Trader’s Narrative

Back in November 2008, when the market was just days away from making that year’s lows I pointed out an ominous double top formation on the S&P 500 index.

The market managed to bounce from that support but when it was tested again last week, it wasn’t strong enough. The double top formation has unquestionably completed. The only remaining quandary is will it complete?

Before I showed a log scale chart (see above link), so here’s an arithmetically scaled chart of the double top:

If we take the neckline to be 776 on the S&P 500 (the 2002-2003 bear market low) and the top to be 1576 reached in October 2007, then a measured move would be meaningless because it would require the market to drop 800 points - something it can’t do right now. Unless we invent a way for stocks to go into negative integers.

Even half-way completing such a measured move would mean utter catastrophe for the stock market and by extension the global economy. Especially if it happens suddenly.

Before you think that is completely impossible, consider the reality that a long term Japanese investor faces:
Continue reading ‘Are We Headed Back To 1980?’

Has anyone else noticed this technical formation? I’m sure many have but I haven’t heard a lot of noise about it.

It is only visible on a very long term chart and boy, it doesn’t look good at all. Double top formations are among the most reliable, which makes this ominous. The sheer size of it is also not good news for the market because a measured move would take the S&P 500 Index (SPX) to … well, let’s just say no one, not even a bear would like to think of a world with the index at that level.

The only consolation I can give myself is that it is reminiscent of the very large head and shoulder formation everyone saw towards the bottom of the last bear market. If you look at the chart you can make it out.

The left shoulder occurred in 1998, the large head from 1999 to 2001 and the right shoulder in 2002. The measured move for that technical formation was also hair raising. But it never actually happened even when it broke below the neckline. It did however, give a lot of doomsday scenario fodder for the perma-bears.

Time to ‘fess up. I’ve been horribly, horribly wrong on gold. So much so that now I’m afraid of being labeled a contrarian indicator!

So let’s see, in December I thought I saw a tentative double top in gold… which didn’t materialize. Instead, gold paused by trading sideways for a month and then continued blazing higher and higher:

To be fair, a double top formation is only triggered when the neckline (the dotted line on the graph above) is pierced. Since that didn’t happen, we didn’t officially have a double top, at least according to the widely accepted definition within technical analysis.

That doesn’t absolve me as I’ve been skeptical of a continuing gold bull market. And I’ve been wrong, wrong, wrong. Gold’s climb has been unrelenting. Just today it closed at $949.20 on the Merc, taking it within a nugget’s throw of $1000.

But while the price of the commodity is 12% above the swing high in November 2007, gold stocks - as measured by the Gold Bugs Index - are barely peeking above those levels. So if you’ve owned any gold equity, instead of the metal itself, you’ve lost out on a lot of money.

The k-Ratio
The discrepancy can be seen in the k-Ratio which shows a slightly downtrending chart (in the short term):

Since the k-ratio has entered a channel, the easiest strategy is to buy gold stocks only when it approaches the “floor” and to sell them when it hits the “ceiling”. I’m hesitant to venture into any trades with a longer time frame since I’ve been clearly off my game on this sector.

I think my mistake was that I used the k-ratio’s valuation message to mean that gold’s trend couldn’t continue. Boy have I been schooled. The valuation is still high - historically - but that doesn’t mean that a trend can’t continue. The k-ratio is an amazing tool but it is really useful in giving you the really big picture. For anything more granular it falls apart.

Seasonal Pattern
Surprisingly, the rise we’ve seen in the price of gold has been against the headwinds of seasonal patterns. Historically, the period of time from the end a year to the end of March of the next year has been a very bad time to be long gold. It is exceptions to such seasonality “rules” that remind you that the market doesn’t have to follow any dictates, no matter how well founded.

In case you’re wondering, the best time in the calendar to go long gold is at the end of August and into October. Traditionally, this short time frame has provided the biggest boost to the price of gold. But right now the summer is way too far away for me to use it to place any bets.

Sector Breadth
Finally, as an attempt to peer into the fog of future prices, lets do a quick review of the current breadth in the gold sector.

Almost 86% of the gold stocks that comprise the sector are trading above their 200 moving average. Since this is a strong bull market, the percent of stocks above their long term moving averages has been consistently high with only a few short blips lower.

In January it even reached the rare maximum: 100% - around the time that the Gold Bugs Index (HUI) topped out at ~480. This statistic tells me that if I want to go long gold stocks for an intermediate time frame trade, this isn’t it. Not even close.

Thanks to today’s strong close, 100% of the gold stocks in the sector are trading above their 10 day moving average. At the beginning of the month, that number was less than 10% - so again, this is not a good time to go long, even for a short swing trade.

The best combination of breadth is strong long term (200 day average) and weak short term (10 and 50 day moving average). A good example was in mid December 2007 when there were only 10% trading above their 50 day MA and 5% above their 10 day MA with a very high 60% above their 200 day MA.

I’m keeping a wary eye on this sector until it presents a similar setup and will post about it.