somewhere in the middle.

One should not be surprised if the UST10 year note heads back to 127 or even 131.

The Dollar index is most important and interesting. 75.16 is a critical level but the important level to really look out for is the 76.30 level. if it is not able to move above that then expect a new low (well below 70) for the Dollar Index. (my personal level is that it could probably test that and may take out the 76.30 level over the next one month. if it takes out that level by Monday then expect a big rally in USD. Any close above 75.85 on a weekly basis will mean that we have hit a bottom in the dollar index.

Gold market is the next important market to watch out for. Normally in times of crisis (like the one that we are likely to have now with the start of the sovereign defaults) Gold should do well - but, "THIS TIME IT IS DIFFERENT". (pls dont get me wrong when i say that). I think gold is due for a very sharp big (good) correction. This are for a number of reasons:

1. Gold is anyway due for a sharp correction. It has returned 34 pc this year.
2. It may well turn out to be a "buy on rumour, sell on fact case".
3. There are huge long positions in gold in various commodity markets. They are likely to be liquidated.
4. The most important reason is that gold is likely to be sold because, all those who face margin calls are likely to sell gold positions and pay the margin call (i would do that if i were in their position - rather than part with cash, so likely that everybody would do that).
5. Fundamentally, this actually long-term good news for gold. I think governments will keep pumping in more money (now they have a good excuse) and that should lead to gold shooting up in the long term (after this correction). so utilise this correction to buy gold and as a second best alternative, its poorer cousin gold.

For all those who are still comfortable with only buying (long only) buy Exchange traded funds like VXX and FAZ. Then... sit back and enjoy the ride. Nobody in their senses would have actually been comfortable when the VIX touched 20.

I must confess that i was not able to sleep well since it touched 35, but that is the problem, i get on to the train even before they have refueled it for their journey, and i get off just as it has reached its first stop, leave alone the actual destination, but that could be the reason why I have lived to fight another day in the markets.

Happy trading.