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October 9, 2008

Historic Crash

Let me run some stats by you. For the week so far the S&P 500 is down 17.2%. The Nasdaq 100 is down 13.3% for the same four days, and its outperformance (a strange word to use for a 13% drop) is due to its mere 4% drop in today's session compared to 7.6% for the SPX. Since the bailout package was announced, the S&P 500 has plunged 27%. I guess Paulson wasn't kidding when he said we were "on the brink." The VXO has printed in the seventies for the last two days (it peaked at 62 during the 1987 crash), and the put/call ratio has spiked hard.

indicator chart

The key word in the chart note is "near." Despite the 17% drop, the CPC 10DMA is not in panic territory. Of course, I've been stating recently that Wave 3-of-3 would not take us into panic territory on this indicator, but it appears now that wave 5-of-3 is being short-circuited. I now suspect that whatever bottom wave 3-of-3 puts in, it will be a lasting bottom which, relative to recent bottoms, means at least 4 months. For the record, I followed my instinct about an assault on SPX 950 by shorting heavily this morning. My cue came when the early pop failed quickly. Since the index did not actually test 950 until very late in the session... and it hardly looked like panic at that time... I managed to ride the wave of selling into the close. It was quite cathartic after watching the market fall 10% on Monday/Tuesday while being caught flat-footed.

I returned to a neutral stance at the close, so if the market gaps lower tomorrow morning... which seems likely given the 30-point drop in ES futures after hours... I will not be participating. At this point I am more interested in catching the beginnings of what I expect to be a monumental bounce. I like the way Gary Savage put it: either we will get a bounce soon or the world will come to an end, and if it's the latter, making money doesn't matter.

Earlier today I posted an opinion on gold, and the late-day action reinforced that opinion. As the market plunged, people fled into the safety of real money and gold's price spiked $30 in 60 minutes. When the market finds its footing and pops hard, I expect gold's price to plunge. People will be selling anything and everything in order to get their hands back into the equity pie. I think gold bugs will be shocked at how fast precious metal prices drop.

So, how will a PM price plunge affect the miners? Well, let's have a look at the chart:

stock chart

The read on GDX is quite different than on metals themselves. Mining shares appear to be under accumulation, and the chart pattern looks constructive. In addition, GDX was getting pummeled earlier this week along with the general stock market even while gold was up sharply. Add into this mix the fact that oil is plunging and I think we have a formula for miners to rally without gold as long as the stock market finds its bottom and starts rallying. As a kicker, the miners are ridiculously cheap as compared to gold:

index chart

If being long GDX makes you nervous with the prospects of gold plunging, then go long GDX against a GLD short. The ratio should work profitably in your favor. In fact, I believe being long SPX versus a gold short will be profitable in the near-term.

index chart

As for other potential places to play the long side, take a look at Taiwan:

stock chart

Taiwan is rapidly opening relations with China and stands to be a huge beneficiary to China's growth. With Asian market following the U.S. down this evening, I expect to be able to open my initial position in EWT at a bit of a discount in the morning.

Okay, I'm exhausted. Until tomorrow!


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