Stocks:
I
expect, barring some kind a catastrophe, next week should be another good
week for the market. The recent minor pullback has worked off the short
term overbought conditions and in the process formed a small bull flag.
As
long as we continue to get these minor corrective moves it will serve to keep
intermediate sentiment from getting too bullish too fast, and ultimately it
is sentiment that will halt this rally, especially if this does turn out to
be a bear market rally (which I’m by no means convinced it is yet).
As of Friday, intermediate term sentiment was still depressed and at
levels that often halt corrections much less start them.
The
market is only on the 4th week of this intermediate cycle. The cycle
averages about 20 weeks so the next major intermediate trough won’t be
due until November.
Of
course that doesn’t tell us when the top is going to arrive, but even
in bear markets these intermediate term rallies usually last 6-8 weeks and
occasionally as long as 10 weeks. Depending on how severe the preceding
correction was, it usually takes at least that long for sentiment to reach
bullish extremes again. And this correction was very severe.
It pushed intermediate sentiment levels much lower than even the March
`09 bear market bottom. Even if the stock market is back in the secular
bear trend I really doubt we will see the top of this intermediate cycle in
less than 7-8 weeks. And if the cyclical bull is still alive we will
see new highs and the top won’t arrive until somewhere around week
12-18. It’s even possible with the elections (i.e. lots of
monetary stimulus) that we could see a stretched cycle that carries into the
New Year like we did last year.
As
long as we stay locked between the July lows and the April highs it’s
anyone’s guess as to whether this is the next leg down in the long term
bear or another leg up in the cyclical bull.
Breadth:
Often
2 or 3 small moves in a row on the McClellan oscillator precede a big move in
the market.
This
pattern played out at the February and July intermediate bottom and since we
are still early in this intermediate cycle I think this time will also unfold
as a large move higher.
Dollar:
No change
here. I continue to think we are in a failed and left translated daily
cycle that is only on day 10 and should still have 10-15 days to go yet.
I’m expecting a test of 80 before this daily & intermediate
cycle bottoms.
Once
the intermediate cycle does bottom the rally out of that low should
correspond to stocks moving down into their next daily cycle correction.
Stocks are only on day 20 and that trough usually doesn’t arrive
until about day 40. So if the position of the dollar cycle is any indication,
stocks should continue generally higher for another 2 to 3 weeks yet.
Gold:
We
now have some follow through to Thursday’s swing low and unlike the
last two times, this one is not taking the shape of a bear flag. As I
explained last week in the nightly reports, and this week on the blog in
Hoping for a Break, I was looking for smart money to run the May pivot
followed by a quick reversal as my final buy signal.
The
failure to follow through to the downside is a sign that someone was in the
market buying all that the technical and emotional retail traders were
selling.
Now
we need two more things to happen before we can be reasonably sure the
intermediate cycle has indeed bottomed. First, we need to complete a
weekly swing low. That will happen this week if gold can hold above
$1155.90 and move above $1194.50.
We
also need to break the pattern of lower lows and lower highs. Gold will
do that if it can trade above $1204 next week.
I
know that 6 weeks of negative returns are frustrating but the reality is that
this has been one of the mildest intermediate pullbacks of the entire bull
market. Gold dropped a mere 8.6% and miners only 14%.
That’s almost unheard of for this volatile sector.
Several
weeks ago I showed subscribers this chart of the public opinion poll for
gold.
Chart
courtesy of www.SentimenTrader.com
During
this intermediate leg up, sentiment never really got extremely bullish on
gold. On top of that, neither gold nor miners got very stretched above the
200 day moving average. I said at the time that was a recipe for a very
mild correction and that is exactly what has unfolded.
I
think there is a very good chance gold put in the intermediate low this past
Wednesday and we are now headed higher into the strong demand fall season.
(Gold sentiment has since dropped below the level we saw at the February intermediate
low. A definite sign we are nearing or at a bottom.)
From
time to time I will see posts on the blog or on the internet questioning the
wisdom of investing in miners as they have underperformed gold. To
begin with, miners have not underperformed gold, not by a long shot.
What happens is people take a short little piece of history where the
miners have underperformed for one reason or another, and wrongly assume this
period of underperformance is representative of the sector during the entire
bull. Since the bull started, miners, as represented by the HUI index,
have increased over 1100% whereas gold has gone up 400%. The reality is
that miners got quite a bit ahead of themselves during the first 10 years of
this bull market.
There
is a reason why miners lagged a bit during the last C-wave and that had to do
with skyrocketing oil prices that were compressing profit margins.
There is a reason why miners are struggling now too. Let me
explain.
First
off, don’t forget we had a huge move off the November `08 bottom.
That was a 250+% gain in one year. From time to time you might
see a single stock do that but for an entire index to make that kind of move
in a year is almost unheard of.
A
move of that magnitude has to go through a consolidation period at some
point. That is exactly what miners have been doing this year; they are
consolidating that monster rally.
Miners
have now made four attempts to break through resistance in the 500 area.
In the process they have formed a giant consolidation stretching all
the way back to March of `08. As many of you may have noticed the
larger these consolidations are the bigger the rally tends to be when the
breakout finally comes (I’ll show you a really big consolidation at the
end of today’s report).
Another
thing that has been holding miners back is the law of regression to the mean.
All financial assets obey this law. Gold and miners are no exception.
When anything, whether it is gold, miners, oil, or housing prices,
stretch too far above the average, eventually the law of regression to the
mean pulls it back down. In the next chart you can see this in action.
In
volatile sectors the moves up can get pretty stretched, as you can see.
I’ve found that about the most any sector can stretch is 50-60% above
the 200 DMA before gravity pulls it back down. And like a rubber band,
the further one stretches above the norm the harder it tends to snap back.
In the mining sector that almost always means a move back to, or even
below, the 200 day moving average. What we really need to take away
from the above chart is that the 200 DMA has now had time to “catch
up”. Miners are setup for the next big move higher and they can now do
it without the law of regression to the mean acting to drag them back down.
Incidentally,
when we see the rubber band has gotten extremely stretched, that is the time
we want to sell. Unfortunately most traders and investors do the exact
opposite. They buy high and sell low because they are being controlled by
their emotions. During these intermediate corrections the calls to sell by analysts
and bloggers will get intense, but that simply isn’t how one makes
money in this business. You buy when it’s hardest to buy and you
sell when it’s hardest to sell. Professionals understand that in
order to make money you buy into dips in bull markets. And about every
5-7 months we will get one of these dips in gold. They happen like
clockwork.
For
the last couple of weeks I have been trying every way I can think of to make
investors understand this, so they can take advantage of this opportunity and
so they don’t make the mistake of selling during a normal corrective
period. Many have taken advantage of the “opportunity” and
hopefully many more will before it’s too late. And judging by the
number of Old Turkey investors on the blog, a big percentage of subscribers
have now switched from trying to trade the bull to just riding him.
Invariably,
what happens though is that most people simply can’t buy into the
correction. They have to wait till it “feels” good before
they can buy. Unfortunately by that time a big part of the rally is
over.
Warren
Buffett said it perfectly. “We simply attempt to be fearful when others
are greedy and to be greedy only when others are fearful.”
Folks
we are now at that point where it’s time to be greedy.
I’ve
mentioned many times in the past that I’m not a big believer in
patterns. Too often they end up morphing into something else or just
outright fail like the head & shoulders top did recently on the S&P.
There are however a few patterns that I do pay attention to and they
include triangles, which are often consolidation/continuation patterns,
crawling patterns (also continuation patterns) and T1 patterns, again a
continuation pattern.
We
saw a great example of a triangle pattern last year right before gold broke
out above the `08 highs.
We saw
a text book crawl pattern recently in the dollar.
And
we’ve seen multiple T1 patterns form as gold has progressed through its
bull market.
I
think we are probably seeing one form right now, although not in gold. This
T1 pattern is forming as the miners are consolidating that huge move out of
the `08 bottom.
The
first leg up tacked on 350 points. Second legs in T1 patterns usually
gain almost as much as the first leg. That puts the HUI at roughly 850
by the time this T1 pattern reaches its top. That is a huge move up
from where the HUI was on Friday (425) and another reason why I think this
C-wave is going to run into the spring with another corrective sideways move
late this fall (gold’s next intermediate cycle low). 425 points
is way too big of a move to unfold in only 3-4 months. The law of
regression to the mean would pull it back down before it ever had a chance to
raise that far. No, I think it’s probably almost a given that
this next phase of the C-wave is going to unfold in two stages and correspond
to the dollar moving down into its 3 year cycle low.
Then
as gold moves into its D-wave decline, which will mirror the dollar’s
bounce out of the 3 year cycle low, we should see the HUI complete the T1
pattern with a test of the consolidation zone, which incidentally will tell
us when to get long again for the next A-wave advance.
Oh
and before I forget, how’s this for a really big consolidation pattern?
Toby Connor
Gold Scents
Toby
Connor is the author of Gold Scents, a financial blog with a special emphasis
on the gold secular bull market. Mr. Connor's analysis skill of the markets
is largely self-taught, though he admits to being an avid reader of Richard
Russell and Jim Rogers, among several others. Toby is an avid rock climber
and world class weight lifter (for his age). Toby's premium service includes
daily reports and an extensive weekend report.
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