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September 18, 2008

Extreme Trading

No one could have been too short the stock market nor too long precious metals yesterday. Unfortunately, the prior day's action afforded a confident view on neither. I will admit to being tempted to take a small long bet on equities after the Tuesday's huge reversal, but to borrow a Steven Seagal line, there were only two things stopping me: fear and common sense. Of course, Wednesday changed everything so let's pull up some charts and see what can be deciphered.

Starting at the top, we see that the S&P 500 is testing the lower boundary of its bear market channel:

index chart

The S&P 500 is becoming quite stretched below its 75WMA. I won't use this measurement alone to close my shorts (which were re-applied mid-day yesterday, by the way), but it does make a case for reducing them and certainly for not chasing the market lower here with larger positions.

indicator chart

The put/call ratio suggests that panic is setting in, but has not become extreme just yet.

indicator chart

On the other hand, the VIX is showing extreme panic.

index chart

It will be important to see how the BKX handles support at 60. My "educated" guess is that a brief rally for both banks and stocks forms there, works off some of the sentiment extremes, and then we get a plunge to the 1080 area on the SPX to complete Elliott wave 3 of 3.

As for precious metals, gold and silver were both up in excess of 10% yesterday. I have not verified this next statement myself, but I read the gain was the largest one day gain for metals ever. The rally certainly looks juicy, especially when one considers that PMs are up sharply again today. But let's keep an important market lesson in mind. The sharpest rallies do not occur in bull markets but rather in bear markets.

For us precious metals bulls, it will be very difficult not to see this pop as the beginning of a new monster run, especially in light of the ongoing banking crisis and the massive liquidity injections being pumped by the world's central banks. However, let's not lose sight of expectations we laid down a month or so ago. Those expectations called for the first countertrend rally in precious metals to be strong enough to convince both bulls and bears that the bull market was back. Hmmm.

So despite the fact that I believe this rally may have a little more room to run, I'm just not going to chase it. If I'm wrong, my base position will take care of me, and if I'm right, I'll have plenty of cash to load up on metals when I've got a better feel for things.


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