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January 26, 2011

Gold On the Cusp

What a day for precious metals miners. We saw gains in the larger stocks of 4-6% while some of the micro-caps such as First Majestic (AG) posted double-digit gains. Yesterday's purchases now seem brilliantly-timed, but I cannot claim to have been bottom-calling. I just saw what appeared to be extreme conditions and decided to boost my exposure. Apparently, I didn't do enough. Today's strong follow-thru provides the impression that mining shares just formed a significant low. Does that mean the intermediate low is in for gold? Not necessarily. Let's dig in...

The Fed basically delivered what markets were anticipating which was to reaffirm they will print the dollar into oblivion. I think mining shares were sniffing that out with yesterday's reversals. Gold also posted a nice rally today and managed to form a swing low, but unless our little yellow friend manages to break its daily cycle downtrend, the door is still open for a cycle-ending panic sell.

Gold Daily

For those of you wondering why I am deferring recognition of a new daily cycle until gold surpasses its cycle downtrend line, consider how last February's intermediate low formed:

Gold Daily Feb

Last February's wiggles may, at first glance, seem like unusual action, but it is actually quite common for gold to produce a false swing low just before an intermediate bottom. Furthermore, the fact that the current swing low formed as gold bounced off an important pivot in the low $1320s just provides more impetus for a potential sucker punch. A move below $1320, which I've described as an ideal place for big money to deprive traders of valid long positions, now has an even taller pile of stops to blow out. If such a panic were to transpire with mining shares holding above yesterday's lows, we would have about as solid a case for an intermediate low as we'll ever get. We could then step in and buy confidently... and buy big.

The potential for a blow-out move in gold fits quite nicely with the setup in the dollar's daily cycle:

DX Daily

So, we could see gold edge up to test that cycle downtrend line as the dollar sets its own daily cycle low. The move up into a new daily cycle by the buck would then induce a gold dump. As the dollar quickly rolls over... and as I mentioned yesterday, left-translated dollar cycles typically peak within a week... gold would post its first gains of a new intermediate cycle.

The alternative is that gold manages to rally above the trend line immediately, thereby confirming a new daily cycle. In this scenario, it would be possible an intermediate low is already in. I would buy that confirmation, but not in as big a way as if given the opportunity to fade a panic. In the case of a panic, weak hands will be cleansed in one fell swoop, and the door would be open to substantial gains as traders are forced to chase a rising market. If we see a mundane cycle low, gold will probably have to drift sideways for a while to bore folks out of the market before making larger gains.

Given our interpretation that the dollar has commenced the terminal decline of its 3-year cycle, I highly doubt gold will waste a daily cycle moving sideways. In conjunction with cycle tendencies discussed above, a panic day seems to be in the cards.

The S&P 500 managed a new, bull market high today, so as promised, we are labeling a new daily cycle.

SPX Daily

While that daily cycle decline does not look like much to the naked eye, I am confident in the call because the declines in tech and small caps were more pronounced.

RUT Daily

The recognition of a new daily cycle also gives us a firm level to watch for confirmation that an intermediate decline has begun. A move below Thursday's low at SPX 1271 produces a failed daily cycle, which, of course, is our primary signal of a larger-scale decline.

I should remind everyone that while a stock market decline seems imminent, there is nothing in cycle theory stopping this rally from extending further. For reasons discussed in previous letters, we have been expecting the current intermediate cycle to run 30+ weeks. The only limitation to the length of this cycle lies in the tendency for yearly lows to fall within two months of the previous yearly low. Now, I know the last yearly low is labeled in July, but that labeling is the product of an unusual decline. We still expect the current cycle to decline into a yearly low within two months of last February's low.

This cycle, therefore, has until early April to find its low. So technically we could see higher prices into March! Do I expect such an extended move? No, but as always, we should keep an open mind. My subjective view is that the dollar's bounce into a new daily cycle will trigger the failed daily cycle we anticipate in equities. Stocks should then fall in commiseration with the brewing dollar crisis. If the daily equity cycle fails to fail, so to speak, as the dollar bounces, I will exit my shorts because there would then be a grave risk of seeing stock prices go vertical. We could then seek another entry near the end of the dollar swoon.


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