Hi folks,
Since returning from my holiday there seems to be one major talking point on the sites that I look at: Are markets slipping into reverse or merely pausing for breath before continuing on their merry way? Or, to put it another way, where are the next trading profits coming from?

The past few weeks have seen a rally in equities and the Dollar, whilst gold, oil, Sterling and the Euro have retreated faster than the Georgian army. Low volume volatile markets have presented some fantastic trading opportunities. But were these moves down to a shift in world affairs or was it just easier to move prices with so many of the heads of investment desks away?

This is a tricky time of year to make a major call, as excessive moves on low volume make a real mess of the chart patterns. But as traders we need to be awake to changes in sentiment so here’s my humble take on life, which at least ought to provoke a few responses.

It’s The Economy Stupid
A lazy view on the economics is that nothing’s changed; growth is slowing and prices are rising. These two factors are becoming increasingly polarised and are setting more new records than the Olympics.

But scratch below the surface and you’ll find a shift in the pattern. It’s becoming much clearer that the US didn’t use a tissue when it sneezed! Large parts of the world have caught its cold, with Japan and parts of the Eurozone recording negative growth for the second quarter of the year.

Inflation’s more than double its target in both Europe and the UK yet Governor of the Bank of England, Mervyn King, chose to focus on the gloomy prospects for growth. And the European Central Bank’s mega-hawk, Monsieur Trichet, put the skids under the Euro when he smelt the coffee and declared that Europe might not be growing so fast after all. The cosy view on inflation is that as the oil price is now falling there won’t be an inflation problem in a year’s time. Hmm, by my calculations the oil price has fallen by around 22%, but petrol in my town has fallen by only 8%. And I’ve not noticed any price cuts from the energy companies either.

Equities
Cast your mind back to earlier in the year when Chelsea thought they’d win the Premiership. Equally as daft, investors were pencilling in the third quarter as the recovery period. After hitting a summer low, confidence would return, the birds would start singing and equities would be carried off into the sunset.

It looks like some investors still believe it. Personally I’ve struggled to see any improvement in the economy, and the banks are coming out with more kitchen sink jobs than B&Q. There are weekly (sometimes daily) reminders of the turmoil in the banking sector. Two stories have dominated the markets this week. The first is the possible nationalisation of Fannie Mae and Freddie Mac, with the fear that shareholders would receive nothing. Secondly, a former economist at the International Monetary fund opined that it was probably only half-time in the credit crunch match and that the next few months would see a major bank go t*ts up.

Granted, equities were due a bounce after the mother of all sell-offs. And in the States the SEC temporary ban on short-selling saw a vice-like squeeze on short positions in bank shares. But that ban is over now, at least until the next emergency measure is put in place. And there’s little in the real world that argues for higher valuations. Although money market rates aren’t at the extreme levels of earlier in the year, banks are still reluctant to lend money. Meanwhile consumers are being squeezed by rising mortgage, fuel and food costs, which don’t bode well for retailers and the leisure industry.

The chart below of the Dow shows a similar pattern to the Dax and FTSE. This week’s falls have taken prices below moving average and trendline support. That move certainly got me rocking about and opening a few short bets. But more seasoned traders might be waiting for a weekly close below support and/or a more pronounced downturn in the 14 and 21-day moving averages before calling the next leg down.

Oil and Gold
This summer was bad for sunbathing, English cricket, Irish Eurovision songs and commodities. Oil and gold both fell by a whopping 20%. At first the fall was put down to the realisation that slower global growth wouldn’t need so much fuel (Dur!). But was this just a much-needed enema with a lot of loose positions rapidly going down the pan? Specialists in these markets say that the bull run in both is still intact and that this is no more than an overdue shake-out.

This week Goldmans re-iterated their year-end forecast of $149 a barrel regardless of movements in the Dollar. Venezuela plans to propose a cut in output at next month’s OPEC meeting if prices are still falling, and I wouldn’t rely on the new regime in Russia to help the west out. As the Olympic games draw to a close expect China to re-open the factories and start pumping loads of black smoke into the sky.

On the other hand Bush’s invasion of Iraq is slowly starting to produce oily dividends. Production is likely to pick up in the Canadian tar sands, and new fields in Saudi, Nigeria an Angola will help relieve the pressure. And as the US driving season comes to an end, this week’s inventory figure showed a huge surplus. Experts expect there to be a larger surplus of oil in the near future, but then that was supposed to be the case during the recent rise.

Thanks to the guys at ADM Investors for the chart of oil futures

I reckon oil’s due a bit of a bounce, but I’ll be happy to watch from the sidelines. I’m currently trading gold, the Dollar and FTSE, and that’s plenty for me.

For me the gold chart is tricky; I reckon it’s been oversold and is due a bounce, and I’m happy that the bull run dating back to King Midas’s time is still intact. But the medium view shows the 14 and 21-day averages pointing firmly down the mines, with the price way below its key 200-day moving average. Having said that, a retracement to test the 21-day moving average at around $860 would still be worth participating in.

Gold picks up a seasonal bid around now ahead of the Indian Diwali festival and will probably also find favour as a hedge against inflation, war and the credit crunch. But the question is whether there will be enough demand for bling if a deep recession spreads across the world.

If you’re new to these markets have a read of our beginners guides below:
How To Trade Oil-The Cruder Way
A Crock Of Gold

There’s probably a rule somewhere that says I’ve got to disclose my interests. Yep, I’m a small long of gold; I’m not sure how far it will go so I’m trailing my stop pretty close behind the price. You can see how that, and my other bets, are doing on the daily blog, and in the subsequent postings.

US Dollar
Currencies are hard to call, as they’re never an outright sell (when you sell one currency you have to buy another one). Much of the Dollar’s recent strength was put down to the realisation that other countries had caught the US’s cold. The diagnosis was changing from a US problem to a global one that required lower interest rates than had been priced into the currency markets.

Not long ago Europe raised rates, hinting that there were more to come if needed. Now, even Trichet has taken his finger off the trigger. The UK’s MPC tried talking tough on inflation a while ago, but traders saw through them. The recent 4.6% (much higher than expected) headline inflation saw selling of Sterling. The logic here was that UK rates couldn’t fall now because inflation was so far above target. And, as we know, interest rates are the main weapon in a central bank’s fight against inflation. So a rate rise would squeeze the economy even further, requiring a bigger cut in rates some way down the line. And it’s those ‘cuts down the line’ that forex traders are focussing on. For more on how the central banks, and their role in fighting inflation, check out Loan Sharks In Expensive Suits.

Like equities and commodities, the period of Dollar weakness was due a snap-back. But the savagery of the fall suggested panicky dumping of positions and triggering of stop losses. Now it gets tricky; the moving averages point to a classic strong Dollar trend. Also the lack of worthwhile bounce hints at a further need to buy back Dollars and little desire to sell them. There’s nothing the forex guys like more than a good trend to trade with so I’m nervous about calling a turn here.

Chickens and Eggs
The tricky question is, “Which market is in the driving seat?” Was the strong Dollar sending commodity prices lower, and consequently giving equities a bid? Or were traders buying the Dollar on the back of falling commodities? Will either/or both commodities and the Dollar revert to their earlier trend (weak Dollar equals strong commodities) and what bearing will this have on equities? To me, equities seemed to be tiring, even with the oil price falling. I’ve less of an opinion on the next big move in forex or commodities, but one thing’s for sure. There’s still a lot of investment money out there looking for a market to back. For the past year it’s been in commodities; if traders don’t believe in the bounce where does the money flow to?

What am I trading? Well, I’ve been trading most of the above over the past few days. But I reckon a telling fact is that I’ve bought gold and GBPUSD quite a few times for a bounce against the trend. I’ve made money, but on each occasion my tight stop has been taken out. This tells me two things: Firstly that there’s a lot of random swings in these markets at the moment. Secondly, that I’m (rightly) nervous about trading against the trend so I’m unlikely to make my fortune.

Contrast that with my short bet on FTSE. I feel more confident that a trend is emerging so I’m keeping a wide stop loss and staying in the game. The profits aren’t huge, but I’m there playing the game.

Finally, with thanks to Moneyweek, here’s a little chart illustrating the trading cycle.

Who agrees, who disagrees? It’s great at the moment because anyone reading the posts will see there’re a lot of opposing views amongst you. Let’s get the debate going.

Happy Trading.