Investors are scared right now, and rightfully so… Last week’s violent pullback in the markets reminded battle-scarred shareholders that our latest rally is anything but guaranteed. In the past 12 months we’ve witnessed a massive decline in market fear, but with last week’s market movement some of that fear volatility has returned.

But one thing I’d like to stress in today’s Sleuth, with the Volatility Index ($VIX) around 25, is that I believe we’re still at a reasonable level of volatility – and if anything, last week’s correction was long due.

The sell off was the worst since March 2009 with a 5% drop in the last three days of the weak week. Put in perspective, though, 15 Month S&P highs were made Monday January 19th – only a few trading days ago.

My focus lies on the recently humbled physical commodity markets that were down 6.5% as the raw materials sector retreated on Chinese concerns. Their coordinated announcement of slowing growth from the official 10% latest quarter GDP jump is designed to temper inflationary pressures – but contrary to some published obituaries the Red Dragon is still very much alive.

Last week has definitely gotten our attention but remember we have seen this action repeatedly before. For the last 10 months, every time the market looks like it will turn down it has responded with a rally to new relative highs.  Take a look:

One component in pricing for the options that my Resource Trader Alert readers invest in is volatility. For our purposes it helps us determine simply to buy an outright option if price are cheap or to purchase a spread if expensive (in relative terms). An increase in volatility is an increase in price movement – and don’t forget we need the markets to move in order to make money on our positions.

Stocks had slowed in the last couple of weeks and the $VIX, which measures the S&P 100 stocks, was solidly below 20 and as low as 16 January 11th. No fear, no movement as you saw quiet market conditions with tighter daily trading ranges while the market searched for a catalyst for prices.

Earnings have begun once again feeding the beast with its necessary diet of market information to digest. Banks have been permitted to make back some money from interest rates held low by the Fed. They had to make some money the old fashioned way:  they Earned it with the risk free policies of the Central Bank allowing them to replenish their dwindled cash coffers.

Is This Just a Pullback, Jack?

After any turnaround (in any market), traders look for price support. The logic is to start small with not making new lows for an hour, then a day, then the week. For example, the highly traded e-mini S&P 500 futures declined to 1089 in today’s session but not below Friday’s lows at 1086 and reversed to move higher on the day.

As a group commodities have done much the same with Gold and Oil closing higher after testing last weeks lows. Crude actually made a lower low at 73.97 Monday for the March contract but closed higher on the day which is a positive technical sign with that reversal on lower volume than Friday.

Another clue can be taken from the action in Treasuries, which benefited from the stock uncertainty last week. 30-Year Bond futures are off by nearly half a basis point as some fear has subsided in the short term. The next round of market volatility will tell us a lot about the market’s future direction.

It may be cliché, but my nearly 20 years of experience makes me most afraid when others are not and gives me a sense of calm when the public is frantic and unhinged.

This from Bloomberg:

Traders are piling into bets that the biggest sell-off in U.S. shares since March will increase stock market volatility, pushing call options on the VIX Index to the highest level in 19 months.

The VIX jumped 55 percent to 27.31 in the last three sessions, the biggest surge since February 2007, as demand rose for options to protect equities from losses. Futures show traders are betting it will remain above 25 for six months after averaging 20.29 over its two-decade history.

The VIX had its biggest annual drop ever in 2009, falling 46 percent, as the smallest stock-market swings in two years reduced the value of equity derivatives. The gauge is still down 66 percent from a record 80.86 in November 2008.

These emotional inputs have been successfully interpreted and managed within my readers’ disciplined RTA trading plan through ups and downs. Risk is always quantified and controlled with our strategies and that does not change as volatility increases, but opportunities do. We’re going to take advantage of those opportunities going into 2010.

It all comes back to commodities,
Alan Knuckman

January 29, 2010

Alan Knuckman

Commodity expert Alan Knuckman hails from the home of commodity trading in Chicago, where he began working as a clerk on the floor of the Chicago Board of Trade (CBOT).  Alan’s worked with all aspects of the commodity markets for the past 18 years - and now he brings his inside knowledge on energies, grains and gold to you. Alan's expertise and authority has led to frequent appearances in mainstream media, such as MarketWatch, Bloomberg, Fox Business,  CNN Money, and Reuters. He has also made multiple appearances on CNBC and CNBC Europe programs. Alan is currently the editor of Resource Trader Alert, a trading service devoted to raking in profits from hard commodities.

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