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September 5, 2010

Silver Lining

This past week was a peculiar one. The days flashed by in the blink of an eye, yet the conditions that existed a week ago seem ancient. Way back in the old days, namely Tuesday, stock market sentiment was in the gutter, and calls for an imminent plunge to SPX 950 were pervasive. In that evening's letter I subjectively noted my belief that traders were about to be quite surprised how quickly stocks could rally. It is safe to say the surprise has been sprung. Bears would have rather fallen into a nest of adders than suffer the whipping they took into the end of the week.

SPX Daily

I have been using the rally out of the July low as a model for the current move, and so far the two remain remarkably similar. If parallels are to persist, we should see 3-5 more sessions pass before stocks make their first noticeable retreat, at which time it would be reasonable to expect the 65DMA to be back-tested. This retreat will be followed by another surge into the daily cycle high, which I anticpate will also be an intermediate high.

Along those lines, I've recently been pounding the table over signs that implicate April as the peak of the major counter-trend move, but keep in mind there are no guarantees in this business. As traders, the best we can do is pursue a model which provides a probabalistic advantage. The probabilities currently tilt bearish, and until the action deviates in a meaningful way, I will continue to expect a bearish outcome. We should have a pretty good indication by the end of September regarding which way the market will break. The daily cycle will have formed a trend line by then, and we can just watch for either a break of the trend line or an acceleration away from it.

Of course, if the stock market is going to sink into bear mode, equities are going to have to change the nature of their relationship with the dollar. The dollar's cycle setup suggests, with a high degree of confidence, that a plunge into a 3-year cyce low is in the works, so stocks will somehow have to become positively correlated. A quick glance at the dollar chart tells us that the inverse correlation is still firmly in place:

DX Daily

So for the time being, a falling dollar should keep stock prices moving higher. However, the collapse in the DX since June is likely signifying that the Fed has either already cranked up the presses or that they will do so soon. I'm curious to see what will happen to equities once a public announcement is made to that effect. My suspicion is that such news will correspond to an inflection point in confidence and hence an inflection point for the stock/dollar correlation. Folks will interpret further printing as an act of desperation by the Fed and sell stocks. Naturally, the dollar will respond negatively, as well.

On these points of conjecture, we will just have to wait and see. Stocks cycles are telling us one thing while dollar cycles are telling us another, so it is only natural to speculate on how to reconcile the differences. As for the present setup in the buck, the daily cycle, now on Day 20, is firmly lodged within its timing band. However, since the last cycle ran short, we could easily see the current cycle run a bit long and extend past the 28th day. Therefore, a daily low could occur any time within the next two weeks.

If the cycle were to bottom soon, I suspect it will do so as part of a last-ditch effort to hold the 200DMA. If the cycle runs long, the ascent of the next daily cycle will likely constitute the final bounce off DX 80 before that level is lost for good. Since the next cycle is likely to roll over quickly, though, the level at which the current one bottoms is not so important. The critical level to watch is DX 80 because a break below this level confirms the primary decline of the dollar's intermediate cycle.

There is nothing new to present with regard to gold's cycles, so I am going to get subjective on you again. The generally-accepted scenario for gold action, based on banter I've been reading on various blogs and news sites, is that the price of the yellow stuff is going to pause or even pull-back as the all-time high is tested. I beg to differ. We are only on Day 8 of a daily cycle which should easily extend 2-3 more weeks before rolling over. Price has no compelling reason to use the high as an excuse to hesitate. An often-quoted Docism... in a bull market, surprises come to the upside... has a chance to express itself here.

Gold Daily

The gold, silver, and mining shares charts are just oozing with the sensation that the dam holding back prices is about to burst. Silver, in fact, is leading the way:

Silver Daily

Measuring from the commencement of the move at $18, a 30% or so surge puts silver in the neighborhood of $24... and this is just the beginning of the overall run anticipated into next spring. I have described on several occasions why I think silver could push $40. Once our outlooks advance a bit further, I will revisit that topic.


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