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October 6, 2008

You're Such an Elliott

Another Monday, another mini-crash in equities. I think the selling is over for a while, however, and the stage is being set for a multi-month rally. Another way to phrase it is that today marked the end of wave 3-of-3 for the bear, and we should now see a labored rally form as wave 4-of-3. Based on the duration of previous countertrend waves in this bear market, wave 4-of-3 should unfold over 3-5 weeks. Neither shorting nor going long will be very rewarding during this phase, so I plan to spend my efforts looking for call-writing opportunities on financials, real estate, and consumer discretionary shares (after a bit more of a bounce, of course). Wave 3 will then end when wave 5-of-3 sets in as a quick drop back to test today's low. I'll continue to keep a close eye on sentiment indicators for clues to the finale because big Wave 3 should be followed by a more rewarding Wave 4 rally.

Recently, I've been harping that Wave 3-of-3 would extend to SPX 1080. As measured by wave 1-of-3, 1080 would have provided equality. However, wave 3-of-3 also tends to be a nasty part of bear markets, so the overthrow is not too surprising. There was also a longer-term Fibonacci line attracting price lower. Personally, I don't believe in Fibs. I don't actively study any technical indicator I can't directly explain via human psychology. I know Fibs are based on the golden ratio and naturally occurring sequences, but honestly, it's all a bit too mystic for me. Of course, technical methods can be self-reinforcing when the number of followers is in the sweet spot. Therefore, I do consider Fibs to be at least a curiosity, and what they did today on the S&P500 is damn curious:

index chart

Here are a few more indications that today's action marked a multi-month low:

indicator chart

index chart

indicator chart

We also had some interesting action in precious metals. Gold managed a close above the $850 pivot point with a 3% gain. However, I'm not putting too much faith in that move since silver dropped 2.5%. Today's action was all about liquidation, and the only explanation I have for the continued daily divergence between gold and silver is that paired trades are being unwound to free cash.

gold chart

A couple words of caution for those currently short the metals, however. The U.S. Dollar Index is getting quite stretched on both daily and weekly stochastics. I believe a multi-week correction is just around the corner for the buck, and such a correction could lend support to precious metals. Also, if we see coordinated intervention by the world's central banks... which could take place at any moment, really... precious metals would also get a global hyperinflationary boost. It's really tough to commit either way right now.


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