A couple of sentiment readings published by Sentimentrader.com provide clues to what we could expect from stocks and precious metals over the next 2-3 months. Beginning with the stock market, both smart and dumb money confidence suggest a meaningful correction is on the horizon. Smart money has dropped to less than 40% confident, indicating that big players are becoming quite bearish. On the other hand, dumb money confidence currently sits in the high-60s, suggesting the retail trader is becoming exuberant. Both readings reside at levels which have greeted intermediate-degree peaks in the stock market.
However, traders should keep in mind that sentiment is far from a perfect timing tool. As an example, consider that both the aforementioned readings posted more extreme levels for over two months... from December 2010 into February 2011... before the corrective process took hold. In other words, based on sentiment alone, equity traders have no strong edge at this juncture. Stocks could grind higher for a few more weeks or an intermediate decline could take hold presently. Over the next 2-3 months, however, the odds of catching a large move certainly favor the bears. Therefore, I would not want to be aggressively long, but neither would a short attempt be prudent without at least a weekly swing high in hand.
The second sentiment reading in question belongs to silver which posted a 72% bullish reading this week. In most cases, silver rallies do not peak until sentiment punches through 75% bullish, and more recently, 80%+ readings have been required to halt rallies. However, the rapidity of this indicator's ascent out of the multi-year bearishness seen in December may be a clue that precious metals will not be setting new all-time highs anytime soon.
Gold sentiment remains tame, so I do not believe the current rally has peaked. Friday's drop likely signals a minor correction in play... a daily cycle decline in the lingo of the Member Letter... but I suspect last year's high will be tested as part of the process of consolidating last year's huge move.
Basically, this outlook calls for gold to test its high as part of the second leg of the rally out of the December low. The yellow metal would then coil for a breakout as stocks finally sink into their inevitable correction. In fact, consolidations following parabolic runs in gold typically test the high several times before breaking out. I also noted in my 2012 Outlook that precious metals were likely to form large consolidations in 2012 before accelerating higher again.
My trading plan has remained the same over the last few weeks: to use gold's daily cycle correction as an opportunity to augment positions. Unless the action forces me to recognize an alternate scenario, I will then look to unload positions as the yellow metal's price approaches its high.