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July 11, 2010

Stocks Find Some Legs

As anticipated, stocks found their legs as the 75-week moving average was tested on the S&P 500. With a rapid, 6% pop now under the market, the question turns to whether or not we will see the low tested before the rally plays out. For a couple of reasons, I judge the liklihood of a bottom test in this case to be slim. First, sentiment has not budged as the market bounced. We will usually see optimism surge as a low is initially left behind, thereby providing an impetus for a back-test. With the public still playing the role of the skeptic, this rally is more likely to just keep chugging or, at worst, to pause for 2-3 sessions before continuing higher.

The second reason to dismiss the possibility for a test of the low is a bit more subjective. As I stated in the previous post, I do not expect this rally to better the April high before rolling over. In other words, this rally will fail, and a common characteristic of failed rallies is an initiation out of a V-bottom.

S&P 500 technical analysis

It is also interesting to note that the yearly low back in February formed as a V-bottom, and lo and behold, the next cycle formed a lower low.

More pertinent to the Docfolio is the outlook for precious metals. As with equities, gold appears ready to launch out of an important low. However, unlike equities, gold is poised for a spectacular run to new highs.

Gold technical analysis

As you can see, gold wanted nothing to do with the recent correction in stocks, a clear divergence in behavior from the December to February correction when gold fell sharply, leading stocks lower. In fact, the drop by gold over the previous two weeks appears to be nothing more than a modicum of commiseration as stocks sunk into a significant low. With the tailwind of an equity rally now at its back, gold should surge to a new high and perhaps sprint toward the $1400 extension suggested by several technical patterns.

There is, of course, one group of stocks that will be the direct benficiary of a simultaneous rise in stocks and gold: mining shares.

gold mining share prices

Of course, mining shares had tripled in the 12 months leading into the December high, so it is natural to see an extended consolidation. But when these shares are ready to move, a 30-50% surge in as little as a month is typical. I believe we are on the cusp of one such move.

 

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