Gold Still Shines

Despite a week which saw a healthy rally in the U.S. Dollar, gold continued to show impressive strength, and in fact, yesterday broke significantly higher despite the higher greenback. The wish-washy correlation between the U.S. dollar and gold should be no surprise at this point, however. As we have pointed out numerous times, gold appears to be wearing "Everyman's Hat" - and its inexplicable bullishness apparently the result of its own secular uptrend.

For now, the game remains buying pullbacks and break-out levels (we were provided two most recently, with the pullback to 100, and the resistance break above 104.5). Further short-term pullbacks to the 104.50 level may give traders and investors second chance buying opportunities. And the recent price action perhaps allows us to be a little bit less nervous about every gyration in the currency markets, at least for the time being:


Disclaimer: author's clients maintain positions in the GLD.

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Scouting the Next Bounce for Shortable Opportunities

Technical

The recent multi-day slide in the stock market has set the stage for some decent shorting opportunities. As we've highlighted in recent posts, major market averages such as the S&P 500 and Nasdaq have been looking tired, and now are finally giving us the first real signs of distribution. While we must leave the door open for the possibility that the market could squeeze out of this malaise, I view the higher likelihood being some follow-through to the downside once the market alleviates its current oversold tensions.

Some of the candidates I am looking at for short-side exposure are: UWM (the UltraLong Russell 2000 ETF), HYG or JNK (Junk bond ETF), KRE (Regional Bank ETF), and TLT (20-yr Treasury ETF).

At the same time, I am looking at the following long positions: VXX (Volatility Index ETF), GLD or UGL (Long and UltraLong Gold ETFs), and TIP (Inflation-protected treasury ETF).

Charts

Taking a look at some of the ideas more specifically:

The small-caps have been leading the upside all year, and now are showing the most clear-cut signs of distribution. Relative strength massively divergent as the indices "double-tapped" their highs, and then the downside volume surge on the breakdown. One way to play a short on this index would be to short the UltraLong ETF (UWM), as the time-decay characteristic of these leveraged ETFs should make this trade profitable even if the movement is sideways and not straight down. A move back to 59-60 in the IWM (parent ETF) might make a good entry zone, with a safety stop at the October highs.

Another interesting idea would be to short one of the junk bond ETFs, such as HYG or JNK. Given the macro environment, it seems unusual that credit spreads would be reflecting a normal default environment. Technically, the ETF is showing signs of divergence in both relative strength and in terms of volume. Again, clear risk/reward parameters here with a safety stop at the recent highs.

While the financials have helped lead the rally from the March lows, the "black sheep" of the family, the KRE (Regional Bank ETF) has barely rallied. As one can see from the chart above, the ETF has scrawled out a triangle pattern that it is currently failing from on big volume. Weak attempts to break through the top of its multi-month range have been marked by non-existant follow-through. Pretty clear risk/reward as long as KRE stays below 22.

On the long/short side, TIP (the inflation-protection treasury ETF) should do well irrespective of whether we face a resurgence of deflation- or inflationary fears, and technically looks very solid. On the flip side, the TLT (20+ year treasury ETF) looks horrible and might be worth a short with a clear stop at 96.

Disclaimer: author's clients hold positions in TIP, GLD, UGL, and KRE.

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Ominous Breakdowns Across the Board

Finally seeing meaningful distribution across the indices today. And while we may see some short-term snapback in the coming days/weeks, I would wager they would be prime opportunities to get out of anything you failed to trim back on, and/or initiate some short positions at more favorable prices. Take a look at the Nasdaq, a former leading index:


When leaders accelerate the downside, you are being given a warning flag. Recall last week we mentioned the sudden sell-off in the EWZ as a harbinger of future woe. Take a look at today's action:

We have now see four straight days of above-average selling in the SPY (S&P 500 ETF).

And while this suggests we may be oversold in the short-term, it certainly implies more selling ahead, as recent buyers get spooked. Buyers in October will soon see their newly minted "bull market" positions put to the test.

Further evidence of this theory can be seen in individual stock names. A lot can be learned from observing a list of "I wish I had bought those" stocks. Everyone has a list of such names, stocks you wish you had held or bought at the bottom. Stocks that have rarely let up or given investors a chance to hop aboard. Well, I look at my list and I see tons of breakdowns I would NOT buy. Gap-downs, breaches of trendlines, ugly volume. This tells me that stocks that people would ordinarily want to catch or buy "on the dip" will continue to trap investors or scare away smart money buyers, who come to realize the ride is over.

A perfect example of this kind of price action in formally "hot stocks" can be seen in the Russell 2000. Small-caps lead the rally, now have already breached recent support:


Be forewarned. Analysts and pundits have been telling average investors to buy every dip since July (the midpoint of the rally in terms of time). However, not all pullbacks are to be bought. Watch, and be wary.

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How Low Can She Go

After months of transition, of watching bear flip to bull, and bulls snorting increasingly confident that we have entered a "new bull market," it would seem the time is ripe to see if they are right. As we have pointed out since the rally turned 1000 on the S&P, the market move has been defined by divergent breadth and decreasing volume. Now, as we vacillate within the range of what could be called the "expected retracement zone," we are seeing increased volume distribution, and some sure-fire warning signals.

We are also getting the timely reinforcement from sober market forecasters such as Jeremy Grantham of GMO, and specific market technicians who simply no longer like the risk/reward of the markets, even if they were bullish on a rally in March (or on Emerging Markets in general). Technically speaking, given the parameters of our old expanding range model, the market has downside to 840-850, whereas few place the upside at more than 1200 on the S&P 500.

Investors should have heeded warnings and turned cautious on the rally at the 50% retracement zone. It seems all too many are eager to forget last year. There are clearly longstanding economic issues facing us that many would prefer to simply turn a blind eye too. Technical damage (if one would call it that) has finally ruptured trends that dated back to the 1980's, and are not going to simply be erased.

For the time being however, if the market is turned back and pervasive doubt allowed to return -- perhaps corresponding with a dollar rally, the return of deflationary fears, the rationalization that corporate profits are going to be pinched by a reticent consumer on one hand and rising input costs (raw materials) on the other -- investor sentiment could swing back to an ambivalent level. Assuming an important top is set here, a new range on the S&P 500 could be established between 666 and 1100 (with 850-950 as fair value).

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Bull Trap?

Shrewd investors would continue to execute a plan of taking profits and defending open long positions. This most recent high in the S&P 500 has occurred (once again) on divergent breadth, and mixed fundamentals. Good companies beating lowered earnings estimates notwithstanding, it is hard to imagine, with the Dow about 10,000, that the easy money hasn't already been made on this rally. The question now remains, is the party over - or will the market continue to make liars and fools of the cautious and the wary?

From the daily "take this as a warning sign" file, the EWZ (Brazilian ETF) is showing a very large one-day distribution after setting a new high on lower volume. Given the leadership status Brazilian stocks (and other emerging markets) have provided during the Mar-Oct rally, a slide in the EWZ would be a foreboding sign, as emerging markets have largely foreshadowed the action:


Also keep an eye on the dollar. One day price moves mean little (perhaps), but I am getting "mom and pop" phone calls wanting to buy gold, which means a serious counter-trend move in the dollar could be the surprise that no one expects.


In short, this is an opportunity to take risk off the table and to watch the market, not get greedy and bask too blindly in the "Dow 10,000" headlines. As if we weren't 4,000 points higher just two years ago.... oops.

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Taking Another Look at Nat Gas

In late August we highlighted several key divergences in the price pattern of natural gas. Since then we have witnessed a fairly fierce rally, most likely spurred on by short-covering and seasonality-driven demand build. Short interest and volume both declined on the move, further supporting that thesis.

Short-covering rallies at historic lows often help form the foundation for important bottoms, or they can signal nothing more than a pause in the trend. However, that is why technicians look so carefully for divergences in the strength of moves. Admittedly, I find it somewhat intriguing that traders have not gotten bullish on the commodity given the break-outs in other inflation-sensitive materials:

In August, we saw a lot of traders chanting "buy nat gas now!" ... a rallying cry that has now seemingly been replaced with "too far, too fast!" or "getting out while I still can!" This kind of Doubting Thomas sentiment may suggest that the move will go further than most expect, or a retracement could set up a more meaningful move, and an intriguing trading opportunity.

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Watchlist Additions: TIP

Lots of chatter about inflation lately. Arguments abound whether we should still be worried about deflation, or whether the demon of hyper-inflation is more pressing, as signaled by the break-out in gold. Try to filter out the noise. Gold's move is a consequence of its own longstanding consolidation. The new uptrend is likely only in its early stages, given the disconnect between its inflation-adjusted highs and other commodities. Furthermore, the Fed's printing presses may have saved us from deflationary apocalypse, but that doesn't mean that inflation is going to set in tomorrow and wrack us with 1970's-like pain.

Inflation in the future will large be a consequence of tectonic shifts occuring in Asia - India and China more specifically - as they continue their near-gravitational transformation from an agrarian society into an urban and industrialized economic force. And by consequence cheap labor and material rich countries in Latin America. This process takes time, and will take place over the next decades, not years. Nonetheless the inflationary pressures created by the raw materials these countries need are very real. It is no coincedence the first surprise interest rate hike came from Australia.

It will undoubtedly be written some day that the biggest opportunities of our lifetimes back in March were the emerging markets and natural resource stocks. Nonetheless, we now live in a world of trades, with fewer and fewer bargains. The barbell approach to portfolio management still should be applied - make your growth trades work hard for you, and keep a basket of steady dividend-yielding stocks and ETFs to anchor your positions.

One ETF that might make a nice addition to investment portfolios is TIP (the inflation-protected treasury ETF). It sports a 4% yield, with a nice price pattern as well:

The chart above clearly shows a steady uptrend, increased volume and positive relative strength on this recent move higher. Nonetheless, a pullback to the 100-102 area would present a better entry opportunity.

Disclaimer: the author or his clients maintain positions in TIP.

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