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August 16, 2009

Golden Era

In Thursday's post I noted that if the S&P 500 managed to close back below 1010 on volume, I would be prepared to start shooting bulls again. Only half of the requirement was met as the index edged back below the pivot on a closing basis, but failed to show the necessary volume commitment. Furthermore, despite the paltry volume, the spyders were met with nearly $200M of buying-on-weakness... not the type of statistic I want to fight. If that is not enough to worry a bear, consider the weekly chart:

weekly s&p 500 chart

An army of traders are probably expecting the channel line to turn price lower. About the only hope of seeing such an outcome would be for immediate and sharp weakness on Monday. If we were kissing the 75WMA and seeing strong SoS data instead of BoW, I would place much higher odds on a downturn. Of course, it is not outside the purview of market gods to turn us lower and set another bear trap. The SPX 945-950 area acted as such an important psychological level, I'd be surprised if the index simply shot higher without a back-test. So, the stock market outlook remains in limbo and we traders must simply await clearer waters.

On a personal note, before the market opened Friday, I re-opened the ES short which I had discussed closing the night before. The NQs were taking a dive, and I shorted simply to follow their lead. Within a couple hours I had captured nearly 20 handles on the trade and then watched all day as the market churned sideways. I was anticipating a second wave of selling, but as we entered the 3:00 hour the danger of seeing the typical late-day ramp job was growing, especially since it was also end-of-week. I dumped the position for 16 handles and sidestepped the anti-gravity action in the last half hour.

It was a relief to see a portion of recent losses from shorting efforts dumped back into my account, but this type of trade is not my aim. If I could execute day trades so well on a regular basis, I'd be trading 30 lots, and the focus and content of the blog would be considerably different. Unfortunately, day trades are the only type for which I've had success recently as my longer horizon trades have continued to find themselves against the trend.

Going back to the SPX outlook, I've mentioned many times the importance of the 65DMA. This moving average is currently at 937 and rising. If one expects the next big market downturn to test or break the March lows, waiting for a close below the 65DMA would provide a safer entry while also offering nearly 300 handles of potential downside. Personally, I'm becoming less keen on the idea of a 1930s-style bear market where the market experienced a series of lower lows, each coming after huge rallies, and more keen on the 1970s scenario where the liquidity pump caused several huge gyrations as monetary stimulus fought the resulting inflationary effect for control over the economy. In other words, the current rally could continue a vertical ascent and may even approach or break the nominal highs, but eventually inflation will break its back and send prices painfully back into the abyss. For those of you keen on shorting, perhaps using a combination of Gary's cycle analysis and a failure of the 65DMA would improve odds.

Speaking of inflation, precious metals continue to hold up well. I notice a few traders are worried about action in the dollar, and the noise increases every time the buck posts an up day.

dollar index chart

It's possible the dollar's 5th wave aborted at the beginning of August, but until the index posts a higher high, I'm not fretting a trend change. Even so, the setup would only put us in a larger corrective wave which, as the Fed fights its deflation battle, would give way to another impulsive sell-off a couple months from now.

As you all know, I am expecting a parabolic move to develop in precious metals going into early next year. There are many factors lining up to support this move, including huge consolidation patterns, seasonality, and the fact that Obama's stimulus package will be weighted toward the first half of next year (which PMs should start discounting early). These moves tend to begin between August and November as gold breaks out of a consolidation.

weekly gold price chart

As you can see, the preceding consolidation range provides no indication of the scope of the impending parabolic move except that the move tends to be much larger. Our current consolidation has taken a different form and is also much larger both in time and range ($300). I suspect that a parabolic move launching from this base is going to blow away the $1300 target suggested by its height. The 2005-06 run posted a 70% gain. Personally, I would not be surprised to see gold double.

You all also know that I prefer silver to gold. What is going to happen to silver's price if gold doubles? Let's see what happened during previous parabolic runs:

gold silver price ratio

The 2008 liquidation saw the gold/silver ratio unwind rapidly due to the thin nature of the silver market. I suspect the next parabolic move will realign the ratio with its bull market trend, bringing it back to 50 or below. If gold runs to $2000, we should therefore see silver hit $40 or higher... a triple from current prices!

Now I'm not predicting these targets but rather demonstrating potential. Perhaps gold will only rise to $1500 on the next run, but such a move should be enough to pop silver to $30. You see my point.

A similar realignment should take place with the XAU/gold ratio, which was also knocked way out of whack during the crash.

XAU gold ratio

There is no historical precedent for the ratio dropping to 0.09. Mining shares are simply dirt cheap, especially if one believes, as I do, that a big run in precious metals is due. If this ratio reverts to 0.27 as gold goes vertical, a $2000 price puts the gold mining index at 540, or more than 250% higher than the current level. For those of you who want to be long stocks, I see no reason to waste your time with the SPX. It is simply not going to be tripling any time soon.

One of the reasons I am becoming more keen on a continued stock market rally is this view on precious metals. The data say an explosion higher is around the corner, but I don't think such runs can occur while stocks are crashing. The amount of new money being pushed into the system is going to float all boats. My primary job at the moment is to hunt for developments that will either signal the beginning of an acceleration higher... so I can augment positions... or warn that I am wrong... so I can axe them.


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