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December 10, 2009

Phase Emulation

Did anyone mention how difficult it would be to short this correction? Oh, yeah. It was some guy in the comments section who goes by the moniker "thedocument." Looking at the S&P 500 chart, one would hardly know we are in a correction. But we are, and I expect it to get nasty soon.

s&p 500 chart

Given an additional $112M in selling-on-strength today, a trader would have to think the break is imminent. How ugly of a candle could be posted when the day comes? Well, the 65DMA is 26 handles south of the current price...

So how can I profess a correction when the SPX is barely a percent off its rally high? Perhaps equities have not manifested the correction just yet, but we are definitely in corrective mode. The dollar chart attests:

dollar index chart

We are only on Day 3 of the dollar's breakout, and the last two sessions appear to be consolidating the breakout itself since the 76 pivot has held support. We should see another tall candle higher on the DX no later than Monday, though I put higher odds on the move occuring tomorrow. I'm almost certain the next leap higher in the DX will accompany our nasty day in equities.

The big question for those of us who are stalking the home run swing in precious metals is what form will this correction take? In my opinion, the harder price jolts the longs, the more forceful the launch. Therefore, a back-test of the consolidation breakout could set up a huge move to $1500, $1600 or higher. However, history does not support a back-test but rather a mid-point consolidation. The action so far rhymes fairly well with the last round of madness. I annotated a chart to demonstrate, but due to its size, I cannot embed it in this post. You can view it here.

As you can see, the price action during this cycle seems to be emulating the last in both structure and duration. Therefore, if gold presently unfolds a 6-week triangle, we should then anticipate a $300 move from the tip of the triangle over about a 3-month period. I'm guessing such a scenario would escort gold to the low $1400s for this round. Likewise, silver could be expected to perform similarly to its previous parabolic runs, which have seen price roughly double from the summer base. In this case the move from $12.50 should produce a two-bit silver price.

There is, of course, no guarantee that this cycle will continue to emulate previous cycles. The macro environment is different. Markets experienced a liquidation event since the end of the last cycle, and central banks have provided plenty of the primary fuel for the gold bull: fiat currency. We are also in a new phase of the commodity bull, one in which I expect monetary, rather than industrial, commodities to be the star performers (the final phase should see agriculture take the lead). These factors may provide the fuel for a larger parabolic move. The main benefit of the analysis above to to be on alert for divergent behavior so we can judge whether the coming launch will be typically or extraordinary.


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