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Clif Droke

Clif Droke

Clif Droke is the editor of the two times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock…

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The "Surprise Inside" Awaiting the Bears

(A positive for gold stock investors?)

There is a potent "surprise inside" the broad market awaiting the bears like a trap in the forest. Once this trap springs shut it will produce the bears' worst nightmare in the form of a massive short-covering rally. It could also produce a nice rally in the gold stocks, particularly among those listed on the NASDAQ.

What am I referring to? The "surprise inside" awaiting the bears when they start growling too loudly is the phenomenally high level of short interest on the QQQ. Right now it reads something like 60%, which is undoubtedly an all-time high reading. Do you realize what that means? That means the majority of all shares outstanding in the "Cubes" (which track the NASDAQ 100 index) are sold short. This high reading, in and of itself, is a major support undergirding this market and will also be the catalyst for a huge short covering rally in the not-too-distant future. I fail to see how this market can outright collapse in the face of such astronomical short interest. I also would be very surprised if this market didn't get an extraordinary short-covering rally in the near future based on this high reading. This should also have the effect of boosting the recently-depressed gold stocks, particularly on the NASDAQ.

To take one example, there is a well-known gold stock listed on the NASDAQ which currently has a short interest of over 11%! That's pretty high for a gold stock, especially given where we are in the overall gold stock cycle (i.e., still early in the cycle). This could easily result in a nice-sized rally off the recent lows in this stock, especially once that tech sector short interest kicks in.

Speaking of the tech sector, some would undoubtedly find it strange that the XAU in recent months has actually been somewhat of a leading indicator for the NASDAQ itself. Strange? Not really, especially when you consider what is driving this market right now, which is inflation from the past two year's financial stimulus efforts of the Fed. In an inflation-driven market the sectors that are closest to real wealth will always lead the pack. This is now the time for the natural resource sector to shine.

As for the recent stock market decline, it was mainly a function of the terrorist scare in Spain on Thursday. If you look back at the Dow's recent history you'll see that a few days before a major terrorist episode hits, the market will have a 3-5 day plunge before reversing after the event is over and has been completely discounted. Usually thereafter the previous losses are retraced and the market continues its upward path.

Last week was the anniversary date of the 2003 major stock market low. Does this have any significance right now? Of course it does, especially since the famed trader and market technician W.D. Gann put such a big emphasis on the concept of anniversary dates in the market. A breakdown below the 1-year uptrend line in the Dow this week would have been an extremely bearish signal for this market, but by holding up and reversing above the 1-year uptrend (and 30-week moving average) the Dow keeps its uptrend intact and passes its first major test of the trend in terms of time.

Assuming the market finds support near its recent lows and turns around this week we should finally get a taste of that "surprise inside" that the bears will find so distasteful, yet gold bulls and stock bulls should enjoy.

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