“Extend or Pretend?” asks Larry Pesavento

As many predicted, the world’s economies are now focused on the Greek credit crisis. The question on everyone’s mind (especially that of the European Central Bank) is whether the ECB is going to extend more money to this capital-strapped nation (one of a growing number of Euro members), or simply pretend that the problem will just go away. One thing we can be sure of with one hundred percent certainty is that the markets cannot hide what the outcome will be.

On my weekly radio show at www.tfnn.com, I recently hosted one of my good friends and very first mentor John Hill from Futures Truth. I asked John what would be the best advice that he could offer our listeners from his 60-plus years of experience in the stock and commodities markets. John quickly stated that the one single thing that would help them, more than anything else, was to learn how to read a price chart. Within the charts are the price actions of what is going on with any given stock or commodity. Charts cannot hide anything from you: if prices are going up, someone is buying; if prices are going down someone is selling. The best example of this is how many times we have heard analysts describe how good Enron’s stock was on its way from $95 a share to zero. Recall how this also happened with a long list of others including AIG, Bear Stearns and, of course, Lehman Brothers. The power of price charts is in the fact that they are the sum total of all the buying and selling.

This week, CNBC started a new show called Buying Blind. As they describe it, they used the term “blind” because the show’s premise is that nothing other than technicals are used in their analyses (i.e. no fundamentals at all). I found this rather amusing that they would call this method “blind”, particularly when the charts reveal more truth than any financial statements that are printed by companies they track (or the government, for that matter).

In this week’s letter, I feel it is timely to review the long term cycle that we described starting from several months back, and that we now believe is strongly in place. This cycle is a debt cycle that occurs roughly every two centuries or so. In fact, the last time we had something of this magnitude was the Panic of 1837

when Andrew Jackson was in power and was attempting to abolish the National Bank (which later became the Federal Reserve). Recall that on August 15 2007, the stock market made a major bottom. October saw new highs, but this quickly reversed, breaking the lows of August 15. This phenomenon started what we believe is the big debt cycle that we face right now. Studying the chart of the New York Stock Exchange index, you can see that the market rallied recently back to that fateful low of August 15, 2007. I believe the next leg down is going to be just as nasty as the one in 2008.

The lunar cycle that we have been watching, is still in bearish mode (i.e. selling on new moons followed by buying on full moons). However we are at a point now where the market is incredibly oversold and we have in place the following technical factors suggesting it is ready for a rally:

1. The volatility index has rallied to the 61% retracement of the March high.

2. The Dow Jones Transportation index has made a perfect 0.618 retracement.

3. The Dow Jones Utilities index has made a perfect 0.618 retracement.

4. The S&P 500 has made a 0.786 retracement and the NASDAQ is completing a very large AB=CD pattern.

5. The Banking index has also completed an AB=CD pattern.

Does this mean that the market is going to rally? Not necessarily, since this is represents a strong probability that the market is ready to move upwards. Nonetheless, should this rally materialize, we could be looking at one of the best opportunities to get into a short position since the new moon on May 2 2011. The question arises as to how much a rally we can expect. After dropping for more than seven weeks, the market could easily rally back for three weeks before starting lower. But there is always a possibility that the market will give up here and start down dramatically. Therefore, the key thing to watch for is any single day where the stock market is down more than 2% below the lows of the full-moon of June 15.

Treasury Bonds

Bonds continued to complete the AB=CD pattern we noted previously at the 1.26 level, an area that they have seen several times over the past several weeks. Treasury Notes (i.e. the shorter-term government paper) has completed the 0.618 retrace of the entire down move. This could be an indication that the flight to quality that we have been worrying about could have occurred for short-term paper and that the longer bonds are actually showing some weakness. Our long trade in the ETF for short Treasury bonds (TBT) is now at the 0.786 level again and we will keep our stops working at 31.99 per share. Should this position fail, we will be looking to re-enter at the completion of the next pattern.

Crude Oil

For the past several weeks we have been discussing the importance of the $95 per barrel price barrier in crude oil. This level was shattered this week and oil subsequently closed 2% below that at 92.63 per barrel! There is strong support for crude at $90 per barrel which is the 0.786 level as shown on the enclosed chart. Closing below that would be strong evidence that a deflationary environment might be on the horizon. Consistent with this, the Commodities Research Bureau index, which we have mentioned several times during the last few months is completing a long-term bearish Gartley pattern from its 2007 highs.

Foreign Currencies

The Euro is completing an AB=CD pattern on a daily basis at the 1.44 level and should meet strong resistance at the 1.45 level. At this point, going below 1.39 would setup much lower targets in the Euro and may actually lead some to question the actual existence of the ECU itself! Europe is drastically trying to hold the Union together and are essentially doing it in the same way as the U.S. – by pumping money indiscriminately to protect weaker countries (e.g. Portugal, Greece and Spain). Remembering that many of the things that we hear in the news are not to be believed, we should once again heed the strong advice from my friend John Hill, and look to the charts of these currencies and countries to determine if this catastrophic collapse has a possibility of occurring.

Metals

Gold is approaching strong resistance at the $1,553 per ounce level that we went short at a week ago. I would suggest moving our stops to breakeven in the GLD (ETF for gold) to the 150.53 mark, making it now a risk-free trade. Silver has also completed a bullish Gartley pattern and is showing the possibility to rally up to the $40 per ounce level. We would consider both of these patterns to have failed if we go below last week’s lows in either of these commodities (i.e. 1,510 per ounce in gold and $33 per ounce for silver). In the meantime, copper has completed a bearish Gartley pattern in classical AB=CD fashion and should start to work its way lower.

Trade of the Week

During this past week we covered all of our short positions in the stocks we were short on (i.e. Intel and Wynn) as well as SDS which was being short the general market through a double-weighted ETF that we have held since May 3. We will look to re-enter these on any rally. There is one trade that looks particularly interesting at his point: ABX, the largest gold producer in the world. The stock has strong support at the 42.20 level which is the 0.618 retracement of the down move. I suggest risking no more than 1.50 per share in the stock while looking for a profit potential of around four dollars per share.

Technical Corner

This week we focus on failed patterns and there is no better or more timely example than the price chart for Research in Motion (RIMM). As you can see from the chart below, it made a perfect Gartley pattern and then within two days turned down. It has been in a freefall ever since. This is a perfect example of why strong money management principles must be applied by placing appropriate stops. Keep in mind that the executives at RIMM expected that things would improve a little. At least this is what they kept repeating up until this latest earnings announcement. Again, it is important to stress that patterns are based on probabilities and not certainties. You should strive to be right six or seven times out of 10. The money made on the trades that you win should exceed the amount of money that you lose on trades that fail.

Final Thoughts

In listening to just a small handful of the news coming out of the major financial capitals regarding the crisis in Europe reminds me of the Texas Hold’em poker tournaments which I love. The players are constantly bantering about how good they are, how unlucky they might be, and their superiority over other players. But the proof in the proverbial pudding are always on the table when the cards are laid out at the end of the hand. It is my (personal) opinion that we are going through a giant head fake in the world markets. While the recession and problems in Europe (Spain and Portugal are probably next in line after Greece) the real problem might be far to the east in Asia, especially China where speculation in real estate and commodities has been running amok for the past decade. Looking at the stock markets of these countries, there are certainly few bullish signs. In fact, they seem to have been in clear bearish trend since 2007. While I have little doubt that this will end badly, just as on other similar bubble situations, the trick is to navigate through the current market with enough capital intact to take advantage of the upcoming storm.

What Do We Know So Far – by Larry Pesavento?

Since the formation of the top in early May which coincided with the new moon, the markets have had their longest consecutive downward move since all the way back in 2006. The multiple major patterns that have now completed in the Dow Jones Industrials index, the Nasdaq, and the S&P 500 are highly indicative of bear market rallies as we have mentioned previously. In addition, the non-confirmation of new highs with new lows as well as the low volumes that have characterized this previous stretch should be worrying to any investor on the bullish side. On top of this, Asian markets have been in a clear downtrend, a situation that is particularly apparent in the Chinese and Hong Kong stock markets. Thus the ageold advice of “Sell in May and go away” certainly seems to be all the rage for this year. Even the new IPO market, which had previously shown some signs of life is now clearly signaling that the market does not intend to be as bullish as some would like it to be. This is particularly true for several Asian IPOs which are now significantly below their initial offering prices. Lastly, the VIX volatility index is also reflecting plenty of complacency among investors, suggesting that that most people are not acutely concerned about the downturn we have had since May 2.

This coming week, we will be coming into a full moon as well as a total lunar eclipse on June 15. As we have mentioned in previous letters, over the past four lunar cycles we have repeatedly made highs on new moons accompanied by a low on the following full moon. Since we are entering what would be the seventh week of a downtrend in the stock market, it is likely that we have in our hands the tail-end of an outlier event that is due for a rally.

We would expect any countertrend rally (probably 3-8 days in duration) most likely immediately following the low on the upcoming full moon on June 15. Make no mistake about this though: we are in the midst of a very bearish scenario. A quick glance at the Financial index including some of the world’s major banks will show that they violated the critical market lows set back on March 4 low. In other words, the market clearly wants to move lower.

Treasury Bonds

This entire asset class is turning out to be quite an enigma. Specifically, it amazes me that investors can still view Treasuries as a flight to quality, given their measly returns and not-so-absolute security. Nonetheless, this is what they perceive and their perceptions continue to drive prices in the market. We have now completed an AB=CD pattern in Treasury bonds. The ultrashort ETF for Treasury bonds (TBT) has pulled down to the 0.786 retracement while municipal bonds (MUB) and highgrade bonds have also put in what looks to be major tops. Thus, the most pertinent question for this sector is that if a so-called flight to quality materializes, how much would bonds rally? With a weak stock market, continuing uncertainty in Greece and the Eurozone, and the upcoming end of QE2, we should know more by next week’s letter.

Crude Oil

This past week showed that crude oil still has strong support at the $95 per barrel level. However, there is also potentially strong resistance at the 0.786 retracement at $102 per barrel. The 3% price drop on Friday may have been rather alarming to the bullish camp but the 95 level appears to be etched in stone in the crude market. As long as this holds, we could still see higher prices, although any penetration below this level would set up a much lower range.

Precious Metals

Gold rallied up to 0.786 retracement level at $1,553 per ounce but silver was unable to even take out its previous week’s high. A quick peek at the XAU gold/silver index suggests that the overall outlook for gold and gold mining stocks is not very good. This is reflected in particular in the chart for Barrick Gold (ABX), the largest gold producer in the world, which has a decidedly bearish pattern. Copper also completing a perfect bearish AB=CD pattern (i.e., Gartley sell pattern) at its current levels.

Foreign Currencies

The Euro has found strong resistance at the 1.49 level we mentioned previously and is now poised to break the 1.40 level. The British pound is also looking like it may roll over from 1.65-1.60 level that has represented strong resistance in past week. Meanwhile, the Japanese yen seems to be holding at its long term 0.618 retracement at 80 versus the U.S. dollar.

Trade of the Week

This week, we review some of our current positions from our recent trade recommendations:

• - Short MUB (ETF for municipal bonds), which is working.
• - Short WYNN at 146, which is currently giving us a 15 point profit.
• - Short INTC at 21.98, small profit.
• - Short GLD (ETF for gold) at 150.53.
• - Long SDS (short ETF for S&P 500), nice profit which we will be looking to
• liquidate on the full moon this week.
• - Finally, we are also long TBT (short ETF for Treasury bonds) at 34.14 with a
• stop at 31.99. This is our only losing position at the present time.

Technical Corner

In the Final Thoughts section below, we discuss how the lunar cycles correlated with the markets going all the way back since February 21. They have been making highs on new moons and lows on full moon, which is the exact opposite of what was published in a high-profile research report from the Royal Bank of Scotland several months back. I should stress that this does not mean they were wrong nor does it invalidate their findings. Rather, what we are seeing is simply an example of markets having inverted during this cycle. Thus, instead of buying on the new moon and selling on the full moon, the markets have been making highs on new moons and lows on the full moons. Keep in mind that these markets shift in and out of phase regularly (though their periodicity is still clearly intact in this example). More importantly, the fact that we are already on our fourth consecutive cycle suggests that something could happen soon, perhaps as early as this week given the astroharmonic events (i.e. full moon and eclipse) due in a few days. While I do not know precisely what will happen, past cycles suggest that these events have a high propensity to coincide with significant moves in the market.

Final Thoughts

From a cycle perspective, this coming week marks one of the most important weeks since the May 1 high. The reason to keep a careful eye on this particular cycle is that we have violated the lows from the March 14 super full moon. If you recall, this was an important cycle low – had the market indeed been bullish, it should have gone much higher. Instead, we have seen the Banking and Financial indices break down very badly since. In fact, only the natural resources sector and a few Dow stocks that have kept the market from melting down during this period. Thus, what happens during these next few weeks will probably determine what happens in the coming fall. I am already of the opinion that we will see a nasty break into the fall this year. Even though the VIX is not always a good leading indicator for market prices, it does do a good job of revealing the balance between fear and greed in investors. Despite what should be a dire situation, there appears to be no fear at this time. All of this makes me all the more skeptical about the strength of the market.

Perception – why markets move : By Larry Pesavento

ALL MARKETS MOVE BECAUSE PEOPLE PERCEIVE THAT PRICES ARE TOO LOW OR TOO HIGH

All of our frustrations come from unfulfilled expectations- in our last letter two weeks ago we focused on the negative technical structure in the stock market in the United States. New highs were seen less on the daily basis accompanied by declining volume. We had completed major bearish patterns in all the indices and finally we had seen the market rise into new moons and sell off into full moons. So why is this important? In the study done by the Royal Bank of Scotland (the 3rd largest bank in the world) it proved that buying on new moons and selling on full moons over a 90 year period since 1928 produced 12 times the return of a buy and hold program. What was not discussed is what happened when the market was bearish! If you sold on new moons in bear markets the return was even better, this is what is occurring now, in the last 4 lunar cycles the stock market has crested on the new moon and dropped into the full moon i.e. a bear market! The next full moon is not due until June 15th with a total lunar eclipse -there is also a p-index near that which will be covered as we get closer – as it stands now we should be lower in US stocks into mid June.

Precious Metals

Gold has reached the 786 level after the $120 correction of early May. Silver on the other side of the coin (pardon the pun) has had a meager 38.2% exactly, which is usually a sign of weakness. As silver was finishing the parabolic move into the near $50/oz level we began watching the drop in open interest (new entries into the market) at the same time the volume accelerated to record levels at the highs suggesting a “blow off ” high. This produced a 25% drop in less than 2 weeks. Gold was only able to drop a little in comparison. Silver and gold need more new players, and soon, to keep the bullish fires burning. There are certainly a lot of news stories to make these speculative favorites remain bullish for a long time to come.

Foreign Currencies

The strong correlation between stocks and the U.S. Dollar (weaker dollar weaker stock market) has disappeared at least for now. Why this has occurred is not important, but what is important is to look at each market separately. The U.S. Dollar stopped at the 786 level we discussed in our last letter. The level corresponded to the 1.4900 level in the GBP and the 80.00 level in the JPY. What is amazing is how the EURO can rally in face of the constant barrage of negative news reports coming on a daily basis from Europe. Someone must know something the rest of the world doesn’t. I am of the opinion the U.S. Dollar will hold support at the 72 to 73 level over the next several months, but longer term it does look to move lower over the next several years.

Crude Oil

Oil has tested the 618 level of $95/bbl four times over the past month. The inability to rally much could be the first sign of the 618 May fail. Strong bull markets come back quickly after corrections and crude oil is not acting in this manner, at least not now. Failure to hold the 618 level sets up a move to the 786 level which is back where the last up-leg began its move. On the upside $117/bbl is the 618 of the entire down move of the 4 year bull.

Treasury Bonds

Bonds have completed the AB=CD pattern mentioned in our last letter. This AB=CD pattern has taken 4 months to form and is suggestive of a very bearish market i.e. higher interest rates, lower bonds. The FED is currently in the last stages of the quantitative easing of the QE2 program. Much is being said about a potential QE3 program. It makes no sense to do something that has done little to help the economy (it did help stocks) but this is why people with “no skin in the game” make their decisions. In any event I don’t think QE3 (if it comes) will make any difference, interest rates still look higher.

Trade of the Week

Our trade this week will be to sell GLD, the ETF for gold, at 150.44, risk 3.00.

Technical Corner

Many subscribers ask how I decide if an astro date is working, failed or inverted. It is a tough question but I will attempt to answer it here. Astro dates are very precise and accurate. They differ from nominal or seasonal cycles because of the accuracy. When I first started using astro cycles it became important to see if they worked, defining how they work need to be addressed. They should show some time frame under which the market would react, as a rule of thumb I used 2 days on either side of the event i.e. a date of the 19th could move from the 17th to 21st. At first glance this might seem like a lot, but in reality when added with pattern recognition where price is included it narrows the time/price window to a very close set of parameters. As we come into the full moon and p-index date of mid June we will try to pinpoint the lowest risk entry to cover our short SDS, INTC, and WYNN short positions.

Final Thoughts

Sentiment is becoming more bearish as each day passes. It is happening on a global basis also. Commodity prices have stabilized in some areas but in others they are looking weaker. Dry Baltic rates are very weak showing demand for transportations. The Dow Jones Transports are weakening more than the major indices which should also be troublesome to the bullish camp. Next week’s letter will be longer and cover some longer term charts of economic significance.