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August 8, 2008

Slaughterhouse 0808

What a day! A big drop in crude's price set the stage for a big equity rally as well as a drubbing of precious metals, particularly of silver. Any lingering doubts that oil has entered into a major corrective phase were neatly nixed. Sharp counter-trend bounces aside, oil should zip its way down to at least the $100 level and perhaps as far down as $85.

What were also nixed were any lingering hopes that precious metals had a bullish burst left in them. Silver got clubbed for a massive 6% while gold slumped 1.5%. I am of the mind that this drop marked a capitulation for the recent slide and that a corrective rally should now ensue. We can also anticipate some support from the fact we are entering into a period of positive seasonality for metals.

This correction in PMs has the potential to play itself out in a significantly different manner than the corrections of 2004 and 2006. Why? Because 2004 through 2006 saw sustained demand for metals, as well as most other commodities, due to the expansive nature of the global economy. The globe is now in recession, and this recession has the potential to be nasty. Traders should be on red alert for a longer and deeper drawdown than previous cycles. A look at the 1970s bull market shows that in the middle of that great bull market, gold retreated nearly 50% over an 18-month period before staging its finale by rising 8-fold in three years. A similar performance would put gold in the mid $500s by late next year, leading into a massive run to $4,400/oz. Sounds juicy, eh? Patience is the key here. Taking on sizable position just doesn't seem prudent at this juncture.

Equities found some legs today, crutched by oil's decline. Traders don't seems to have connected the dots here. Oil's decline is discounting a gloabl recession. A global recession is not good for company earnings and hence not good for stock prices. I believe we will see stock and oil prices declining together in the near future. In the meantime, equities seem set to extend gains a little further.

stock chart

At a minimum, the SPX should get back to its 65DMA, which lies at 1321 (and declining). When it flirts with that area, I would look at the usual oscillators and also for a daily price reversal in order to pick a shorting point. 1320 to 1380 is also a huge congestion zone, so when/if the SPX approaches 1320, those traders not to keen on outright shorting may consider writing calls at the 1375 strike.

Well, I'm still battling a mild case of jet lag. I'll post more thoughts this weekend as I get rested.


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