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This essay is based on the Premium Update posted on June 25th, 2010
In our most recent essay we
have emphasized what influence might the general stock market have on the
prices of the precious metals. Since the situation appears to be developing
in the direction mentioned earlier and a part of the precious metals sector might
be particularly affected in the near future, we would like to provide you
with a follow-up.
We will start with the
long-term SPY ETF chart (charts courtesy by http://stockcharts.com),
which allows us to analyze volume.
.
Last week, we devoted a great
deal of the General Stock Market section in our Premium Update to the
emerging head-and-shoulders pattern. Price and volume trends this week
further confirm the likely full development of this very bearish pattern. We
have seen declines in price along with increased volume levels. This will be
more visible in the following part of this essay, where we study analyze
short-term chart.
Note in the long-term chart,
SPY ETF is close to the declining support level indicated by the black line
above. It is possible that a slight upswing may be seen. This would not
invalidate the emerging head and shoulders pattern unless a significant price
increase was accompanied by high volume levels and if it took the value of
the ETF above the $115 level. This is not expected to occur soon. It
is much more probable that any upswing will be accompanied by low volume and
thus short lived. The full development of the head-and-shoulders pattern
continues to be quite probable. This spells trouble for stock prices in the
following months.
This week’s short-term
chart reveals that volume levels and declining prices have been far less
dramatic than in prior weeks. We have seen sharp declines become the norm but
it is important to remember that a daily or even weekly upswing would not
invalidate the bearish outlook we have at present. Only a move to a level
greater than 115 or so on high volume would accomplish this feat. We are far
from this level today and see no signs of this as even a remote possibility
in the near-term.
The Broker-Dealer Index, i.e.
the financial sector this week confirms points we have made earlier. Note
that the present level is close to previous lows. In fact, we are quite close
to the lowest close since July, 2009.
It is important to note here
that the financial sector often leads the other stock indices and the fact
that we are presently at an 11-month low is quite important. Indications are
that the general stock market will likely decline during the summer months
reaching a probable bottom in the fall. History then supports a likely rally
for much of 2011, a pre-election year for the U.S. President. This cycle of
bullish markets has been in place for each pre-election year for nearly 80
years.
Therefore, the bearish
sentiment professed last week has been further validated by the markets this
week and we remain bearish for the medium-term. The possibility of temporary
upward moves leads us to a neutral sentiment for the short-term (1-2 weeks).
Historical trends have significant effects on market emotions, often
overriding other underlying factors. Simply put, the strong patterns, which
exist around and before U.S. Presidential election years cannot be ignored.
At the same time, the head-and-shoulders formation could cause the main stock
indices to move much lower during the summer months. In order to estimate
decline's influence on gold, silver, and mining stocks, let's take a look at
our correlation matrix.
The correlation matrix is
mainly used to seek information on how the major markets and indices impact
the PM sector. We see very little change as compared to last week. However,
several factors are worthy of note. Gold seems to be moving independently of
the USD. Note the correlation coefficient is close to zero, that is, very
low. This indicates near total independence as compared to the USD trends.
The 30-day column does show a positive correlation in the range of 0.3- 0.4
but this is really not significantly high.
The main inference from this
chart is that gold is less likely to be affected by weakness in the general
stock market than silver and mining stocks. Note that their correlation
(based on the last 30 trading days) hovers around 0.7. This is a strong
correlation, which indicates likely movement in the same general direction.
Finally, we see that juniors are also highly correlated with stocks, which is
normally the case.
Consequently, given the
current bearish situation on the general stock market gold itself appears to
be the best option for the vast majority of Precious Metals Investors and
Traders. This is consistent with what we have stated for several weeks. The
risk/reward ratio has been and continues to be more favorable for gold.
It does not mean that silver
nor mining stocks will not move higher along with gold - it means that the
risk of them being negatively influenced by move lower in the main stock
indices is higher than it is the case with gold. In other words, silver and
mining stocks are not a bad long-term investment, but a more significant
decline in these two sectors could occur if further downtrends continue in
the general stock market. Simply put, gold is preferred in the short and
medium-term. Silver and mining stocks continue to be quite risky for
speculative capital at this time.
Let's take a closer look on
gold chart itself for more details.
All in all, not much change
was seen since last week. An appropriate motto could be much
has happened but little has changed. Although the recent move
down caused the gold market to decline, at this point the weekly chart
suggests that this move was nothing more than just a verification of the
previous breakout above the 2009 high. Consequently, the huge
rally which gold has shown for the past four months may not be running out of
steam yet.
The trend is still likely to
be higher although we have seen increases followed by decreases throughout
the past several days. Still, gold is within the rising trend channel, the
RSI is slightly above middle range, and the stochastic indicator is below 80
(and it was not clearly above the 80 level, which was the case before
previous tops were formed.) These indicators clearly show there is room for
an additional rally. Any gains seen in the near-term, however, are likely to
be less than spectacular, as at this point we don't see gold moving much
higher.
Summing up, little
changes of significance were seen in the markets this week (the general stock
market being the only exception, as it continued to provide further bearish
confirmations.) The frantic developments in Europe directly affecting the
euro and the USD have somewhat calmed. Without any extreme headlines
reverberating around the globe, the markets were generally quiet as seasonal
factors were able to yield some guidance to market direction. As far as gold
and silver are concerned, they are likely to move upwards and the risk-reward
ratio of gold continues to be much preferred over that of silver and mining
stocks.
Thank you for reading. Have a
great and profitable week!
Przemyslaw Radomski
Editor,
www.sunshineprofits.com
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