Correlations are awesome when they work. So far, these correlations have been working.
COT report shows extreme readings again. Don't try to find fault with every nook and cranny and over-analyze such a simple report.
Last time the commercial hedgers were extremely short, bonds (NYSEARCA:TLT) fell and that fall was nasty. This time, we are seeing even more extreme readings. Like I stated in my gold article, the safest direction is the short side. Ignore all of the gobbledygook in between the highlighted areas. You are not trying to catch every single gyration. You are trying to make a high probability decision. The probabilities of a sell-off are more likely than not.
Also, we have inflation worries as well. This is another factor that could potentially kill the bond rally. What can we use as a proxy for inflation? How about the inflationary commodities? These would be in the agricultural ETF (NYSEARCA:DBA).
Below is a list of a few of the products it contains. These products tend to rise if there is a fear of inflation occurring.
(Source: Yahoo Finance)
If we look at the graphs of the bonds and the DBA side by side, notice what happens (Pardon the scales. It appears that scaling cannot be one for one even though the time frame and ranges are aligned).
Notice when commodities fall, bonds rise. Right now, agricultural commodities seem to be a better prediction for bond prices rather than the old-school stock and bond correlation. That correlation is out of sync. I just don't pay attention to that anymore. If you look at the recent correlations, an alarm should be going off in your head.
The S&P 500 has been stagnant while the bonds for the year have been trending higher. You cannot assume that if the S&P 500 rises, bonds will fall or vice versa. It's just not there. Another thing to note is the COT is god awful at predicting turning points with equity markets, which is why I did not bother adding it in the chart below.
I also watch the correlation of gold (NYSEARCA:GLD) with respect to bonds. This is the first time both instruments where the commercial hedgers are extremely negative in their sentiment at almost the exact same time. As I mentioned before, you can read my previous article on why I said to short gold. The extreme indications are a telling sign. Now gold seems to be in the beginning stages of a fall. It may signal that bonds will follow suit and begin its descent.
Lastly, the final correlation I watch is the Japanese yen. For some strange reason, it seems to be driving the bond rally. You do not need to start creating reasons as to why this is occurring. Just know that the correlation now seems to be if the yen rises, equity markets fall, bonds rise. Unfortunately, the other major currency pairs are unable to give us an edge to understanding what will have a significant impact on bond prices.
With all of this, here is what you need to do:
You need to watch how inflation fears are playing out with the DBA, how gold is responding to that, and how bonds are dealing with the inflationary fears and if bonds are following gold's descent. Lastly, see how bonds react to the rising Japanese yen. The rise of the yen may delay the fall. However, it is wise to begin to position yourself to the short side. That is the safer bet.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.