Trader’s Narrative

In an attempt to thoroughly confuse my remaining few readers, here are two polar takes on the market:

Seasonality
The best time to be long the stock market has been from November to the end of April. The months from May to October, produce so little in returns - on average - that you would do better parking your money to earn income. This seasonal pattern is usually expressed with the rhyme: “Sell in May and go away”.

Now, this is just a historical pattern and it doesn’t perfectly play out each year. But over time this has been the average performance. So now we have seasonality working against us, rather than with us.

As well, Hulbert did a quick study showing that winter months that have produced negative returns go on to produce negative returns in the summer as well. But winter months that have produced positive returns buck the “sell in may” trend and continue the positive performance.

The only good news from the data mining is that the summer months following down winter months have much higher volatility. So for those who are equally comfortable going long and short, we may have perfect trading weather breaking on the horizon.

Oracle of Dow Theory
On the plus side, Richard Russell, is unapologetically super-bullish. Russell believes that the bull market never really left. Even the 2000-2002 bear market was just a “correction” within a continuing secular bull market that began in early 1980’s.

He bases this on two reasons: during the darkest days of the bear market in 2002, we never really got to a true bear market valuation. Two, from a technical point of view the market has been building a base.

Russell is worth listening to because he has seen decades of market history and he has studied it closely day after day. There was a time when he was a frequent writer for Barron’s. This was way back when Barron’s had a technical analysis bent, before it jumped the shark.

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.