AAII Bulls, Silver and Natural Gas

Key Points

• The stock market remains weak; however, a useful sentiment indicator continues to suggest extreme bearishness
• Silver has rallied in recent months; however, this market is entering a seasonally unfavorable period and faces significant upside resistance
• Natural gas has rallied in a straight line since entering a seasonally favorable period and that period has more time to run; however, sentiment is reaching a level that has warned of trouble ahead in the past

AAII Bulls

The most recent weekly reading for AAII Bull fell to an extremely low reading of just 15.8%. The chart below displays all weeks when this measure was below 20%. You can run this test in the Backtest Engine.

The table below displays a summary of S&P 500 performance following all previous readings below 20% (including overlaps).

Several key macro factors are currently working against the stock market (inflation, rising interest rates, high valuation, and poor price trend action come to mind). Nevertheless, this latest AAII reading suggests that a lot of bearishness has already been factored in and that stocks may well rally in the 6 to 12 months ahead - with the caveat that a full capitulation decline could occur between now and then.

Silver seasonality raises a caution flag

The chart below displays the annual seasonal trend for silver futures. As you can see, we are on the cusp of an unfavorable period. This period extends from Trading Day of the Year #73 through TDY #117. For 2022 this equates to 4/18 through 6/20.

The chart below displays hypothetical $ + (-) achieved by holding a long position in silver futures only during this seasonally unfavorable period every year since 1970.

The table below displays a summary of silver futures performance during this period.

Two key things to note:

• With a 46% Win Rate, it is important not to assume that silver is doomed to decline in the months ahead
• During this period, when silver is good, it's pretty good, but when it's bad, it's very bad

One other thing to note regarding silver is that it presently faces much upside resistance. This is illustrated by the horizontal lines in the chart below.

Can silver ignore seasonality, cut quickly through perceived resistance, and rally to new highs? In a high inflation and strong commodities environment, absolutely. In addition, a trader should rarely rely solely on seasonality to trigger a trade. Seasonality merely points out times when a given market may be ripe for moving in a particular direction. For now, the point is simply that when dark clouds start to form, it is typically a good idea to pay close attention for a potential storm.

Natural gas is trying to go parabolic as Optix reaches a cautionary level

To be crystal clear, the purpose of the following text is not to convince anyone to try to sell short into the teeth of what is becoming a parabolic advance in natural gas. The purpose is to remind us that "trees don't grow to the sky" and that when parabolic moves end, they often do so abruptly, and a reversal can occur very quickly.

The chart below shows the powerful rally in UNG (United States Natural Gas Fund, LP) in the last month).

There is no reason that this rally cannot continue. The chart below displays the annual seasonal trend for natural gas futures. This market is still in the middle of a generally bullish seasonal period.

Still, while natural gas can continue to rally higher, it will be important to keep an eye out for clues of a top. The chart below displays those days when Natural Gas Optix crossed above 68.9 for the first time in 26 weeks. You can run this test in the Backtest Engine.

The table below displays a summary of natural gas futures performance following the signals in the chart above.

The results are even more dramatic when looking at the ETF ticker UNG. The table below displays a chart of UNG highlighting all days when natural gas futures Optix crossed above 68.9. You can run this test in the Backtest Engine.

The chart below zooms in the last ten years of the chart above to provide a clearer picture of UNG price action following previous signals.

The table below displays UNG performance following the signals above.

The results above suggest that natural gas (and UNG) can continue to rally for a time. In fact, a runaway "spike" in price and/or sentiment would not be at all surprising. But alert traders should pay close attention, for history suggests that that reversal may be swift and severe when this market reverses.

What the research tells us…

The situations detailed above present excellent opportunities to invoke:

Jay's Trading Maxim #18: Follow the trend, but DO NOT fall in love with the trend.

Riding existing trends is one of the best time-tested ways of profiting in the financial markets. The problem is that human nature tends to cause us to feel elation when a trade is moving quickly in our favor - and the desire to enjoy that elation can cause us to "overstay our welcome." This can be extremely problematic at times, as sometimes the strongest trends are followed by reversals that are swift and severe. This reminds me that it's a good time to invoke:

Jay's Trading Maxim #306: Human nature can be a detriment to trading success...and should be avoided as much as humanly possible.