Earnings excitement disappeared as commodities imploded on worries over a double dip recession returned to the headlines.

Market Statistics

Commodities drove the markets today with once in a decade type moves. Crude oil was down -$10 today and -$16 for the week. Silver declined another $4.70 to $34.25 and -$13.50 for the week or -27%. Moves like those cause severe unintended consequences across the entire market spectrum.

Kicking off the moves this morning was the weekly Jobless Claims, which rose unexpectedly to 474,000 and the highest number since October. This immediately brought back fears of a double dip recession even though analysts thought it was related to automakers doing temporary layoffs due to parts shortages. However, New Jersey, Massachusetts and Pennsylvania led the list of the most new claims and I don't think those are heavily related to auto manufacturing. Since we don't know what industries the layoffs came from everybody keyed on the headline number. This was the second consecutive weekly rise and the fourth consecutive week over 400,000.

Jobless Claims

The jobless claims probably would not have been as big a deal were it not for the big Non-Farm Payroll report for April due out on Friday. The March report showed a gain of +216,000 jobs and the official consensus for April is now 189,000. However, the whisper numbers are now under 100,000. That would be a blow to the equity market as well as the oil market.

However, the Monster Employment Index rocketed higher by +9 points to 145 for April. The report was released today but was ignored. That is the third consecutive monthly increase from a low of 122 in January. This suggests hiring is accelerating. Something does not compute. I heard an interview on the radio this morning from a headhunter in California. They claimed their college graduates going into the job market for the first time were getting multiple offers over $100,000 each. Of course $100,000 in California is like $50,000 in Denver but it is still an important metric. Some graduates had received more than ten offers. Startups, a heavy component of the job market in California, were unable to compete for qualified workers.

The confusion over jobs and jobless claims could clear somewhat after Friday's jobs report but it could also be ugly if there is a significant decline.

The spike in jobless claims was blamed for the -$10 implosion in the oil markets. Fewer people working meant fewer people driving to work and lower gasoline demand or so the theory goes. I have a slightly different theory of the collapse.

The hottest market for hedge funds and speculators for this year has been silver. As prices continued to rocket higher funds and speculators continued to leverage up to the maximum to capture the rally. That was a good plan until suddenly it wasn't. When silver began to crash in $5 increments ($25,000 per contract) that knocked a serious hole in investor accounts. For hedge funds and institutions with thousands of contracts the obvious thing to do is wait for a bounce to exit.

Enter the CME with their hair on fire. The CME started raising the margin rates on silver every 48 hours for the last two weeks. Now traders are not only underwater on their silver contracts but the CME wants an additional $10,000 per contract in margin. For those already underwater on their contracts and their accounts squeezed the margin hikes became margin calls and a new wave of forced liquidations began to hit the market. Remember, not only was silver falling $25,000 per contract per day but also margins had spiked $10,000 per contract. This was the proverbial double whammy. The CME announced last night another margin hike for today and to make matters worse they also announced another hike effective on Monday to $21,600 per contract. Margin on silver before the craziness began in February was $4,250.

The holders of silver futures were being hacked apart with a double-edged sword. Now the scary part begins. Obviously these large institutional investors and hedge funds are invested in more than one commodity and in plenty of equities as well. When a black hole appears in your trading account and the broker demands it to be filled the only option is to sell anything of value and do it quickly. Margin calls have to be satisfied immediately or brokers will force liquidate assets of their choosing to cover the margin. Traders are watching the black hole grow larger as the minutes pass and once they understand the severity of the problem they start throwing everything available into the margin pit in order to stop the bleeding. What they threw in today was oil futures.

How do you free up margin when disaster happens? You can sell something for cash and wait for it to settle OR you can sell other assets that are also margined to free up that margin and deleverage your portfolio. Since oil has been a very popular trade this year almost every major institution had a deep portfolio of oil futures of various durations.

I believe, based on the scenario above, that oil crashed not because of the jobless claims but because of the black hole in the silver market demanding to be filled with cash from the sale of any available asset.

You probably noticed that despite the $10 decline in crude prices that oil stocks were hardly affected. For instance Exxon was down only -$2, Chevron -$2, Conoco -1.65. You would think with a $10 drop in oil prices those oil stocks would have also imploded. They didn't because they are not really trading vehicles like other marginable commodities and they are held by a different class of traders. Goldman may be trading tens of thousands of gold, silver and crude contracts a day but they are not day trading Exxon or Conoco. Those are long term investments, not day trades. When traders are forced to raise cash quickly they will sell the trading vehicles not the long-term holdings. If the carnage continues they may be forced to sell equities as well but today was a commodity fire drill not a portfolio dump.

Volume in oil futures today was more than 650,000 contracts and well over the 300,000 average.

I believe there was also a fear the Nymex could take a page out of the CME playbook and raise margin rates on crude as well in order to slow down speculation that had pushed crude prices over $100. That would have been a real killer to have another margin disaster on a different commodity.

WTI Crude Oil Chart

Brent Crude Oil Chart

Helping to accelerate the decline in crude was a comment was a comment on the wires that OPEC "may" consider changing their production quotas at the June meeting to show the world they are serious about controlling prices. While I believe this is pure politispeak it did give traders another reason to trim crude holdings. Since OPEC nations are already pumping 2.5 million barrels per day more than their quotas the actual quota is a joke. It only matters to the public at large that see a six word headline in the news and believe it to be true. They could raise their quotas by 2.5 mbpd and not pump a single barrel more. It is just a tactic to take them out of the headlines as the axis of evil in the oil market.

Silver is due for a bounce now that it has fallen to support at the 100-day average at $34. However, I would not venture into the silver market until next Tuesday or Wednesday. We need for the new margin requirement to pass at the close on Monday and let the final contingent of weak sellers to throw in the towel. Then I would consider a long-term position or look for a tradable bounce. The -27% drop this week is a once in a decade decline, probably a once in a lifetime decline but since it occurred after a 31 year high there could be some lingering volatility for some time as traders hoping for a bounce to make them whole again finally give up and toss the towel.

The Silver ETF (SLV) traded 295 million shares today compared to 77 million on a normal day. There were 347,000 puts on the SLV compared to the March average of 15,700.


Silver Chart

On the bright side of the oil equation the decline will probably end the assault on $4 oil. The average U.S. price today was $3.985 per gallon. With the drop in crude prices and the increased production of summer gasoline blends now that the spring maintenance season is over we could see prices back in the $3.50 range by June. That would be a huge relief valve for the economy, which is obviously already seeing the impact of high prices.

The dollar index rebounded more than a full point in a monster move counter to the trend. You have to ask yourself why the dollar would rally so strongly when the Jobless Claims suggested the economy was tanking. I believe this is also related to the need to dump any futures contract with a margin component. Every institution in the U.S. has been shorting the dollar for months. Shorting currencies requires margin. When that silver black hole appeared those shorts were covered to free up the margin and deleverage the accounts. Just my opinion but I am sticking with it.

Dollar Index Chart

Some analysts were pointing to the drop in copper as evidence the economy is slowing rapidly. Again, I disagree. The drop in copper was purely related to the same factors over covering the hole in trader's accounts. All of these commodity contracts require futures. There are also multiple commodity ETFs and commodity indexes. An implosion in silver tanks these commodity indexes and ETFs and that drags down everything else in the indexes. For instance the CRB Index fell -5%. The decline in the index required tracking trades to dump the associated commodities. Everything in the commodity market is interrelated.

CRB Index Chart

Copper Chart

The commodity implosion completely erased any earnings news from the headlines but there were some big earnings. Visa (V) reported its Q1 profits rose +24% due to higher use of credit cards by consumers both in the U.S. and abroad. More than 60% of the revenue growth came from outside the USA. Non U.S. revenue was 45% of the company's total. Visa said the good growth came despite a sharp drop in travel and spending in Japan. Visa earned $1.23 per share compared to estimates of $1.20. Revenue rose +15% to $2.25 billion. The company said it was also authorizing a new $1 billion stock buyback. Shares fell $1 in regular trading and another dollar in after hours after the earnings were released.

Visa Chart

GM posted a $3.2 billion profit of $1.77 per share. This compares to only $900 million in the year ago quarter. The company said they were seeing strong demand for their fuel-efficient vehicles. That was the fifth consecutive quarter of profits. Profits would have been higher except for the recall of 154,000 of the Chevy Cruze for transmission problems. That is the best selling car for Chevy. The government still owns 26.5% of GM, down from 61% in 2009. Earnings without special items were 95-cents and that beat analyst estimates of 80-cents. GM shares fell -3% thanks to the market.

The other bailout twin, AIG, reported a loss of -$1.41 for the quarter despite a significant rise in revenue to $17.4 billion. Analysts had expected $14.97 billion. Analysts expected a loss of 15-cents per share but that was not comparable with the unfiltered number AIG released. The company had to take a $3.3 billion charge related to the termination of the credit facility from the Federal Reserve. The government is on track to sell some more of its 92% of the company beginning later this month. Shares fell about 50-cents after the close.

The S&P declined by -12 points but the S&P decline was orderly with declining volume only 3:2 over advancing volume. Advancing stocks totaled 130 and declining stocks 341. Considering the Dow was down over 200 points at its lows this was an orderly bout of profit taking on the S&P. The support at 1340 was broken and the index dipped to the next support level at 1333 before rebounding slightly. The S&P was dragged lower by the energy sector and the mining sector as a result of the implosion in the associated futures.

If the support at 1333 fails I could easily see a decline to 1300 and the 100-day average. There is considerable support at the 1300 level so I don't expect that to fail without some material change in economics or geopolitical conditions.

S&P Chart

The Dow rallied +700 points in the prior two weeks so a decent bout of profit taking was expected. Since the 12,807 close on the 29th the Dow has declined about -300 points. No material support levels have been broken since it was so over extended from the prior week. The next downside target would be the 30-day average at 12,438 followed by 12,250.

The biggest decliners in the Dow were Exxon, IBM, Chevron, Caterpillar and 3M. I don't see any material problem in the Dow's decline. I mentioned more than once last week that we should expect some profit taking. Nothing has changed.

Dow Chart

The Nasdaq returned to major support at 2800 but the point decline was minimal at only a 13-point loss. There was no disaster in the tech sector. In fact there were some major gainers like PCLN +7.24, ROST +5.12, SINA +3.54, TRMB +3.51, MELI +3.22 and PNRA +2.80 to name a few. Unless this bout of profit taking suddenly takes on a new post jobs report flavor this is just a temporary dip.

Nasdaq Chart

The Russell declined to major support at the 50-day at 829 but could still decline to support from April at 820. Despite the three-day decline the Russell has performed exactly as it should have over this period. Now we have a clear level to watch at 820 for market direction. A rebound there is a signal to buy and a break there is a signal to sell.

Russell Chart

Volume today was 9 billion shares and the highest since March 16th at the bottom of the March dip. However, it was only 3:2 in favor of declining volume. There were still plenty of buyers and there was definitely no capitulation of any kind. I believe this is simply a bout of profit taking and cash raising to cover commodity losses. I don't believe it is a "sell in May" event but it is still too early to tell.

The Non-Farm Payrolls on Friday will be a pivotal event. If the worst-case whisper numbers are not hit and jobs are even close to expectations the market should recover quickly. The commodity dump may not be over and it could still be the tail wagging the equity dog until next week. There have got to be thousands of stubborn traders still holding commodity positions and hoping for a rebound to salvage their losses. Until those traders capitulate we have not hit the bottom in commodities.

Enter passively and exit aggressively.

Jim Brown

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