Assessing the Gold Breakout

Gold has broken a major resistance line, now what? This blog will dissect the gold breakout and the strategies that have arisen. Lets look at four different cross-currents of technicals on the GLD.


1. Continuation/Bottoming Patterns.

2. The Throwback.

3. What it all means in the market.

4. How to trade it.

1. Continuation/Bottoming Patterns:


We'll first look at the different technical patterns that have been called on the current consolidation/bottoming pattern of the Gold, replicated by the GLD, and discuss their respective calculations for price points.


Head and Shoulder(they are not usually continuation patterns)



There are many out there who have seen the head and shoulders pattern in the GLD - although HnS formations are usually bottoming patterns, not continuation. Measure the height of the head at top/bottom and add/subtract that from the neckline. The current values and calculation for the GLD would be: {100(Neckline)-75(Head)}+ 100(neckline) = 125 or approximately $1,250 for one ounce of Gold.

Flag Pattern

The flag pattern is a continuation pattern. There have been many calls that the current consolidation is a flag pattern. The calculation is to subtract the breakout point price from the price at the top of the consolidation of the flag formation. Add that # to the breakout of the consolidated flag. The current values and calculations for GLD are: 100 -65 = 35. Add that to 80 which gives you 125, the same value as the H n S bottom.

2. The Throwback



When a stock breakouts through an old resistance price it will usually come back and test that resistance as support. This is known as a "throwback". Also notice that this breakout move could begin an Elliot Wave count.












3. What does it all mean for the market?



An important divergence that seems to have been developing - Gold/Gold stocks have been outperforming the early cycle sectors in the past 4-6 weeks. There is a 20% difference in the 6 month performance of the AMEX GOLD BUGS INDEX(AMEX: ^HUI) vs. Dow Jones Transportation Averag(DJI: ^DJT) and the (Philadelphia Semiconductor Index: ^SOXX).







Gold's breakout has also increased the volatility of the markets. This is usually indicative of tops and bottoms and means the markets will get more volatile in the short term. The market can thrust higher in this volatility - a blowoff top if you will, but the VIX, although it has been sleeping in its den, can wake up and give us a scare, albeit much less then the VIX during the market crash.







Also remember that in the economic cycle, commodities move last - this also backs up the theory that the market is nearing the end of its current trend, as commodities have been on fire. It doesnt mean we cant consolidate for 6-9 months with a 10-15 percent corrective range(which presents great opportunities as a trader)before making another leg higher sometime in the summer/fall of next year. Which would probably sit gold at 1400-1500 and ready for a large correction.




4. How to trade it.

The throwback in the price of gold could hold the crucial element for the soon coming "real" market correction. On the breakout of Gold we have seen the volatility of the market increase which is warning you of something to happen. This could mean another leap higher in the market on the current breakout of Gold prices - creating a blowoff top of some sort for the markets and finishing the Wave 1 and moving into the Wave 2(throwback) of its trend. When gold corrects at around 1200, the market should begin the correcting and stagnating phase of inflation.

A 2:1 long/short model weighted long gold/silver stocks and short early cycles like semis and banks could bode well for a managed risked portfolio. This strategy should work during the current breakout of gold to around 1200. Once that manifest's, you would want to be less long gold/gold stocks and tilted short on the early cycle sectors and shifting to a 1:1.5 long/short strategy.


A further strategy will have to be evaluated once and if we see any of the first 2 strategies manifest. You'll have to assess the inter-market relations at that time to see how to realign one's holdings.

NEW UPTREND CHANNELS

First things first: find the trends and make sure you are on the right side of that trend. Below are 5 stocks with clear uptrends. I only include 5 because one should only stick to a handful of stocks and leave the rest for research. If you try and own or trade too many stocks, this can lead to overtrading which reduces profits due to trading costs, margin calls, inability to make clear and decisive decisions, etc.

So, sometimes it is more efficient to find 5-7 stocks and stick with them. Find your favorite stocks based on clear signals from your favorite technical indicators and with a clear uptrend/downtrend. Trade those stocks based on the trend lines - buy at bottom of trend, sell at top. Only introduce another stock if those favorable signals show signs of deterioration along with the break of the trendline.

During this time of trading your favorite stocks, there is always time for research, but the only time to enter into different stocks is if/when your technicals deteriorate and your trades start losing money. If it ain't broke, don't fix it.

I like to use MACD's, STOCHASTICS, MONEY FLOW and ADX indicators for the technical indicators and I always make sure I can identify a uptrend channel. Here are a few of my favorite uptrend stocks that have been working.

COEUR D ALENE CP NEW(NYSE: CDE)




MercadoLibre, Inc.(NasdaqGS: MELI)




FREEPORT MCMORAN B(NYSE: FCX)




MICRON TECHNOLOGY(NYSE: MU)






GOLDMAN SACHS GRP(NYSE: GS)




Notcie the slope of each trend - the lower the degree of the angle, the less profitable and less risk. The higher the degree of trend, the more profitable but also more risk.

NOTE: Whether the market has more to correct or not, these stocks should continue on their trend unless they break through that bottom trendline. Yes, they are associated with the market but new stock leaders will turn before the market bottoms. Notice that many of the stocks have recently tested that bottom trend at a time the market has been correcting.

1,000 is the new 100

Numbers are symbolic, almost ironic sometimes. We see them everywhere in our daily lives, and even try to use numbers familiar to us to facilitate luck or certainty - family birthdays for lotto picking are a good example. So, with keeping up with a common theme, and watching Gold rapidly approaching the 1,000 mark, I am declaring that 1,000 is the new 100. Our lives will now be yielding more numbers in everything we do - phone bills, gas bills, mortgage bills, grocery bills, etc. Even the government has entered a new realm of numbers with the billion dollar theme being left behind for the next phase of numbers - trillions. Back in the day, if one pulled a C note(100 dollar bill) from their pocket heads would turn, but today 100 dollars is nothing more than a grocery odyssey with some spare change for a local do-it-yourself carwash. So how does one protect themselves from this overwhelming invasion of numbers? Gold. And if you want a simple equation of when to get rid of your gold, lets look at some simple, maybe easy to understand numbers.

The US goverment is going to issue near 3 trillion new American Dollars, which will devalue any existing dollars currently in our system. By how much the dollar is devalued is the trillion dollar question, but perhaps lets use this simple equation and how it relates to Gold. For every trillion dollars the government has put on the street could ultimately equate in a 1,000 dollar increase in the price of Gold. 3 trillion = 3,000. Current Gold price is 1,000, so if we add 3,000 to its current price we get: 4,000 dollar Gold? Mmmmmmm. Yes and no. Of this 3 trillion dollars, some of it will yield inflation, but some of it will yield true GDP and economic growth so all of that money can't be discounted to price of Gold. So what is the price target for Gold? I'd have to say somewhere between complacency and mania, but for now you're either long or you're wrong.





Bullish Flag Formation Near Term target 1,300. (Top of flag resistance - breakout price) 1000-700 = 300. Add this to 1,000 and you'll get $1,300

The Exit Strategy.

Spring has sprung and so has the stock market. The current sentiment looks like we may have a classic "Sell in May and go away" - but with a twist. More about the twist later. The below chart and information on the Business Cycle/Economic Cycle - provided from Stockcharts.com - is a good place to start from when determining which sectors to be in and when.





Legend: Market Cycle(Red) Economic Cycle (Green)


This theoretical model is based on Sam Stovall's S&P's Guide to Sector Rotation and states that different sectors are stronger at different points in the economic cycle. The graph above shows these relationships and the order in which the various sectors should get a boost from the economy. The Market Cycle preceeds the Economic Cycle because investors try to anticipate economic effects.


The current intermediate trendline is still in tact, but at a pivotal moment as the chart shows. If this trendline holds here, we can see a fast move higher. The resistance zone matches up with a May sell signal.





If we look back at the business cycle/economic cycle we can see the models shows that finanicals lead. In this current market, financials are leading in the last month and are helping make a case that a bottom is being put in place. As the market made new lows in February, so did the KBW Bank Index (^BKX), and while many other indexes did not reach new lows - indexes such as the PHLX SEMICONDUCTOR SECTOR INDEX(Philadelphia: ^SOXX) and the AMEX GOLD BUGS INDEX(AMEX: ^HUI)
- a relative strength collage started to emerge. Everyone knew without the financials though, everything was off the table - the market could not recover. But now that the financials have bounced - in a big way - and currently lead on a 1 month relative basis off of the bottom, the promise of a new market/economic cycle is showing improvements, and sector rotation is currently being construed: financials/transports, technology/basic material, and then energy/commodities.


1 Month Relative Performance

3 Month Relative Performance

6 Month Relative Performance


Notice the AMEX GOLD BUGS INDEX(AMEX: ^HUI)is lagging on the 1 month basis, which confirms that they should be the last to run. They have clearly been the strongest sector in the 6-9month timeframe.

According to the cycle rotation, we should continue to see sector rotation out of financials - this does not mean that banks can't go up, it just means they will lag now - with transports still showing some room to outperform short term - the outperformace of the transports will give us DOW THEORY, and will confirm that we have a classic sector rotation off the bottom. Look for money to start moving into technology stocks/basic materials also in the short term, and outperformance till May sometime. This coincides with the "sell in May" theory. This is the sell signal and where we can start looking for money to rotate back into energy/commodities for summer. At this time, a good strategy would be 50% cash 25% hard assets and 25% stocks. Over the summer, look for the markets to be flat, and hard assets to outperform.

The Twist:

The twist is if Gold breaks out and over the 1,000 mark - if that occurs, we could see commodities begin a spectacular rise to create some of the best returns in commodities since its secular awakening. But nonetheless in this new risk averse world, don't count your chickens until they hatch, or in modern terms - sell them before the expiration date.

One Should Be Long Technology.

The Nasdaq comeback has begun! The new bull market will be led by Semiconductors. Here's why.

The NASDAQ and the PHLX SEMICONDUCTOR SECTOR INDEX (^SOXX) are at 8-10yr lows, which means, according to the current Kondratieff Long Wave Theory, we are smack dab in the middle of a major economic cycle - this one so happens to be the depression(or Winter Cycle) - and that makes sense.

This bears good news and bad news. The good news is we are in the middle of the winter cycle, not the beginning, and the bad news is that we still have around 5-8 more years to go - most cycles last between 14-18yrs, so if we had the beginning of the "Winter Cycle" start in 2000ish, then by 2014 - 2018, you will see the cycle end. This so called "market goes nowhere for awhile" that everyone keeps saying is true, but remember that by 2014-1018, the DJIA, and more notably, the NASDAQ, should be aiming for their old highs - this is based on the fact that the market has been flat for the last 8-10yrs, so in 5-9yrs, the winter cycle will be finishing - gold will be plummeting, oil will become oversupplied, and new technolgies will advance at an ever increasing rate(probably aerospace). After this winter cycle a spring cycle will emerge, which I believe will take the NASDAQ, and Semiconductors on a huge run that I want to ride - and the tickets are sold right here and right now, today.



With that being said, and knowing Commodities have been in a Secular bull during the last 8yrs, we can assume that we are in the middle of the Secular bull for commodities but more importantly at the beginning of a new secular bull for Semiconductors. See chart below.

Commodities make roads and buildings. Chips make everything else.

We can see that the PHLX SEMICONDUCTOR SECTOR INDEX (^SOXX) is showing the best relative strength against its peers on a 3m, 6m and 1yr timeframe - except for a 6m timeframe - the AMEX GOLD BUGS INDEX (^HUI) leads at that time interval. But if you look closer, Semiconductors are even leading the Dow Jones-AIG Commodity Index (^DJC). Gold stocks and Semiconductor related stocks should outperform, near term and long term, and have been outperforming for the last year. The S&P BANKING INDEX has lagged everything.

3 MONTH

6 MONTH

1 YEAR

BREADTH IMPROVES



The number of new stocks hitting new lows continues to show signs of strength. Breadth indicators continue to favor a case for a bottom, albeit a long and uneven trudging of one. The Nasdaq is showing relative strength still - and if you notice, its New High/New Low chart exemplifies what should be happening when a bottom occurs. If you look at the NYSE stats, the data is less defined and unclear - that's why the Nasdaq will outperform near term and long term.





NASDAQ LEADS MAJOR INDEXES

Looking at performance charts: Nasdaq has started to outperformed on a 3m timeframe. This is important since the major part of the crash, and leading up to the 6500 area support is about 3 months - so far, NASDAQ has held up the best.



The major thesis here is that a new secular growth story is emerging. A growth story that will heal all of the cuts, bruises, and breaks that the Nasdaq left us in 2000. One should now be long technology.

STOCKS: MICRON TECHNOLOGY(NYSE: MU) TAIWAN SEMICOND ADS(NYSE: TSM)
TEXAS INSTRUMENTS(NYSE: TXN) STMICROELECTRONICS(NYSE: STM) LSI CORPORATION(NYSE: LSI)MRVL Marvell Technology Group, Ltd.

MU - Channel Break.

2 charts: one story - many endings.

A long-term channel break occurring in MICRON TECHNOLOGY(NYSE: MU) could bode well for itself in the next bull market. A channel break, as shown in the first chart, is the sign of a reversal of a trend and direction of the channel. The trend has been down for Semis since 2000 as you can see in The Other Commodity post. If you believe we are to emerge from this crisis stronger, then high-tech manufacturing could be our new shop floor.

If we look at the second chart, which shortens our time frame, we can see a potential cup and handle formation forming. Cup and handle formations are traditionally continuation patterns, and not long-term bottoming patterns, but the channel break could be of more importance in determining which way this stock should go from here.

And since we are in the midst of the unfamliar, a stop loss should be placed at around 2.50 which would break the pattern and cause for more consolidation or continuation of the downtrend.

Chart Analysis: Comparing Bottoms

Chart Study: DJIA 02-03 bottom vs. DJIA 08-09 bottoming - when, where, how and why!

Many are calling the bottom here - and there is good reason to do so. The above charts are the differences between the 02-03 bottom and this 08-09 bottom. There are many differences, but many similarities.

• 02-03 bottom went from 10500 down to 7500.
  
• 08-09 bottoming went from 13000 to 7500 - giving us an Oct plunge that started at 10500 and ended at 7500 - that single move was equivalent to the entire 02-03 bottom.

This is a big difference in the "amplitude" of the "phase", or the measurment of the top to bottom of the cycle of the 02-03 bottom and this 08-09 bottom. That's why this one hurt so much because it was faster and had a bigger plunge.

On the charts posted, you will see the calculated targets for the first bounce off the bottom of this new "cycle" or "phase". Here are things assumed in order to reach those targets.

• The bottoming formation of 02-03 bottom- Inverse Head and Shoulders: see chart for measuring technique and targets.
  
• The 08-09 bottom is showing a very similar HNS pattern, as many have been predicting and waiting to confirm: see chart for targets and analysis.

A couple of things I have been waiting for.

1. More Volume
2. Vix hits resistance area
3. New Highs vs. New lows continues in the right direction.

These all have been starting to show signs of dramatic improvement and confirming that the market could now be creating the right shoulder of the HNS bottom, and could now be ready to move higher until this summer - which will give a trader the best performance chances during this period.

Knowing this can also be a very tricky market where patterns emerge and dissapear, move in opposite of its original intention, etc. - risk management must be assumed.

PLAN #2 - Risk Management - possible scenario if we breakdown on the right shoulder here.

If this right shoulder doesn't hold with more volume to come, a possible breakdown to the 7500 retest would be considered the next support and also a place to then call for a bounce, or double bottom attempt. If that happens, then we will have a sideways market for the rest of 09 with a possible restest of the 7500 a third time sometime in Sept. or Oct. - and a day that would be a very scary moment, for sure, but I don't believe the probabilities are in this favor.

Mixed Signals and Weak Technicals - VIX and DJIA

The VIX's thrust to new highs from the 35-40 area to the historic 80 area in Sept. and Oct. brought the market to it's knees - from 11500 to 7500 in a month. Now the VIX is back to 40 and the market can't sustain any sort of rally that has legs - this may be problematic short term - and may be signaling more volatility soon.

VIX and DJIA show more range bound technicals and signals; even the possiblity for a scare of more volatility in the coming week or days. The last blog analysis of the VIX and DJIA relationship put the DJIA target at 9500 when the VIX would correct to the 50 area - it bounced and the market corrected from the 9500 area- that was correct, but what hasn't proven itself is the test of the 40 area on the VIX which, I believed, would have the DJIA higher than 9500 since the VIX at 50 equated to 9500 on the DJIA, so you would think a break into the 40 area would equate with a higher price than 9500. Well, the VIX is now at 40 but the market is well below 9500, it right now sits at dismal 8599, and well short of the 10500 target with a VIX at 40. With the VIX now at the 40 support it now seems like 25-35 area on the VIX would be needed in order for the DJIA target of 10500 to be achieved.

Looking forward, the VIX has still not hit its large support area around 25-35(congestion area), although a bounce on the 200EMA is currently in progress, and knowing the 50EMA is reading 50.40 on overhead resistance, the current bounce should have resistance there and come back down toward the ever so slight drag to the 25-35 area - maybe this can finally get the market back to 10500. What is concerning is that the DJIA hasn't moved far for a 50% correction in the VIX. Can the 25-35 area be the true test the VIX needs to be at before we see any sort of a sustained bull run in the DJIA - or is the VIX going to fade into the distance for the mean time while other patterns/indicators become more prevalent.