Saturday, 25 August 2007

COTs Flip to Bullish on 30-Year Treasury Bond, Rosier On Equities

Interesting signals from Friday's Commitments of Traders reports. The latest report has flipped to bullish for the 30-Year Treasury Bond. (In other words, bond yields to fall.)

I got this signal based on action in the futures and options markets by two groups of traders - the large speculators and commercial traders. My research suggests the large specs (large investment firms and hedge funds) are the "smart money" in this sector.

Yeah, I know what you're going to say. Trade with the hedge funds? Aren't these the same bright lights that brought us the Credit Crunch of 2007? In fact, in most other markets, you'd be right: The large specs are indeed the "dumb money," positioned the wrong way at key market turning points. But in the case of the 30-Year Treasury, I surprised myself by finding that we want to be in the same boat as these guys.

In the latest COTs report, the large specs dramatically reduced their net short percentage-of-open-interest position in Treasury Bond futures and options. They're now so barely bearish that their position has hit a historic extreme that, in the past, has tended to lead to trend changes in the bond market.

But that wasn't enough for me to declare a bullish signal for the bond. I get a signal in this market only when my setups for the large specs and commercial traders both concur. As it happens, the commercials first gave a bullish signal for the bond four weeks ago. In Friday's report, they gave a renewed bullish signal. (These signals are based on fading, or trading opposite to, the commercials - the "dumb money" in this sector. They've been reducing their net long percentage-of-open-interest position to historic extremes.)

So now both groups of traders do concur: The 30-Year Treasury Yield seems headed down. For more details on this setup and how I trade my system, check the "Trading Setups" and "How It Works" links above. For one thing, this setup calls for trades to be executed with zero time delay (i.e., on the open of trading, Monday, Aug. 27).

Other highlights of the latest report:

- Renewed bullish signals for the 10-Year Treasury and 13-Week T-Bill. Falling yields should help boost equities.

- A renewed bullish signal for silver. Is the precious metals bloodbath finally over?

- A renewed bearish signal for the Japanese yen. That could be more bullish news for equities: Maybe the carry trade is still alive?

- A third consecutive bullish signal for my COTs U.S. Equity Composite Indicator (a composite of the readings in my COTs setups for the S&P 500, Dow Jones industrials, NASDAQ 100 and Russell 2000). The reading rose to 0.68 from last week's 0.58. (A "1" or more would mean that, on average, all four setups have just given a buy signal to be executed for next week's open of trading.)

The indicator's latest 0.68 reading is nearly one standard deviation above its 156-week moving average, which gives me a renewed bullish signal for the S&P 500. (A signal comes when the indicator is 0.8 standard deviations or more from the moving average. See the "Trading Setups" link for more details.)

Overall, the COTs report seems to have a bullish tilt on the markets, with some exceptions. The S&P 500 small traders - whom I fade in my setup based on the S&P 500 COTs data - are still too bullish to change my bearish signal for this index.

But the latest data answers a large question that has hung over markets in recent days: Would Friday's COTs report tell us anything scary about how traders were positioned during and right after the worst of the market slap-down late the week of Aug. 13.

Would we get a slew of new bearish signals as we head into September, which the Stock Trader's Almanac folks say is the worst month of the year? Or would the latest COTs report continue in the same vein as previous weeks, suggesting the selloff hasn't been some kind of seismic 1987-like event after all, but just a regular correction within the five-year bull run?

The data seems to be stacking up mostly in the more optimistic camp. So far.

New Signals*
-30-Year Treasury Bond


Renewed Signals**
-U.S. Equity Composite Setup for the S&P 500
-10-Year Treasury Note
-13-Week Treasury Bill


-Natural Gas***
-Semiconductor Index, SOX
-Japanese Yen

Existing signals (date of original signal in parentheses)****

-10-Year Treasury Note (31-Jul-07)
-13-Week Treasury Bill (27-Feb-07)
-S&P/TSX Composite (15-Aug-06)
-NASDAQ 100 (27-Mar-07)
-Dow Jones Industrial Average (20-Mar-07)
-Russell 2000 (1-Aug-06)
-S&P 400 Mid Cap (7-Aug-07)
-Silver (3-Jul-07)
-Gold (29-May-07)
-US Global Investors Funds US Gold Fund, USERX (12-Jun-07)
-S&P/TSE Canadian Gold iUnits ETF, XGD.TO (22-May-07)
-Gold Bugs Index, HUI (29-May-07)

-S&P/TSE Canadian Energy iUnits ETF, XEG.TO (3-Apr-07)
-Oil Service Holders, OIH (3-Apr-07)
-S&P 500 (26-Jun-07)
-NASDAQ Composite (26-Dec-06)
-Semiconductor Index, SOX (20-Mar-07)
-Nikkei Average (19-Dec-06)
-Soybean Oil (11-Nov-06)
-Copper (10-Apr-07)
-Canadian Dollar (10-Apr-07)
-U.S. Dollar Index (3-Oct-06)
-Japanese Yen (2-May-06)

-30-Year Treasury Bond (31-Jul-07)
-Crude Oil, Light Sweet (3-Apr-07)***
-Natural Gas (27-Mar-07)***

* For an explanation of what I do after a new signal, click “How It Works” above.
** A “renewed” signal is when a market is already on a bullish or bearish signal, and traders again register an extreme net trading position in the same direction. I normally ignore renewed signals unless I don't already have a trade on in this market. I haven't studied the profitability of trading on renewed signals.
*** See my special caveats for my Crude Oil and Natural Gas setups (click “The Trading Setups” above and check the table footnotes).
**** The date in parentheses is the date of the COTs report that gave this signal - not the date my system called for the trade to be executed (which can be up to five weeks later). The existing signals are often several months old and are listed here as references, not trading recommendations.

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