Trader’s Narrative

Gold has the wind at its back right now. Not only has it cleared the challenging $1000 resistance level, it has support from lax monetary policy as central banks around the world clearly hold the health of their economy in higher priority than the health of their budgets or their currencies.

The recent purchase by the central bank of India is being interpreted widely as a vote of strong support for the precious metal. Although I don’t argue against a secular bull market, it is amusing to me that a decision to buy gold at above $1000 is deemed to be a ’smart’ move when just a year ago they could have made the same purchase for 30% less. The fact that almost any news is interpreted as positive for gold has more to do with the prevalent sentiment than with facts.

In any case, before we get to the short term sentiment for gold, here is the recent commentary from David Rosenberg of Gluskin Sheff on the monetary backdrop for a secular bull market in gold:

All India did was bring gold to a 6% share of its total FX reserves from 4%. Fifteen years ago, that representation was closer to 20%. China has increased its gold holdings by 76% over the past six years but they are a mere 1.9% of the aggregate 2.2 trillion of reserves and Russia’s gold holdings is just under 5%. This is not the 1990s when Bob Rubin was running a hard U.S. dollar policy, U.S. fiscal deficits were vanishing and gold production was on the rise. Today’s world is exactly the opposite. Policymakers beginning in the 1990s wanted disinflation and got it. Now they want inflation — it will take years, maybe a decade, but it will come. For the near-term, we are still optimistic on Treasury securities but be forewarned that this view has an expiry date that is earlier than the peak we are likely to see in gold.

It is very clear that central banks are behaving in a way that would suggest that gold is now again being considered a currency within the global monetary system. As we said before, it is all about relative scarcity and a well-defined supply curve — fiat currency at this juncture does not share that quality.

Turning to the breadth in the gold stock sector, you can see that we’ve seen a sudden and dramatic jump from a week ago. The chart below compares the percentage of gold stocks trading above their 10 day moving average with the Philadelphia Gold Bugs index (HUI):

If you’re interested in timing the gold market, then you would be concerned that 82% of gold stocks are trading above their short term moving average. But you would also be alarmed that just a few days ago, that number was below 10%. Historically, gold shares have a very tough time continuing to climb when faced with such short term headwinds.

Turning to sentiment in the gold sector, on Monday when we looked at the arguments that Paul Tudor Jones II presented for his case of a secular bull market in gold, we also digressed a little to check the Hulbert Gold Sentiment index. That sentiment measure was showing a majority in the bullish camp; which from a contrarian point of view means that gold probably will have difficulty in advancing in the short term.

In a similar vein, here is a chart, courtesy of Elliott Wave, which shows the price of gold with the Daily Sentiment Index (DSI). The most recent DSI is 91% which is just about where previous short term tops have been formed:

Similar to the breadth measure (shown earlier) the DSI increased to 91% in a sudden jump (an 8% point jump over a day). Accoding to Elliott Wave, which tracks the DSI, this was the single largest increase since March 19th 2009 (11% point jump from 75% to 86%) when gold made a two month high at $960. With Elliott Wave, not only do you get their analysis of various markets but they do a good job of monitoring DSI, which is a proprietary sentiment metric from trade-futures.com and by itself would costs about $2000/year.

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While the bulls flex their muscles day after day, it is daunting for those who believe that the economy is not on sound footing and that the latest earning season is not about to suddenly provide a cornucopia of better than expected earnings - especially since expectations have been ratcheting up so much recently.

More and more, this is a technically driven market, decoupled from such mundane things as P/E or the economy or any type of anchor we may think is rational to attach to it. We just ricocheted off the S&P 500 index’s 50 day moving average. If you recall back in June and July it was the 200 day moving average which buttressed the index before turning up itself.

But arguing with the market is about as useful as standing in front of a runaway train and doing a PowerPoint on why it should stop in its tracks. Remember that bears have always had the most lucid and convincing arguments.

I’ve been guilty of comparing this spring rally to the 2003 cyclical bull market. If you’ll indulge me once more, here is yet another point of similarity.

The percentage of S&P 500 components which trade above their 50 day moving average fell through the floor to hit the basement in the summer of 2002. Those were dark days indeed. Then even as the S&P 500 index went lower, this metric did not - suggesting that less and less individual stocks were participating in the continuing bear market:

The first sign that things had changed was the almost unanimous involvement of the components in the ensuing rally. In June 2003, out of the 500 stocks in the index, 471 of them closed higher than their intermediate moving average. Then it started to show a remarkable resilience as each subsequent low in this metric was higher than the previous one.

Here is the recent chart of the percentage of stocks above their 50 day moving average, showing a remarkably similar script:

A caveat is that we are starting to see some speculative fever getting stoked in the options pit. But even this is not extreme enough (yet). The market resilience continues with few signs of abating.

Here’s a quick update on the market breadth. As measured by the percentage of the S&P 500 Index components that closed above their 50 day moving average, the market breadth has seen a sudden collapse.

After reaching 90%, extremely overbought, in early June, this indicator has dropped 64% points to 26%:

Historically, an important low level is around the 20% area. We’re aren’t there yet, but if we keep dropping at the same rate, we’ll get there by next week. But also remember that oversold in a bear market is a very different beast than oversold in a bull market.

Turning to the longer term view, the percentage of stocks above their 200 day moving average offers an interesting dichotomy. While the shorter term breadth has suffered along with the general stock prices, this long term breadth measure is still pretty much where it was in early May 2009:
Continue reading ‘Approaching Oversold In The Short Term’

Back to everyone’s favorite game: is this the real deal of a new bull market? or is Mr. Market about to get another visit from gravity?

To try to answer this lingering question, I again turned to the lessons offered by the young bull market of March 2003. Here is a chart of the percentage of S&P 500 stocks above their 150 moving average:

The rally started in early March 2003 with eery similarities to the spring rally we saw this year. By June 2003, 90% of the constituent stocks in the S&P 500 index were trading above their 150 moving average. From then forward, the breadth remained incredibly strong. For about 9 months the percentage of stocks above their 150 moving average remained very high.

In contrast, this breadth indicator reached a high of 85.4% in mid June 2009 and it seems to have lost its mojo. But the weakness in breadth is even more pronounced when you consider the commensurate increases in share prices that lead to it.

We’ve had a remarkable 37.4% rally from March 9th 2009 to May 8th 2009 and since then we’ve gone sideways. If the March 2003 rally had taken the S&P 500 higher by the same magnitude, it would have reached 1105 by mid May 2003. Instead it was only around 940 - a mere 17% rally.

Put another way, the S&P 500 index’s slope of incline is about 5 times steeper. That is, in 2009 it rallied 37% in about 2 months while in 2003 it reached similar altitudes after about 10 months time.

But even after such a rocket ride, the breadth measure still didn’t manage to reach 90% - something which it did easily back in 2003 with much less gains.

So what this analysis tells us is that the recent rally was one where a small subset of the S&P 500 rallied, pushing the averages higher. To see a change in market tone, we need to see almost all shares trade above their long term moving average. We can not start a healthy bull market with a few extremely strong shares pulling the rest along for the rise. Eventually they will peter out and with the dead weight of the rest, the whole market will head lower.

While the market has been acting tired this month and the tape looks like it want to head lower, we have some signs that, at least in the very short term, the equity markets are oversold.

For example, take a look at the percentage of stocks above their 10 day moving average. Earlier this week this fell to just 11% which is just a hair’s width shy of the ‘magical’ 10% level:

The medium term breadth measure, percentage of S&P 500 stocks above their 50 day moving average, is not showing any indication of being oversold. As of yesterday about 60% of the 500 component stocks closed above their 50 day moving average.

Since mid April this percentage has been hovering around 90% - signaling an extremely overbought market. But the indexes have been able to move higher in spite of this.

This provides for a potential tell for the health of the market. If we are able to put in a strong bounce (in the short term) here in response to the oversold condition, then there is a higher chance that the market can continue to snake its way higher as it has since March 2009. But if we fall hard in spite of it, then we are looking at a weak market that may retest the previous swing lows.