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October 28, 2012

Green Line or Panic

Over the past week, gold formed a daily swing low in the middle of its timing band for not only a daily cycle low, but also a weekly low. The rallies out of weekly lows tend to produce extended, trending moves, and given the backdrop of a new money-printing program from the Federal Reserve, the next weekly cycle could produce huge gains. So why am I not buying, yet?

My hesitation is a product of typical cycle characteristics for gold and correlated assets such as stocks and the dollar. First, gold usually witnesses at least one session of panic on its way into a weekly low, and so far the decline off the early-October peak has been quite orderly.

Crude oil daily cycle chart

Gold has also spent the last three sessions testing the nice, round number of $1700. Somehow I don't believe the yellow metal will just rocket higher without the big boys trying to take out stops below a psychologically-important price.

The dollar's setup also supports the notion of a final panic in PMs. For the past six weeks, the DX has been laboring out of its own weekly low, and while this new cycle is expected to roll over and find a much lower low than the previous cycle, a key characteristic of a new weekly cycle is still missing.

Crude oil daily cycle chart

The dollar index must move above DX 80.43 (blue line in chart) in order to form a weekly swing low. So a quick 50-cent-plus move may be in the cards for the buck this week. The swing low is so common a tool in trading systems that I would be shocked if one were not soon delivered for the dollar because its occurrence would draw "swingers" onto the long side of the trade at exactly the wrong time. The big boys have a clear incentive to push the dollar above DX 80.43 and blow out buy stops before taking the buck lower.

A final pop higher by the buck would also assist stocks with some unfinished business. The SPX has endured a 6-week decline and appears to be playing out a move into its own weekly cycle low. Like the dollar, however, a key component of its move is missing.

Crude oil daily cycle chart

Without a failed daily cycle, an intermediate decline cannot exist. Of course, stocks also tend to post panic days on their way into a weekly cycle low, so if the dollar manages that final burst higher, stocks are prone to a quick drop. Like gold, the violation of a nice, round number... in this case, SPX 1400... would provide big players with a chance to relieve the emotional, retail crowd of positions before the next rise.

So, I am not buying these late-week bounces in the PM sector. Markets seem to be poised for a violent shake before counter-trend moves are complete, and I can enter with a much stronger hand by buying a panic rather than trying to call a tenuous low. Nevertheless, a Plan B must always be in hand. If gold were to break its cycle downtrend (green line in the gold chart), we would receive secondary confirmation of a cycle low, and I would begin building positions.


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