Thursday, March 11, 2010

Signs of a Golden Spring

So much has changed in only two weeks. I first started writing this update on February 26, when things were looking good for the precious metals market, hence the optimistic title. I put off writing some more until March 6, when I wrote, "Since then, things have deteriorated quite a bit." And indeed, since then, things have deteriorated quite a bit, which was proven this week with gold falling by thirty dollars since I wrote that line. But I'm getting ahead of myself here. Let's start at the beginning.

Since my last update, things have more or less gone as I predicted. Stocks continued falling and actually did reach my target of 1037 before reversing in a bullish hammer candlestick pattern on February 5. However, the correction in the stock market was strong enough that according to almost all of the sources I follow, the intermediate trend has turned bearish. While that doesn't mean the stock market can't keep rising (and in fact, it's been rising for several weeks now), that does mean it has to prove itself before we can say the stock market will post new highs. That being said, the S&P is now inches away from its January 19 high of 1150.45 and is ready to test that high.

Tomorrow is going to be a big day. As I said above, the intermediate trend is bearish. In order to turn that trend bullish, the SPX must break above that high and stay above it for three consecutive days. If it does that, then we can say with a fair amount of confidence that the bull market is alive and well and will continue to rise. (Even though from a fundamental standpoint the stock market is outrageously overextended....) Although volume has been declining -- a bearish sign -- the past few days, volume has been increasing with the new highs, which is a bullish sign. In addition, the Dow is about a hundred points from its January high, meaning it needs to catch up, although it's possible we could have a scenario where the Dow catches up and the S&P posts a new high but fails to hold it for the requisite three consecutive days.

If the SPX does not break the January high (i.e., tests and fails), then it is likely that today's high marks a double top, which is very bearish. The most important support level to look at is around 1115, as that is both the 61% Fibonacci retracement level and the 50-day moving average. Using retracements, the next support would be around 1105, then around 1090. The 1090 level also marks an old resistance/support line. I expect the 1115 level to be relatively strong -- if it breaks easily, then stock bulls better be careful. In any case, no matter how you look at it, it's best to be cautious and see what happens before taking positions on either side of the market.

The PMs also did what I expected, though they did fall a bit more than I had thought. However, in keeping with the title of this post, it's not all bad, as things are looking more positive for gold than they have compared to December or January. Unfortunately, as I said at the beginning of my post, the situation has deteriorated quite a bit. The biggest sticking point is that sentiment is excessively frothy considering the rather lackluster price action we've seen in gold. While it's most likely February 5 did mark the beginning of the next bull leg (and hence likely marked the bottom), gold is going to have to take a breather. The nearest support is $1110, which is where gold is at right now, then $1102, then $1093, then $1080. My feeling is that gold will fall below $1100, as sentiment has not improved even though gold has fallen by over thirty dollars. Fortunately, RSI is neutral, and Stochastics are falling rapidly, suggesting the bottom is not too far way, perhaps a week or two from now.

The situation in silver is similar to gold, but the most interesting thing is that silver has shown relative strength. The PM sector has been highly correlated with the stock market lately, more so than with the USD, which is both good and bad, as I will explain in further detail when I talk about the dollar. However, silver has been particularly tightly correlated with stocks. Stocks have been strong, and so silver has been strong. If the SPX breaks out to new highs, then we should continue to see continued strength in silver. If it bounces off resistance, then we could see a rapid decline in silver to match gold's decline. One worrying aspect is that while RSI is neutral, Stochastics are overbought. Thus, I think there's currently more downside risk than upside risk with silver. With that said, my feeling, though, is that we will continue to see silver leading gold. (As an aside, typically silver underperforms gold at the beginning of a bull wave, then outperforms towards the end. Is silver's current outperformance a sign that we can see a strong bull leg in the future?)

Gold stocks are generally mirroring silver's price action, showing relative strength compared to gold. Similar to silver, Stochastics for HUI are also overbought, and thus the near-term downside risk is greater than upside risk. However, as with silver, I think the strength in HUI/GDX is a good sign for the intermediate and longer terms; during the bull run we saw last fall, gold stocks were weaker than gold, which is the opposite of what we normally expect, and an overall negative sign. If they continue to lead gold, then we should see a powerful bull run in the coming months.

Finally, we come to the USD. The dollar reached the upper bound of my target and since then has been consolidating in a flag-like pattern. Both RSI and Stochastics are neutral. I have a feeling that the dollar will continue consolidating for at least a few more days, but my next target is 82. I'm bearish on the dollar over the long term, of course, but I think for the intermediate term things aren't looking so bad. The intermediate trend is bullish, and a bullish golden cross has appeared on the chart. Interestingly, it's possible that a rising dollar will not have much of an effect on gold. One major issue lately is that it's been unclear whether gold would follow stocks or the dollar. We've gotten some clarity lately, as gold and stocks have been rising in concert in spite of the rising dollar. Of course, correlations can change, as we've seen these past few days, as stocks have kept rising while gold has fallen. Nevertheless, barring a euro currency crisis with Greece in the next few weeks (note that I called out Greece as a "looming problem" before the crisis broke!), I don't expect a strong impact from the dollar on gold.

Since this is a longer post than usual, I'll summarize: stocks are at a critical juncture, gold needs to fall some more but is otherwise building a nice foundation for the next bull run, and the dollar might continue to surprise a few people. The overall theme is to be cautious and let things play themselves out before committing to being long or short the market. After all, in this game, you can always catch the next ride.

No comments: