Let's Get Technical (Part 2)

Yesterday, we built a case that the markets, despite a surprisingly strong Septemeber, were doing their best to prove Abe Lincoln right by "fooling most of the people, most of the time".  There is much more evidence of that.

Technical analysts often use an indicator called the RSI or (Relative Strength Index). According to Investopedia, the RSI is defined as follows:

"A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. It is calculated using the following formula: RSI = 100 - 100/(1 + RS).  RS = Average of x days' up closes / Average of x days' down closes."

"The RSI ranges from 0 to 100.  An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback.  Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued."

To be sure, the RSI is far from perfect, but it has a pretty decent track record of at least measuring the condition of a market that is conducive to either an upside or downside reversal.

At the conclusion of trading yesterday, the Dow Jones Industrial Average (INDU) had an RSI of 66.60, the Nasdaq 100 (NDX) had one of 72.74, the Standard & Poors 500 registered 66.50, Gold came in at 72.50 and the HUI was 55.99 after hitting 68 several days earlier.

A good charting service from which one can review these numbers and other indicators is Stock Charts (http://www.stockcharts.com/). 

If you pull these charts up, you can see that most intermediate term rallies crap out with an RSI in the mid-to upper-60's and bottoms hit 35 or below.  Markets rarely rally much after crossing 70 on the upside or decline much if they penetrate 30 on the downside.

What makes the market seem so weak is not only the poor price action despite a long string of up days as highlighted in yesterday's piece http://markostake.blogspot.com/2010/09/lets-get-technical.html, but also in looking at how extended, or lack thereof, the market got.

A real lift-off will typically pull an index or stock well above its 200 Day Moving Average (200DMA).  Historically, major Gold rallies have peaked in excess of 30% above is 200DMA.  The HUI has historically peaked more than 50% above its 200DMA.

The bullion, despite a near-uninterrupted 10 week rally, has failed to get much in excess of 10% above its 200DMA, while the HUI has only gotten 15% above its DMA.  One might argue that this means that they have further to go.  True enough.  But, in light of the various overbought conditions are measured by the RSIs, it would appear that what we are seeing is a series of markets losing momentum. 

We continue, therefore, to urge extreme caution.  Today's Federal Reserve meeting is a perfect occasion to provide the market with an excuse to begin its trek to lower, perhaps MUCH lower levels.

Once again, while we believe that caution should rule the day even in the precious metals sector, it is highly unlikely that we will see the type of smash that occured in 2008.  And, it may even surprise everyone and rally.  However, use the guidelines outlined in yesterday's piece before jumping in with both feet.

Marko's Take