This essay is based on the Premium Update posted on February 12th, 2010.
It was exactly a week ago when precious metals and main stock indices formed a bottom and provided a favorable entry point for all willing to participate in the next move up in the metals. Consequently we've sent out a Market Alert, and our Subscribers were able to get back on the market during Monday's decline (with prices lower than there were at the end of the session on Friday). While it may seem that the worst is behind us, we still believe one needs to keep an eye on the situation in case it turns around in a flash - especially, if the general stock market is to move much lower from here.
Therefore, let's begin this week's journey through charts with the general stock market (charts courtesy by http://stockcharts.com.) After all, it was this market that provided key signals last week, and which needs to be currently monitored with great caution.
The reason for the particular caution needed while analyzing the main stock indices is that we have strong reasons (sentiment, technical, etc.) to believe that the current downleg is a beginning of a more significant move down. This means that the emotion that we need to deal with here is fear, not greed, which would be the case if prices were rising. From a psychological point of view, fear is much stronger emotion than greed, and taking a look at virtually any chart reflects that. Declines are usually steeper than upswings, mostly because of the abovementioned psychological reason. Consequently, the general stock market needs to be monitored very carefully, because another move lower is likely to be sharp.
The first thing that comes into mind after looking at the above chart is that if this move is indeed a beginning of a serious decline, then we are still in its early stages. Please note that the Friday intra-day low was still much above the 200-day moving average, not to mention the first Fibonacci retracement level of 38.2%. Actually, the SPY ETF would need to move lower by a similar amount of dollars to what it already declined in order to reach the first retracement level.
Naturally, the question here is how low can the general stock market go during this plunge. Last week, we mentioned that it is too early to say, and that it seems that the decline is not even 50% over yet - and we don't have much to add this week, besides stating that the first Fibonacci retracement (around the $96 level) is likely to stop the decline at least temporarily.
The action in volume is clearly negative, as the volume increased visibly along with lower prices and this is the most important technical reason why we believe that there is a 90% probability that this was not the final bottom for this decline. Still, the point made in the latest Market Alert, is still up-to-date:
The general stock market is likely to move temporarily higher and the corrective upswing may take several weeks. It's much too early to say if the main stock indices will move above the January high - for now it doesn't seem likely.
There is one more thing that we would like to comment on before providing you with the gold chart - namely, the fact that during the early part of the 2007-2009 downswing, precious metals stocks were negatively correlated with the general stock market. Please take a look at the area marked with the blue rectangle on the above chart. For over 10 months PM stocks were trading in the opposite direction to the general stock market - if one takes short time-frames into account. Please note that tops in PM stocks were reached along with bottoms in the main stock indices and vice-versa. Still, taking the long-term perspective - both markets plunged dramatically.
The reason why we mention this phenomenon in this update is that it shows just how tricky relying on the stability of a given correlation can be. Today, we see that the main stock indices are closely positively correlated with PM stocks and PMs in general, but that doesn't mean that over several months these markets must go in the same direction. We will keep our eyes open for additional clues, and report to our Subscribers accordingly.
Moving on to the gold market we see that the similarity that was visible during the latest decline is still present after gold bottomed. This time, however, it suggests that gold may soon need to consolidate for a week or so - just like it took place in the past. Please take a look at the areas marked with red rectangles - gold paused when it moved to the declining short-term resistance line (April 2009), or it broke above it and then verified it as support (October 2008, July 2009). Should the history repeat once again, we can see a similar pattern also this time.
Let's turn to the short-term chart featuring the GDX ETF (proxy for PM stocks) for more details.
The volume in the GDX ETF provides us with additional bullish signals, as it - contrary to the situation in the SPY ETF - is higher during days when the price rises. Moreover, the RSI indicator moved higher after having bottomed around the 30 level, which often served as a confirmation of a bottom in the past. One of such examples comes from late October, when GDX started almost $15 rally.
It is too early to say when will the next top materialize, as currently much depends on the main stock indices. For now, it seems that the general stock market will consolidates for some time, which will allow PM stocks to rally along with higher PM prices. The situation on the general stock market can change very quickly (just like it was the case a week ago), so one has to monitor it for important clues. Naturally, we will send out a Market Alert to our Subscribers, should anything important (from the Precious Metals Investor's point of view) emerge.
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Thank you for reading. Have a great and profitable week!