We have never come across a satisfactory way of quantifying overall financial market liquidity, but major trend changes in liquidity can be observed in the price action. In this regard, the price action in several markets points to a major downward reversal in the liquidity trend having occurred during the first half of October.

To further explain, too many markets reversed course during the first half of October for it to be a random coincidence. Therefore, during this period there must have been an underlying shift in something with the ability to pressure prices in diverse markets upward or downward. A shift in the liquidity trend is the most logical explanation.

A shift in the liquidity trend could explain why all the following happened within a 2-week period:

1) There were spectacular downward reversals in the prices of stocks focussed on Rare Earth Elements (REEs), indicating that the REE bubble — a bubble that was extremely profitable for us — has burst.

2) The prices of gold and silver rocketed upward and then reversed downward.

3) The gold mining indices/ETFs peaked in mid-October, two days after breaking above their 2011 highs, and then plunged.

4) The prices of platinum and palladium rocketed upward and then plunged.

5) After peaking during the second week of October, US Antimony Corp. (UAMY), a proxy for the antimony speculation, quickly lost about two-thirds of its value.

6) Bitcoin made a new all-time high and then reversed downward.

7) The German stock market, as represented on the following chart by the DAX, made a marginal new all-time high and then reversed course. The chart indicates that the DAX may be about to complete an intermediate-term topping pattern.

The most important market that is yet to show evidence of declining liquidity is the one that is being supported to the greatest extent by passive money flows: the US stock market as represented by the SPX. However, if a major liquidity trend reversal is underway then its effects should start to become apparent in the senior US equity indices by early next year at the latest. More generally, if a major liquidity trend reversal is underway then no market will be spared and the next several months will be a period in which to ‘play defence’.

[This blog post is a brief excerpt from a commentary published at www.speculative-investor.com on 9th November]

In the 15th October Interim Update, under the heading “The REE Bubble”, we wrote that all the REE-related stocks that we track except for Neo Performance Materials (NEO.TO) were now in bubble territory. This was not only because equity prices had gone parabolic, but also because the price gains in the stock market were not supported by price gains in the underlying commodities. We went on to write that the bull market possibly had years to run, but the risk of an intervening crash had become high. Therefore, we recommended that anyone with significant exposure to REE-related stocks who had not yet harvested meaningful profits, should do so right away. Our warning was well timed, because a crash began almost immediately.

The first of the following daily charts shows that MP Materials (MP), the largest (in terms of market capitalisation) stock in the REE sector and a stock that we use as a sector proxy, fell by 50% from its October high to last week’s low. The second chart shows the performance of USA Rare Earth (USAR), a stock that looked very expensive in early-September — BEFORE it tripled in price on the way to a blow-off top in October. USAR lost two-thirds of its value from its October high to last week’s low.

On average, the prices of the REE stocks on our radar screen fell by around 50% from last month’s high to last week’s low. The stock price of Neo Performance Materials (NEO.TO) held up relatively well and suffered a peak-to-trough decline of ‘only’ 32%, because it didn’t rise by as much in the lead-up to the top and because its current valuation is underpinned by current revenue and earnings.

The way these things usually go, the initial phase of the crash will be followed by a rebound to a lower high, a decline that tests or breaches the initial low, and then several months of base-building. After that, the next leg of the bull market possibly will begin. Note that last Friday’s price action suggests that the initial phase of the crash is complete, so over the weeks ahead there probably will be a rebound.

With commodity-related stocks, we like to do most of our buying during base-building periods and to scale-out during the parabolic rallies.