Die Hard: The Markets

Like Officer John McClane, they continue to expend all of their nine lives.  Is this life number 9?

Without a doubt, my assessment of the state of the markets has got to be called into question.  Two relevant issues to address are:  (1) Has the Hindeburg Omen, become, as Dee Dee Myers used to say, non-operational?; and, (2) Is the Precious Metals arena about to explode?  For more on the Hindenburg Omen, click here http://markostake.blogspot.com/2010/08/hindenburg-omen-all-over-financial.html.

If we do not begin to see a forceful decline commence by the end of this week, it is unlikely to build the kind of downside momentum that would be required to precipitate a crash.  That said, as of this writing, I have not budged from the crash prediction one bit.  The technical reasons were recently outlined in this piece http://markostake.blogspot.com/2010/09/lets-get-technical-part-2.html.

As far as the Gold and mining stocks sector go, I have some further technical thoughts.  For the record, my position is that Gold is forming an intermediate top, before returning to the proximity of its 200 Day Moving Average (DMA), which currently stands at $1175.  That makes downside exposure in the vicinity of 10%.

One thing that troubles me about Gold is that it has underperformed the weakness of the U.S. Dollar over the past several months.  Since June, the Dollar Index is down 11%, while Gold has risen about 9%.  Ideally, we'd like to see the reverse.

More troubling is just how extremely overbought Gold has become.  It now has a Relative Strength Index of 83.46.  The piece referred to above explains the use of the RSI and how it's derived.

An examination of the relative strength of precious metals mining companies, as represented by the Gold Bugs Index (HUI) to Gold itself is quite revealing.  Ideally, we would desire the stocks to substantially outperform the metal.   Since May, the companies have underperformed, although not substantially.  The HUI continues to be unable to materially break out above the 500-525 zone despite daily new highs in Gold.  Should the HUI return to its 200 DMA at 446, it would get smacked for 11%.  Downside risk is very limited.

Ideally, the HUI ought to also do better than the broad stock market. We can measure this by comparing the performance of the HUI to the Standard & Poors 500 (SPX).  The HUI has gained no ground since November, 2009.  This isn't cause to worry long term, but it does tend to suggest that a modest correction is imminent.

Investors should remain cautious but ready to jump in!

Marko's Take

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